What is the minimum level of reserve
currency that should support the currency of countries?
Index
1. Why did I write this work?
2. What is the implicit exchange rate?
3. A different formula
4. The same mathematical probability applied
to deposit/reserve requirements can be applied to money supply/reserve currency
relationship
5. What is the percentage of money supply
that should be guaranteed by reserve currency?
6. The financial disasters
7. Conclusion
1. Why
did I write this work?
Wrote this work because I have seen how in
some countries, as Venezuela, has been applied the concept of implicit exchange
rate of currency, which has been used as an argument to justify a huge
devaluation in that country.
2.
What is the implicit exchange rate?
Economists use the concept of implicit
exchange rate to determine the relation between the national currencies of
countries and the dollar exchange rate. The implicit exchange rate is
calculated by dividing the money supply M2 on reserve currency.
Ideally, according to economists, is that
the implicit exchange rate matches the real or official rate of exchange so as
to ensure the conversion of money supply M2 to dollars when circumstances
require; in other words, that all money supply be supported by its equivalent
in dollars at the official exchange rate of each country.
3. A
different formula
But I think different. I believe it is not
necessary that all money supply of countries be backed by reserve currency, but
only a part of money supply; I will explain why:
a)
I think the operating system of
banking and insurance may be applied, by analogy, to the management system of currencies.
b)
The banking and insurance
operates based on the principle of mathematical probability; this principle
assumes that all bank customers do not withdraw all their money the same day
and all insured do not suffer from diseases or accidents on the same day. There
is a regular index of withdrawals from banks and a regular index of diseases
and claims of policyholders; those indexes usually represent a historical
constant. Those regular withdrawals and claims indexes are altered only in
extraordinary conditions such as bank failures or natural disasters.
c)
Well, something similar happens
in the administration of currencies of countries because there is a regular
rate of foreign exchange transactions; that index usually represents a
historical constant. From this fact we can infer that it is not necessary that
the entire money supply of a country be guaranteed by reserve currency, because
we can assume that all citizens will not go the same day to change their
domestic money for foreign currency.
4.
The same mathematical probability applied to the deposit/reserve requirements
relationship can be applied to money supply/reserve currency relationship
Applying the formula money supply M2/reserve
currency to determine the implicit exchange rate of currencies regarding the
dollar denies the principle of mathematical probability in which the banking
and insurance operation is based, as was explained, because it means to back
100% of money supply with reserve currency, which does not occurs with the
deposits of savers in banking. Governments do not consider it necessary to
require banks to keep a backup (reserve
requirements or reserve ratio) 1-1 by receiving deposits, but a percentage that
varies from country to country, depending on the state of the financial system
as a whole. For example, in the United States reserve requirements for deposits
over $ 89 million is 10% (January 2014), in Europe the European Central Bank
set a reserve of 9,948% for certain types of deposits (April 2014) and in
developing countries as Venezuela reserve requirements is 21.5% (July 2014).
(1)
I think the same principle of mathematical
probability applied to the relationship between deposits and reserve
requirements of banks can be applied to the relationship between money supply
and reserve currency to support the value of currency and its exchange rate.
5.
What is the percentage of money supply that should be guaranteed by reserve
currency?
The portion of money supply that must be
guaranteed by reserve currency should be determined by the historical evolution
of the foreign exchange operations of each country. For example, if the money
supply as a whole is the equivalent of 100 billion dollars, and historical
foreign exchange operations represent only the equivalent of 50 billion
dollars, is this later amount of money supply that must be supported by reserve
currency and not all money supply. The application of this concept would
facilitate the economic activities of countries because it changes the
traditional concept of implicit exchange rate by reducing the amount of money
supply that must be backed in reserve currency.
6.
Financial Disaster
Banks fail, but it is not usual, in the same
way that are not common aviation accidents, because air travel is relatively
safe.
The principles in
which the operation of the banking and insurance is based usually complies, but
when banks fail, governments generally take control and respond to savers. To
do this, there are public institutions in most countries whose main objective
is to guarantee deposits.
7.
Conclusion
Countries can support their national
currencies regarding dollar applying the same principle used in deposits/reserve
requirements of banks, because it is not necessary backup 1-1 national
currencies. Hence, the formula money supply M2/reserve
currency should not be the most appropriate to determine the implicit exchange
rate of currencies regarding the dollar.
We must say, in conclusion, that only a
percentage of the money supply of nations, the corresponding to the historical
behavior of its foreign exchange operations is the one that must be backed by
reserve currency. From this we can infer that this amount represents the
minimum level of reserve currency to support the currency of nations.
Obviously, nations may have higher reserves than this minimum amount and higher
reserves means higher strength of the economy.
An exception to these assumptions is the
countries that use the dollar as its legal tender, as Ecuador, or those
countries that keep their national currency in par relation, 1-1 regarding the
dollar of the United States of America. The other exceptions are the countries
that have higher rates than the dollar of the United States of America, such as
the UK and the European Union change.
(1)
Sources:
Federal Reserve
Bulletin 2014, Volume 100
European Central Bank
Banco Central de
Venezuela
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