US Dollar Decline Beginning to Affect Foreign Exchange Reserves

Japan and Taiwan have reported October data on reserves of foreign currencies. Although they were about 35% and 20%, respectively, above the year ago figure, the increases in foreign exchange reserves over year ago figures have been declining sharply. Part of the reason for the deceleration is the decline in the dollar. The attached chart shows the year over year increases in Japan's foreign exchange holdings along with the index of the trade weighted dollar.

The effect of the decline in the dollar on foreign reserve holdings is beginning to be a cause of concern not only for the foreign governments but also for the United States. The capital loss entailed in the decline in the value of their dollar holdings has tended to dampen the rate at which foreigners are adding to their holdings of US dollars. The decline in dollar purchases by foreign central banks, in turn, results in a reduced capital inflow into the U. S. a flow that has been an important offset to the growing current account deficit.

The problem is one essentially for Asia where the greatest accumulation of foreign currency reserves has occurred. At the end of last year, the foreign exchange reserves of Japan, China, Hong Kong, Taiwan, Korea, Indonesia, India, Malaysia, the Philippines, Singapore and Thailand amounted to $1.2 trillion compared with $223 billion held by the Euro Zone.

A recent article, Reserve Accumulation: Implications for Global Capital Flows and Financial Markets by Matthew Higgins and Thomas Klitgaard of the NY Fed deals with this subject in some detail.