Many foreign central banks have intervened in the foreign exchange market to slow the decline of their currencies. The intervention requires the selling of reserves. The most liquid part of the reserves are often kept in US Treasuries. For ease of transaction, the reserves are often kept at the Federal Reserve itself, which offers some custodial services.
, composed on Bloomberg, depicts the Treasury holdings for foreign official accounts at the Federal Reserve. Since mid-June, the Treasury holdings have fallen by about $63 billion to $2.921 trillion.
Some central bank also hold Agency paper with the Federal Reserve as well. Overall, the holdings of marketable securities (includes Treasuries and Agencies) has fallen by about $48 billion since its peak in late May. This suggests that the decline in Treasury holdings may have been partly a function of allocation decisions.
Nevertheless, with many emerging market currencies having remained under pressure in recent days, it should not surprise investors if the Federal Reserve's weekly figures show another decline in its custody holdings.
The Financial Times
cites research pointing to a $81 billion decline in emerging market reserve holdings in the May to July period. The data indicates that this is roughly 2% of the developing countries currency reserves. Obviously, some countries have seen a larger decline in reserves. Indonesia, Turkey and the Ukraine have drawn down 13.6%, 12.7%, and 10% of their reserves, respectively, over the three-month period of May to July.
Emerging markets experienced strong capital inflows, and during this period, about 15 countries or so amassed substantial holdings of foreign currencies. In way similar to how countries can warehouse grains, for example, they have done with money. The flexibility of reserve holdings can act as a cushion to lower the amplitude of swings in capital flows.
Comparisons with earlier crises in emerging markets are compromised by two significant difference. First, reserve holdings remain substantial; this offers many officials a tool that they were denied previously. Second, many of the earlier emerging market crisis occurred amid a considerably more rigid exchange rate regime. The greater flexibility of the exchange rates also offers an additional partial cushion.
What some observers attribute to a currency war appears increasingly like the vagaries of the huge sums of short-term capital sloshing around the world. The only thing more challenging than the inflows are the outflows. This is one of the costs of integrating into the world economy. Countries are developing the institutional capacity to address those challenges. Businesses and investors are, too.
See more from Marc Chandler at his blog Marc to Market.
No positions in stocks mentioned.