FX Reserves Fly Through Previous Cycle Peak

FX Reserves Fly Through Previous Cycle Peak

Click here for the full Note and disclosures.

• EM FX reserves rose at a $100billion/month pace from the end of 1Q09 through year-end

• The rise has broadened across the EM with all major regions seeing roughly the same percent increase

• Huge appetite for USD assets remains; share rises relative to EUR assets in 4Q09

The massive accumulation of official foreign exchange (FX) reserves over the past decade played an important role in the global financial crisis.1 The benefits of a war chest to fend off speculative currency attacks and the damaging effects of sudden stops to capital flows were made all too clear after the 1998 Asian crisis. These benefits were on display during the past few years, a fact often cited by many emerging country policymakers. However, the active management of currencies that funneled trillions of dollars back into USD assets also came with the cost of distorting the perceived risk-return trade-off, thereby providing the fuel for the greatest financial meltdown in history.

Compared to the benefits of self-insurance to each country, the global costs of rising FX reserves are an externality that must ultimately be addressed at a supranational level. The IMF’s recently introduced Flexible Credit Line, which comes with little conditionality and presumably less stigma, is a step in the right direction. For the time being, however, the rapid rise in FX reserves that existed prior to the crisis has returned. Since troughing in 1Q09, official holdings (excluding gold) have ramped up by over $100 billion per month through the end of 4Q09. In terms of composition, USD assets gained ground against EUR-denominated assets in 4Q09 and still make up more than 60% of total reserves. (See attached file for full note)

http://img.scoop.co.nz/media/pdfs/1004/JPM__FX_reserves_fly_through_previous_cycle_peak_20100409_396057.pdf

ENDS

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