OFFICIAL RESERVES ACCOUNT
The official reserves account is the total currency and metallic reserves held by official monetary authorities within the country. These reserves are normally composed of the major currencies used in international trade and financial transactions (so-called hard currencies like the U.S. dollar, German mark, Japanese yen, British pound, Swiss France, French franc, and Canadian dollar) and gold.
The significance of official reserves depends generally on whether the country is operating under a fixed exchange rate regime or a floating exchange rate system. If a country's currency is fixed, this means that the government of the country officially declares that the currency is convertible into a fixed amount of some other currency. For example, for many years the South Korean won was fixed to the U.S dollar at 484 won equal to 1 U.S. dollar. If the exchange rate is fixed, the government accepts responsibility for maintaining this fixed rate (also called parity rate). If for some reason there is an excess of Korean won on the currency market, to prevent the value of the won from falling, the South Korean government must support the won. Supporting a currency is identical to supporting any price. To push a price up you must increase demand. Under these conditions, the South Korean government would go the currency markets and purchase its own currency until it eliminated the excess supply. But what does the South Korean government use to purchase South Korean won? It uses other major currencies like the dollar, the mark, the yen, or even gold. Therefore in order for a country with a fixed exchange rate to be able to support its own currency, the country needs to maintain substantial reserves of foreign currencies and gold, official reserves.
Many countries still use fixed exchange rate systems. For them it is still critically important to maintain official reserves in sufficient quantity to support their own currencies in case of need. However many of the major industrial countries, such as the United States and Japan, no longer operate under fixed exchange rates. For these countries, holdings of official reserves are not as critically important and have in fact declined substantially over the past two decades in proportion to the volume of international trade and investment.
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