The UK’s currency crisis, with the pound falling to its lowest level against the US dollar this week, is compounded by the lack of options to resolve it.
In this situation, a common decision of central banks is to buy the national currency on the foreign exchange (FX) markets. Great Britain Do it in 1890, and Japan did it just last week. Becoming a buyer of your own money is a quick way to boost it, although the effect doesn’t last forever.
To buy your own currency, you need a wallet full of euros, dollars, renminbi, etc. A safe of gold is also useful – anything that looks like cash, as long as it’s not yours. Japan was able to step in to support the yen because it had $1.2 trillion in foreign exchange reserves in August. Switzerland, responsible for another of the world’s major currencies, also maintains close to a billions of dollars Reserve.
The UK’s foreign exchange reserve is relatively small
The UK reserve of gold and foreign exchange, on the other hand, is $80.7 billion, barely enough to have a lasting effect on the strength of the pound. “Building up foreign exchange reserves has simply not been a priority,” said economist Jens Nordvig. in a Twitter thread. The Bank of England, which controls the reserve, has let it fall for 12 consecutive months, according to the central bank data.
As a result, despite having the 5th largest economy in the world, the UK only has the 18th largest reserves of foreign currency and gold, according to the World Bank.
Falling confidence in UK fiscal policy doesn’t help
There is no hope of amassing enough foreign currency to deal with the current crisis, and many argue that a floating currency like the pound shouldn’t care either. The pound is known as the pound sterling because it was once minted from silver and also derived its value from the metal, but those days are long gone and the pound is now backed simply by faith in the UK. United.
But investors have clearly signaled a lack of faith in the government’s fiscal policy, which aims to catalyze the UK’s stagnant economy largely through tax cuts for the rich and relief for businesses, while borrowing at ever-higher rates to pay them.
“It makes me really sorry to say this, but I think the UK is behaving a bit like an emerging market, turning into a submerged market,” said former US Treasury Secretary Larry Summers. told Bloomberg.
In this context, with markets weighing their confidence even in the British government, the foreign exchange reserve is not limited to its ability to defend the pound. The UK’s ability to weather a full-fledged financial crisis, like several others it has faced before, is also in question. In 1976, the UK was forced to borrow $3.9 billion from the International Monetary Fund (IMF) to prevent the pound from falling further. Back then it was worth around $2, and now the pound is approaching $1.
The composition of the United Kingdom’s international reserve
So what’s in the UK’s meager currency reserve these days? Mainly dollars, euros and gold, in roughly equal parts, which together represent more than three quarters of the horde. Like other countries, the UK maintains “special drawing rights” at the IMF to withdraw major currencies and gold from an account.
In terms of the type of securities held by the UK, only around $15 billion is cold hard cash. Another $17 billion is in gold. Much of the reserve is held in sovereign bonds, like US Treasuries, which are considered as good as cash.
The Bank of England also maintains positions in money markets and repo markets, where cash can be safely parked. Most of the UK’s foreign liabilities, which reduce its net assets, come from transactions known as interest rate swaps, which protect the central bank from fluctuations in other countries’ borrowing rates.
With the pound historically weak and confidence in the UK economy faltering, the foreign exchange reserve will receive much more attention than usual for a developed economy. The Bank of England next update on the reserve is scheduled for early October.