The fast growth of the foreign exchange reserves of the People’s Bank of China and Bank of Japan was a notable feature of the world economy from the turn of the century onwards. Yet, despite the phenomenal growth in the foreign reserves, mostly in the form of US dollars, of the world’s second and third-largest economies, internationalisation of their currencies – that is, the widespread use of the RMB and yen in international trade and financial transactions – has not grown accordingly. This presents a seeming paradox because the very existence of huge foreign exchange holdings implies these major East Asian economies have become more heavily engaged in international monetary and trade transactions.

A recent paper entitled, “Japan’s International Reserves and Internationalization of the Yen” Tony Makin co-authored with Chinese academics Zhiwen Zhang and Qinxian Bai published in Economic Modelling focuses specifically on the case of Japan and argues that foreign exchange market intervention by the Bank of Japan to prevent yen appreciation has reduced international confidence in the currency. In fact, the overall size of Japan’s foreign reserves has empirically been negatively related to yen internationalization. On the other hand, Japan’s minimal gold reserves and special drawing rights have historically had a positive effect on yen internationalisation.

The dominance of the US dollar over the yen, renminbi (and euro) may seem anomalous in light of domestic financial and monetary shocks the United States has experienced since the 2008–10 Wall Street banking crisis, the rise in US public debt to historically high levels, and the flooding of money markets with US dollars via the Federal Reserve’s quantitative easing program. However, this fundamentally reflects the underlying strength of United States public institutions, its still broad and deep financial markets, appropriately regulated, and its robust and transparent legal framework.

Article by Tony Makin, Director, APEC Study Centre, and Professor, Griffith Business School.