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 U.S. Treasuries. For ease of transaction, the such reserves are often kept at the Federal Reserve itself, which offers some custodial services.
This Great Graphic, 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 bln to $2.921 trillion.
Some central bank will 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 bln since peak in late-May. This suggests that the decline in Treasury holdings may have been partly a function of an 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 bln 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. Some countries, obviously, 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 in that three month period of May-July.
Emerging markets experienced strong capital inflows and during this period about 15 countries or so amassed substantial holdings of foreign currencies. In a similar way countries can warehouse grains, for example, they have done with money. The flexibility of reserve holdings an 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 and 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 and 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.