Accumulating Foreign Currency Reserves

Macroeconomics

Currency reserves

Accumulating Foreign Currency Reserves
Using Reserves to Stabilize Currency
Speculative Attack on a Currency
Financial Crisis in Thailand Caused by Speculative Attack
Math Mechanics of Thai Banking Crisis

Accumulating Foreign Currency Reserves How and why a central bank would build foreign currency reserves

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Accumulating Foreign Currency Reserves

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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.
Every A, if you were to go into a foreing currency markets, you could get a B for it.
So there's this kind of this stable supplying demand between this two currencies.
Now let's say for whatever reason folks in A start to believe that country B is the hot place to invest.
They want to buy country B's real state, they want to invest in country B's stock market.
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. So you have this huge supply of A comming out to the foreign exchange markets
but you still have the same amount of B that wanna go the other way, maybe, you know,
these are maybe there to either invest in country A or maybe buy some of country's A exports,
or whatever it might be.
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.
There's more demand for B than there are for A.
It'll get more expensive in terms of A.
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.
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,
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.
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)
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.
But what's going to be the end product of that?
Well, you did succesfully keep your currency from appreciating relative to the A's
which, based on how this was all set up, that was your goal,
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.
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.
That central bank printed their own currency and went out to currency for and exchange markets
and bought other countries' currencies.
And there's multiple reasons for them doing it.
This might be one of them, or it might be to protect them in the case that
this whole dinamic reverses in the other direction,
specially if it reverses in a very dramatic way.

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