Trading Forex – Impact of National Foreign Reserves

Historically, central banks of just about every country, used to hold gold as national reserves, or some kind of last resort source of funding. That also was a storage of country’s wealth. To some degree it’s still true, but is not practical on a large scale. The role of gold has declined since the gold standard was abandoned 30 some years ago by most economies.

These days a lot of countries, apart from smaller gold positions, also hold Foreign currencies as part of national reserves. This mainly applies to currencies used in international trade. Mainly USD, EUR, JPY and to a smaller degree GBP, CAD and AUD. Strategic commodities are usually priced in one of these currencies and they are also most accepted form of payments and conversions in international banking.

There are two groups of countries that accumulate a surplus of foreign currencies. China, Japan and India, manufacture and export more finished goods than they import.
Second group comprises of producers of raw commodities like oil and metals. Russia and Saudi Arabia are the most prominent beneficiaries of those.

How much money are we talking about? Publicly available figures vary widely and are not necessarily precise, but both Japan and China hold in the neighborhood of 1 Trillion dollars of foreign currencies, while India and Russia’s hold about 500 Billions each. Other countries have smaller amounts.

Historically most of reserves have been held in US Dollars, or more correctly, US bonds and notes denominated in USD. As the amounts involved grow, it is only natural that the central banks responsible for their management diversify the funds. Every now and then there are announcements coming from official sources that a respective country plans to move certain percentage of the money involved into another currency.

That diversification process is not done overnight, but rather over a course of weeks and months. Perhaps even years. It is not in the interest of anybody involved to create wild swings in exchange rate by sudden conversions of huge amounts of money from one currency into another. Nonetheless, these moves definitely have an impact on Forex market.

Almost certainly current EUR-USD bull market is aided by steady and systematic diversification of “Foreign reserves” by central banks. EUR has proven, so far, to be a viable alternative to USD as a holding instrument. That said, USD is still, and by far,
the most prominent currency in those holdings and is likely to remain a first choice for the foreseeable future.

Official policy announcements from various central banks absolutely demand attention. Buying power behind the staggering amounts involved can not be overstated. What is, however, largely overlooked, is the staying power of these markets participants. They are not interested in quick trades, but rather remaining in a position for a long time. Months and years.

There is a new twist to this orderly, and somewhat predictable, market participation. China has just launched a 200 Billion dollars “super Forex fund”. That is a large chunk of their reserves. This fund is supposed to be more actively managed than a traditional central bank’s holdings. The exact trading formula of this fund is has not been disclosed, so it remains to be seen just how active it is going to be.

Should this new fund set a precedent for more entities of this kind, “Foreign reserves” will become even more important part of news to follow. More money available for active trading means more volatility and more short term movements. For traders of all stripes that is not bad news- more opportunities ahead.