The size and the growth rates of foreign currency reserves for Japan and Switzerland are distinctly greater. Between 2000 and 2012, Japan’s foreign exchange reserves increased more than 250 percent, to $1.2 trillion; Switzerland’s rose to $460 billion, with the sharp expansion in holdings taking place largely since 2008.While the accumulation of foreign exchange reserves in the other industrialized countries under discussion is traceable to valuation and growth effects on pre-existing portfolios, the accumulation of reserves in Japan and Switzerland is tied to the exchange rate objectives that the two countries have actively pursued through purchases of foreign currency and sales of domestic currency in foreign exchange markets.
Foreign exchange reserves have only rarely been used for intervention purposes by Canada, the United Kingdom, the euro area, and the United States in the past two decades (see the appendix table). Instead, exchange rates have been allowed to fluctuate in line with the excess demand for, or supply of, these countries’ currencies.A recent exception occurred on March 18, 2011, when these countries intervened collaboratively to weaken the yen in the aftermath of Japan’s earthquake and tsunami. This action, conducted jointly with Japan, was designed to counter excessive volatility and disorderly movements in the value of the yen. Prior to this action, these four countries had not intervened in foreign exchange markets since the coordinated effort to support the euro in 2000. This rare use of the intervention tool in recent decades explains why the growth of reserve balances in these countries stems mainly from valuation changes in portfolio assets and the returns on these investments.
Japan and Switzerland, by contrast, have been much more active in using their foreign exchange reserves to influence the values of their currencies. For Japan, this type of intervention prevailed in periods from the 1970s through the 1990s when pressure for substantial appreciation of the yen met with concomitant concerns in Japan that such currency movements would hurt the competitiveness of the country’s exports in world markets.As a result of Japan’s efforts to resist further appreciation in the mid-1990s, reserves grew significantly between 1990 and 2000. Then, from 2000 through 2004, Japan’s Ministry of Finance regularly conducted foreign exchange interventions. These interventions eventually tapered off, but were revived in September 2010. Japan attempted to further weaken the yen with unilateral interventions in August 2011 and between October and November 2011.
Swiss activity in foreign exchange market intervention essentially began in March 2009 when the Swiss National Bank (SNB) began a year-long series of interventions aimed at resisting further appreciation of the Swiss franc. Then, in September 2011, the SNB committed to keeping the euro-franc exchange rate above a minimum level of 1.20 Swiss francs per euro regardless of the corresponding build-up in foreign currency reserves. The foreign exchange reserve accumulation continued as investors sold euros for Swiss francs and these euro assets were added to the balance sheets of the Swiss official sector. The foreign exchange reserve accumulation was not itself the goal of policy, but instead was a by-product of the exchange rate and monetary policy objectives set in place and of the safe-haven flows out of euros.
Official Statements on Holding Reserve Balances
The size and composition of the sample countries’ reserve balances can be considered in relation to the countries’ official statements of their objectives in holding foreign currency reserves. These statements, presented in Table 1, generally characterize holdings of foreign currency reserves as a means of protecting the value of a country’s currency and managing excess foreign exchange market volatility. In addition, specific language in some statements covers additional objectives, including retaining liquidity for foreign exchange policy operations.
While evaluating reserve balances against countries’ reported objectives makes sense in principle, it is difficult to assess how the scale of the reserve balances held by the United States, the euro area, the United Kingdom, and Canada matches the official objectives. Is a balance of $50 billion or $100 billion large or small in the context of these objectives? As we observed earlier, these balances are not large relative to foreign exchange market turnover. Still, they are likely large enough to deal with short-term volatility in exchange rates and to signal a central bank’s intentions about policy and commitments to policy goals. To be sure, a signal may be viewed as more credible if reserve balances are larger and more visible. But it is also possible that these balances are larger than they need be for the objectives of policy. In the case of Japan and Switzerland, it is even more likely that balances have grown beyond the desired size as reserve portfolios have expanded to many times their historical levels and now significantly exceed the balances of the other industrialized countries.
Currency Composition, Approved Assets, and Opportunity Costs
The composition of reserve holdings has also evolved over the past decade. To be sure, the majority of industrialized country reserves continue to be invested in U.S. dollars, euros, and Japanese yen. (Of the six countries in our sample, only Switzerland chooses to hold other foreign currency assets, with the portfolio potentially including British pounds, Canadian dollars, and Danish kroner.) However, the share of dollar assets held by the major central banks (with the exception of the Bank of Canada) has declined.Although neither the euro nor the yen has supplanted the dollar as the dominant reserve currency, the shares of euro and yen assets in central bank portfolios have grown as the dollar asset share has fallen. For Switzerland, the growth of euros in the reserve portfolio in recent years is at least partially the result of the central bank’s interventions (discussed above) to keep the euro–Swiss franc exchange rate above a minimum level.
Japan and the United States can invest their reserves in a relatively narrow group of assets, while other countries—Canada, the euro area, and Switzerland—have actively introduced broader investment opportunities for their portfolios.
The foreign exchange reserve managers in each country follow a range of approaches to establish the currency composition of the overall portfolio.At one end of the spectrum, the Bank of England has a publicly stated target allocation of 40 percent dollars, 40 percent euros, and 20 percent yen.At the Bank of Canada, the currency composition of the reserve assets is specified within the country’s asset-liability management framework, which dictates that the composition of its foreign currency reserves must match the government’s foreign currency–denominated liabilities. Japan, Switzerland, and the euro area do not disclose whether or not they have target currency allocations. The United States does not actively manage the currency composition of its reserves, but instead leaves reserves in the currency in which they were initially obtained.
We’ve seen that all countries limit the assets in which foreign exchange reserves can be held. These restrictions are rooted in the shared goal of having highly liquid positions. The countries reviewed in this article can invest their foreign currency reserves in government bonds and supranational bonds [U.S. reserves must be held in assets that are “obligations of, or fully guaranteed as to principal and interest by, a foreign government or agency thereof ” (Federal Reserve Act, sec. 14).] such as those issued by the International Monetary Fund, the World Bank, or regional multilateral development banks. Japan and the United States can invest their reserves in a relatively narrow group of assets, while other countries—Canada, the euro area, and Switzerland—have actively introduced broader investment opportunities for their portfolios. Two major developments in asset composition in the last decade have been increased diversification of allowable asset classes and the expanded use of derivatives to manage reserve portfolios more actively.