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Foreign Exchange

The market is missing a point about currency reserves

While there is no doubt that a diversification of global currency reserves or the introduction of an alternative reserve currency would be momentous, they are far from being immediate risks. In our view the market is focusing on the wrong issue. By Ian Stannard, senior currency strategist, BNP Paribas.

The FX market has become obsessed with central bank currency reserves and the prospect of diversification away from the USD. This has been fuelled by the recent meetings of global policymakers under the G20/G8 framework and increasingly candid comments on the subject from the largest currency reserve managers, namely China and Russia. Various suggestions have been put forward for an alternative global reserve currency, including expanded special drawing rights to incorporate the yuan and rouble. However, most of the proposals fail to provide a realistic alternative global reserve currency, with convertibility and liquidity the main sticking points. Moreover, it could be argued that recent comments from reserve managers are designed to put pressure on the US to moderate its policy response for fear that the extent of quantitative easing and the expansion of the Fed’s balance sheet could erode the quality of US assets. It may not be a coincidence that the Fed stopped the expansion of its balance sheet following Secretary of State Hillary Clinton’s visit to China in February.

But the market’s fascination with the subject of central bank reserves is likely to remain undiminished – purely because of the sheer scale of the amounts involved.

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