The accumulation of reserves over the past 10 years or so has been truly mindboggling. In 1990, global foreign exchange reserves amounted to US$800 billion, with mature markets accounting for 80% of the total. By 2000, reserves had roughly doubled, with mature economies accounting for more than half.
However, by September 2011, global foreign exchange reserves had increased more than 10-fold, reaching US$9 trillion. Emerging markets accounted for 68% of this amount.
Asia leading the charge
Most of the astonishing build-up in reserves has been due to Asia. The region’s reserves increased from US$800 billion in 2000 to about US$6 trillion in late 2011. Asia as a whole accounted for about 65% of global reserves at this point, with Emerging Asia (excluding Japan, Australia, and New Zealand) accounting for 51%.
Asia is followed by Europe and the Middle East/North Africa region (Mena), each accounting for about 12% of global reserves, while the Western Hemisphere and Sub-Saharan Africa make up 8% and 3%, respectively.
Reserve accumulation was the result of an informal monetary system that benefited all parties until the global financial crisis broke in mid-2007. Under this system, the United States, by running large current-account deficits, became a source of export-led growth for emerging markets.
The central banks of emerging-market countries managed their exchange rates against the dollar by siphoning off the export proceeds and investing them in US Treasuries. This helped fund the current-account deficit and, by keeping long-term interest rates low, ensured that US demand remained buoyant.
Growing financial integration of emerging markets with the rest of the world is another factor that explains reserve accumulation – particularly for Asia after its painful experience with capital flow reversals in the late 1990s. It is no coincidence that Asian reserve accumulation took off in earnest immediately after the Asian crisis.
Drivers of accumulation
Will reserve accumulation continue? Our contention is that Asian central banks will continue to accumulate reserves even though the pace may be less torrid than in the past.
The foremost reason is that global imbalances remain significant. As we argue below, Asian currencies remain considerably undervalued, as evidenced by large current-account surpluses that are hard to reconcile with fundamentals.
It is likely that Asian authorities will allow currencies to appreciate, but only gradually to allow the export sector to adjust and maintain full employment. This leaning against the wind will result in further reserve accumulation.
The erosion of global imbalances could be a drawn-out process. In fact, the International Monetary Fund (IMF) projects a modest re-widening of imbalances over the next five years.
This re-widening presumably reflects expansionary policies in the West and a continued pursuit of export-led growth strategies in the East.
Since 2006 the central banks behind the three major reserve currencies printed money to the tune of US$3.5 trillion. Much of this washed up on Eastern shores, where it was mopped up by Asian central banks and showed up as reserves.