Is FOREX Reserve a determinant of World Economic Power?

Gold is an important commodity since time immemorial, not just because it is a high value precious metal but also because it was used by countries across the world to maintain their currency value. The history-why gold was used for the economic backup- goes long back during 1944 when Bretton Woods Conference took place. The major decisions taken during the conference were the establishment of three major global institutions namely, International Bank for Reconstruction and Development (Currently World Bank), International Monetary Fund and International Trade Organization.

Source: Bloomberg

IBRD and IMF were established but the third one could not come into existence as there were lots of vested interests involved of the large economies of the globe, as they did not want to lose their supremacy making their markets open and accessible to all. Bretton Woods’s conference was the place which motivated the global economies in order to plan their monetary policy and maintain an exchange rate by tying their currency to the USD. And IMF always assisted the countries designing the best possible monetary policies and achieving the monetary strategies, thus trying to correct Imbalance of Payments. Gold was an important metal to every country as each country on the earth maintained the gold reserves to save their currency value. But in 1971, when US terminated the convertibility of the USD to gold, dollar became the command currency. This is explained by the Nixon shock, a major economic incident, and then came the period when countries started to maintain the dollar as the reserve currency. The use of gold as a reserve decreased also because of the threatening incidents of the Great Depression in 1920s.

But the economic clock has shifted and again the countries in the world, major economies including USA, China have started believing the power of gold and the gold reserves in their countries. Yet, economies find it easier to be measured in reference to the foreign reserves. A Forex reserve is the possession held by a central bank of a country, mostly in USD, to back their liabilities- issuance of local currency and bank reserves maintained by the government and the financial institutions with the central bank. Forex reserves are called Reserve Assets in the BOP under the head of Financial Accounts and are inevitable part of Investment Portfolio of a country.

In the current scenario, China has already exceeded Germany, as the largest exporter of the world and USD brought to China, being circulated in the country, increases the reserves. Now, two-thirds of China’s assets are dollar-dominated but the government is motivating companies to reserve foreign currency just making people anticipate that government reserves may fall but you can be stable enough.

But, China’s foreign currency reserves have rushed more than 700 percent and are capable to buy twice the quantity of every central bank’s official gold supply. Is it a sign of World Economic Power?


Note: This article was published in The Himalayan Times, Perspectives