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 »

China has accumulated a massive stock of U.S. dollar reserves in recent years. Statements of concern from China regarding the risk that U.S. economic policy might undermine the future purchasing power of these assets has fuelled the market’s concern that China may shift away from dollar purchases. Yet the chart shows that over the 12 months ending in July 2009 China accumulated more dollar-denominated assets, mainly U.S. Treasuries, than foreign assets in total. Despite its rhetoric, China has thus far taken no actions to wean itself off of the dollar. Read more »

China has long pegged its currency to the Dollar.  After the USD started to depreciate against many currencies in 2002, expectations emerged that China would move away from a tight dollar peg.  Following China’s reforms in 2005, the Yuan appreciated by over 20% against the dollar.  However, since July 2008, the Yuan has been stable against the dollar, leading to expectations, illustrated by the forward price, that China’s repeg will persist. Read more »

China’s total foreign assets, including its dollar assets, have grown substantially. China is worried about the risks associated with holding large amounts of dollar assets, as evidenced by its call for a new global reserve currency. Is it appropriate for so much of a poor country’s national wealth to be invested in a rich country’s low yielding assets? And what risks does the U.S. run by relying heavily on a single country’s government for financing? Read more »

Global imbalances have raised fears of a dollar crisis. But rather than collapsing, the dollar has grown stronger over the last year. What explains this safe-haven status of the dollar, and can it last? The chart above shows the value of the dollar over the last 35 years, highlighting recessions and significant geopolitical events. 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 »