Global Reserves Management

Foreign exchange reserves held by central banks rose to 6.4 trillion dollars in 2007 from 1.5 trillion a decade ago and are expected to rise further in the coming years. Sovereign wealth funds (SWF) manage assets in excess of 2.5 trillion dollars, and total reserves managed jointly by central banks and SWFs are forecasted to top 10 trillion dollars very soon. This chapter presents motives behind this reserves growth and proposes a concept of OCHAR — Opportunity Cost of Holding Ample Reserves — which is defined as a forgone GDP growth resulting from too conservative reserve management by central banks. We estimate OCHAR for a sample of 33 countries which accounted for 80% of total central bank reserves in 2007. We also argue, that unlike in the twentieth century, where central banks used to be very secretive institutions, twenty-first century central banking is characterized by widespread knowledge sharing and transparency. Therefore best practices, such as inflation targeting or efficient reserve management, spread out quickly and are adopted by an increasing number of central banks. Thus central banks collectively embarked on a reserves diversification journey, and it appears that we can speak of the global reserves management in the twenty-first century. At the end of the chapter we put forward several hypotheses of what could be the consequences of this diversification journey. It seems that relative prices of various assets will find new steady states, which may have little in common with relative valuations seen in the twentieth century.