Debt, Deregulation and Financial Crises
Chapter 13: Foreign exchange reserves
Official foreign exchange reserves are the keystone of the global monetary system. They are created when payments in a key currency are exchanged for local currency by individuals and companies with their country’s central bank. The central bank invests the funds in a key currency country’s debt securities to earn a return. Its reserve holdings create credit for the country in which they are invested and backing for credit generated by the central bank that owns them. Since the majority of foreign exchange reserves are denominated in dollars and constitute an enormous inflow of foreign savings, it would be remarkable if the US had not experienced a run of general prosperity beginning in the 1990s. But the mirror image of the build-up in official and private foreign debt was the immense increase in US private sector indebtedness that set the stage for the crisis.
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