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Because foreign currency reserves are viewed as a form of insurance, the risks of excess reserves are often overlooked. Japan holds reserves equal to 20% of GDP, more than it could possibly need for insurance purposes. These holdings make up a foreign asset portfolio that is subject to exchange rate risk. However, this risk is hidden because Japan’s reserves are primarily held in U.S. dollars and their value is reported in U.S. dollars. So as the local and global purchasing power of the dollar falls there is no change in the reported value of the reserves. As shown in the chart, Japan’s reserves increased by over $100 billion since June 2007, but fell by nearly ¥20 trillion when measured in local currency terms – over 4% of GDP. The risk of large losses in national wealth is even greater for China, whose reserves make up 50% of GDP. This risk will become apparent as and when China allows the renminbi to appreciate, in line with market pressures. Read more »

The Association of Southeast Asian Nations (ASEAN) along with Japan, China, and South Korea says it will launch a $120bn reserve fund, increasing the foreign exchange reserves that the region can draw on in times of turmoil. Japan has offered an additional $60bn via a swap line. Can regional funds provide an Asian alternative to the IMF? Read more »

This chart compares the Treasury and Agency holdings of China and Japan. As the chart shows, the amount of debt that the U.S. owes to China has increased sharply this decade and the amount owed to Japan remains high. Will the United States’ continuing need for financing leave it in a weaker position relative to the major holders and purchasers of U.S. debt? Read more »

The G7 has expressed concern over the implications of excessive yen volatility for financial and economic stability, but fell short of promising coordinated action. The graph above illustrates the extreme nature of the yen’s rise. For example, the yen has appreciated 22% against the euro and 35% against the Aussie dollar in the last month alone. The G7 may have to intervene in foreign currency markets to restore stability. Read more »