Did you hide all your $ and ¥ in the basement?

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How the Bank of Korea manages its Foreign Exchange Reserves

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The Foreign Exchange Reserves (FER) are a country’s assets of foreign exchange money that either the government or the central bank, the Bank of Korea in the case of Korea, keeps as a national emergency fund so that it can be transacted into cash during dire situations. For example, FER is used as a country’s source of money supply in solving problems caused by a lack of liquidity in the domestic foreign exchange markets. Additionally, it can be used as a stabilizing source of cash when there is a sudden drop in interest rate. In this sense, the FER is an important factor in determining a country’s the external credibility.

Then, who is responsible for operating the country’s FER? Through the foreign exchange transaction act, the Korean Ministry of Strategy and Finance possesses the final authority and responsibility for finding measures for market intervention and for stabilizing the foreign exchange markets in Korea. Meanwhile, the Bank of Korea closely works with the government to discuss and make decisions regarding the interest rate policy and market intervention. Hence, the actual intervention in the foreign exchange markets is conducted by the Bank of Korea. 

2The Bank of Korea manages the FER with both stability and liquidity as its goal by investing into financial goods with a high liquidity for transaction into cash. For instance, the Korean central bank is more likely to buy U.S. Treasury Bills rather than real estates from another country because government bonds of developed countries are much safer with relatively higher liquidity than real estates. 

Some people may think that the Bank of Korea stores all its foreign exchange cash in the basement storage, and preserves it as it were gold. Is this really the case? Actually, no. If a country holds cash, it loses money. Holding cash means giving up the interest rate of the cash when the country deposits this money. That is why people usually save or invest their money through financial intermediaries in order to further increase the original amount. In such a way, the Bank of Korea also invests FER in financial markets, especially in major developed countries so that it can make more money out of it. Therefore, it is wrong to assume that they pile up its foreign cash in the basement.

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Now, you can easily understand how the Korean central bank secures FER with the goal of stability and liquidity. Korea`s official foreign reserves as of the end of September 2009 amounted to 254.25 billion dollars, up $8.79 billion from a month ago, and the highest level since June last year.

(*) Reference: The Bank of Korea

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