According to the OECD, foreign exchange rate reserves are the stocks of foreign currency denominated assets plus gold, held by a central bank. More simply, they are the assets of the central bank held in currencies outside the home country currency.
A reserve currency, also called an anchor currency, is a currency that is held in significant quantities by numerous governments and central banks as part of their foreign exchange reserves. These currencies are used to transact global business, and are the pricing currency for global trade—particularly in commodities such as gold, and oil.
The primary reserve currency used worldwide is the US dollar, followed by the euro—the official currency of the eurozone, the British pound, the Japanese yen, and the Swiss franc.
Foreign exchange reserves data is released quarterly by the IMF in its Currency Composition of Official Foreign Exchange Reserves (COFER) statistics. COFER consist of a monetary authority’s claims on non-resident liquidity in the form of:
• foreign bank notes,- • bank deposits,
- • treasury bills,
- • short- and long-term government securities,
- • and other claims usable in the event of balance of payments needs.
The amount of foreign exchange reserves that a country can claim is used as an indicator of the ability to repay foreign debt, and is used in sovereign credit ratings. Reserves are also used for currency defence—to halt downward or upward pressure on a currency against a benchmark currency. Closely related to foreign reserves, and also affecting debt repayment capability and credit ratings, are holdings in sovereign wealth funds.
Rebuilding Reserves The top 11 countries—including China, Japan, Russia, Saudi Arabia, Taiwan, India, South Korea, Hong Kong, Brazil, Singapore, and Germany—hold about 60% of total world foreign currency reserves. Total foreign exchange holdings worldwide went from almost $2 trillion in 2000 to more than $8 trillion in the first quarter of 2010.
In 2000, reserves held by advanced economies almost doubled those reserves held by emerging and developing economies—at $1.2 trillion and $0.7 trillion, respectively. By the first quarter of 2010 these figures had reversed, with emerging and developing economies holding almost double those of advanced economies in the COFER database—at $5.5 trillion and $2.8 trillion, respectively. During the Great Recession of 2007-2009 global reserves dropped from a peak of almost $7.5 trillion in mid-2008 to just under $7 trillion by February 2009, primarily as countries tried to manage currency depreciation and used reserves to fund stimulus packages. By the end of the first quarter of 2009, foreign reserves had once again begun to rise—and that trend is still continuing in 2010.
The amount of reserves that a country should hold is not set in stone, although one common benchmark is holding enough to cover external debt for one year. According to a report by the US Treasury, foreign reserves held by China would be more than sufficient to cover the short-term debt of the 12 largest reserve-holding emerging market countries for the 12-month period used as a benchmark.
Quarterly Foreign Currency Reserves, major currencies, 2008-2010 (millions of $US)
Changing the Reserve Currency The dominance of the US dollar has long been a source of contention between the world’s largest economic players, in part because it allows the issuing country—namely the United States—to purchase commodities at a small discount as they do not have to incur the exchange rate charges, although this charge becomes minimal for major currencies. In addition, the issuing country has an advantage in terms of cost of borrowing as it means the market for that currency is generally stronger than for other currencies. Global economists and policymakers have long proposed that a currency other than the US dollar should be the main reserve currency for global business. Countries such as Russia and China, along with a number of central banks and economists have suggested the use of an independent currency to replace the dollar.
In March 2009, Zhou Xiaochuan, governor of the Central Bank of China, posted an open letter on the Central Bank’s website calling for a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”.
He advocated the use of a new currency based on the Special Drawing Rights of the IMF. Special Drawing Rights (SDRs) are international foreign exchange reserve assets, allocated by the IMF to nations, that represents a claim to foreign currencies.
Proponents of SDRs suggest tying them to a basket of currencies—including the US dollar, the euro, the yen and the pound--to create a new, independent currency. In late 2009 UNCTAD released a report supporting the SDR proposal, and calling for the creation of a new reserve currency based on the SDR to be managed by a newly-formed global reserve bank. Data is from the IMF Currency Composition of Official Foreign Exchange Reserves (COFER), June 30 2010. Click on the column heading to sort the table.
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