Accumulating foreign currency reserves

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Accumulating foreign currency reserves발음듣기

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Let's say we've got two countries: country A and country B And at the start of our little hypothetical thought experiment they have a very stable exchange rate, maybe it's one for one.발음듣기

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Every A, if you were to go into a foreign currency markets, you could get a B for it.발음듣기

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So there's this kind of this stable supplying demand between this two currencies.발음듣기

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Now let's say for whatever reason folks in A start to believe that country B is the hot place to invest.발음듣기

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They want to buy country B's real state, they want to invest in country B's stock market.발음듣기

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And so if they wanna buy stuff in B they essentially have to hold more B's currency and so more and more people in A want to exchange their "A's" for country B's currency.발음듣기

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So you have this huge supply of A coming out to the foreign exchange markets but you still have the same amount of B that wanna go the other way, maybe, you know,발음듣기

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these are maybe there to either invest in country A or maybe buy some of country's A exports, or whatever it might be.발음듣기

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But if we just let this happen on it's own when all of a sudden there's a much larger demand for converting A into B than converting B into A, you'll have a situation where the B will just get more expensive.발음듣기

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There's more demand for B than there are for A.발음듣기

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It'll get more expensive in terms of A.발음듣기

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So if you look at it from country A's point of view, you're now having to pay more A per B At a completely equivalent statement from country B's perspective you now have to pay fewer B's per A.발음듣기

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Now, let's say for whatever reason you are the central bank (right over here) of country B and you don't like your currency becoming stronger,발음듣기

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maybe you just don't like the volatility in the exchange market, you don't like the idea that the exchange rates go up and down so dramatically, maybe you just don't want your exports to get expensive or that imports from another country to get cheap.발음듣기

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For whatever reason you do not like this movement happening and so what you're going to do is, because you have the right to do it, because you are the central bank of your country, you can print more of your currency (right here the currency pies)발음듣기

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so you're gonna print more of these, you could print more of them just like that and then you could use that extra bit that you've just printed to buy more A's and so now you've kind of renormalized the supply and the demand for B.발음듣기

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But what's going to be the end product of that?발음듣기

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Well, you did successfully keep your currency from appreciating relative to the A's which, based on how this was all set up, that was your goal,발음듣기

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but the other thing that you ended up with is such a printed B's that you're able to buy A at the open market, you now, on your balance sheet, you have a bunch of A.발음듣기

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And so when people talk about foreign currency reserves and pretty much every bank, every central bank has foreign currency reserves, this is what they're talking about.발음듣기

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That central bank printed their own currency and went out to currency for and exchange markets and bought other countries' currencies.발음듣기

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And there's multiple reasons for them doing it.발음듣기

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This might be one of them, or it might be to protect them in the case that this whole dynamic reverses in the other direction, specially if it reverses in a very dramatic way.발음듣기

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