editor's noteeditor's note
author:Zia Afzalauthor:
, compiled by: Yuan Huiteng
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1. Why do we need foreign exchange reserves?The currency strength of a country largely reflects its economic foundation and credit status, and the key role of the central bank is to protect the stability of its currency. due to mosthttps://baike.baidu.com/item/emerging markets/272881?fr=aladdinCountries are commodity exporters, and the dollar enjoys global reserve currency status, so many of these countries make payments in dollars (or other G7 currencies), and the central banks of these countries will hold dollars as their。
https://baike.baidu.com/item/foreign exchange reserves/702389?fr=aladdin
Foreign Exchange ReserveGroup of Seven (G7)https://baike.baidu.com/item/Group of Seven/4158135?fr=aladdin
The currencies of member countries are used for denomination. Therefore, whether an emerging market country can calmly face the risk of debt surge caused by rising interest rates, foreign exchange reserves are very important.https://baike.baidu.com/item/1997 Asian Financial Crisis/23187113?fr=aladdin&fromtitle=Asian Financial Crisis&fromid=803948
Asian Financial Crisis of 1997
The essence of the outbreak was that the economies of emerging market countries were relatively fragile at that time, and the situation of "spending more and earning less" often occurred, and foreign debts far exceeded foreign exchange reserves. After experiencing the currency crisis in the 1990s, emerging market countries formulated policies one after another, requiring them to hold more foreign exchange reserves than used for trading purposes, and this has also become one of their means of hedging protection. When there is a deficit in the international balance of payments, the use of foreign exchange reserves can promote the balance of international payments and ensure external payments.
Therefore, holding more foreign exchange reserves plays a certain role in protecting the exchange rate of their currencies in emerging market countries, enhancing their confidence in their currencies, and preventing speculative attacks and currency crises.
In general, the primary purpose of a country holding foreign exchange reserves is to balance the balance of payments and maintain exchange rate stability. Especially for emerging market countries whose local currency is not an international currency, the scale of foreign exchange reserves represents their ability to cope with external risk shocks and maintain their own economic development. The strength of financial stability. For example, during the Asian financial crisis in 1997, sufficient foreign exchange reserves played a vital role in stabilizing the value of the renminbi.
Since its primary function is to deal with emergencies in crises, this determines that foreign exchange reserves must have sufficient liquidity and a high degree of security so that the central bank can respond to balance of payments and currency crises that may occur at any time.
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2. Why does the central bank reserve gold?In addition, since the 2008 financial crisis, the United States has implementedhttps://baike.baidu.com/item/quantitative easing/9019987?fr=aladdin
Quantitative Easing (QE)Since 2011, the economies of major emerging market countries have declined significantly, and the growth rate of GDP has slowed down.https://baike.baidu.com/item/consumer price index/2161245?fr=aladdin
Consumer Price Index (CPI)
Stay high. The high inflation not only led to the overvaluation of the actual exchange rate of the country's currency, but also made the domestic people compete to increase their holdings of US dollars in order to avoid inflation, which further aggravated capital flight and triggered currency depreciation.As an independent resource, gold is not limited to any country or trade market, and has no ties to companies or governments. It is the only asset that does not need to rely on national credit or company promises to realize it. Like other market resources, the price of gold is determined by supply and demand. Gold provides central banks with a new tool for monetary policy operations. In other words, the central bank can adjust the composition and quantity of international reserves by buying and selling gold in the gold market, thereby controlling the money supply.
For central banks in emerging markets, gold is an inflation hedge as well as a risk-off hedge.
Therefore, during the period when the G7 implemented quantitative easing policies, emerging market countries generally used gold to hedge financial market risks. As a safe-haven investment, gold has high liquidity and diversified returns, and its function is somewhat similar to that of a reserve currency, making it a preferred hedging tool against the central bank's monetary policy.Cost-effectiveness。
Cost-effectiveness
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3. Gold reserves are not "sit back and relax"
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3.1 Establish value based on consensus
As early as 3000 BC, gold was recognized by humans for the first time in ancient Egypt, and it was considered as an item with the function of preserving and increasing value, with two attributes of currency and commodity. It realizes value expectations through a global consensus of opinion, which takes centuries to achieve. Until this consensus is established, gold itself has no value, it is just a shiny piece of rare metal.
After the value consensus was established, different social classes around the world flocked to gold. It has a close relationship with social evolution and social economy, and becomes the carrier of currency, a symbol of wealth and status.
Even when a gold deposit is discovered, its mining is expensive work. However, in terms of development costs, the current comprehensive cost of major gold mines in the world is about US$1,200 per ounce.
Due to its unique characteristics, difficulty of obtaining, and attractiveness, gold has thus become a valuable asset, serving as a store of value at a consensus price. Before the 1970s, the price of gold was basically determined by the governments or central banks of various countries, and the price of gold in the international gold market was relatively stable; in the early 1970s, the price of gold was no longer directly linked to the US dollar, and the price of gold gradually became market-oriented.
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3.2 How to get gold?positionposition
For emerging market central banks, the biggest problem is not choosing the right time to buy and sell gold, but building a gold position large enough to offset the risk of foreign exchange reserves may take decades. At the same time, when the buying country participates in gold trading, it must ensure that it holds sufficient foreign exchange reserves.
secondary titleGold itself does not need to pay relevant interest. In addition to mining costs, its comprehensive cost is also related to storage. In order to reduce storage costs and avoid the security risks brought about by the transportation of gold, many countries choose foreign financial institutions to reserve gold when necessary. For example, many countries in the United Stateshttps://baike.baidu.com/item/Federal Reserve Bank of New York/6712465?fr=aladdin
new york reserve bank
(FRBNY) stores gold, which is known as the largest gold storage place in the world, accounting for about 1/4 of the global gold reserves.
In general, with high production costs and scarce reserves, gold truly realizes "rare things are more expensive". Unlike some products that have depreciated due to the rapid increase in labor productivity, gold mining technology has hardly achieved any technological breakthroughs since ancient times. Therefore, its production cost and market price are relatively stable and will not fluctuate greatly over time. This means that when the domestic currency inflation is serious, although the legal currency depreciates, the price of gold will rise, that is, gold can offset the loss of inflation, ensuring that investors' assets will not be eroded by excessive inflation.
But since most of the world's gold is controlled by the Group of Seven countries, these countries also have a certain say in the direction of gold prices. Even if emerging markets try to use gold to diversify the risks posed by fiat currencies, they will only stop the boiling water after all, and can only eliminate a small part of the risks of the G7 central bank policies.
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4. Bitcoin: from obscurity to digital gold
Bitcoin is by far the first and purest form of digital currency. Currently, the annual supply of Bitcoin is less than 4% of the total supply, and this supply rate gradually decreases over time, and its supply is capped at 21 million coins.
With the blessing of encryption technology, the entire Bitcoin system has been precisely designed, so that it has many similarities with gold. As a product of the development of the Internet, there is no centralized management organization, and it does not need the support of the government's credit endorsement. Based on this, Bitcoin can avoid the potential risks brought about by the central bank policies of the Group of Seven countries.
Bitcoin mining requires a certain amount of energy, and its mining speed also follows the mathematical curve of a gold mine, and this asset can also be used for transaction settlement. Unlike gold, however, Bitcoin has a finite and known supply that can be mined anywhere in the world based on a consensus price.
In the digital age, it is no accident that Bitcoin, or digital gold, is considered by many to be the gold standard.
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4.1 Like gold, Bitcoin achieves value measurement through consensus
Like gold, Bitcoin establishes its value properties based on consensus. When the digital currency is linked to the real economy, based on the consensus of users, the digital currency can be converted into legal currency, virtual and real goods and services can be purchased, and digital currency can also be converted into legal currency. In an increasingly digitized global economy, users are building trust in this permissionless, censorship-resistant digital currency. Not just Bitcoin, but a general consensus has built up around this unique idea of decentralization over the course of a decade.
Bitcoin is similar to gold, but slightly different. The total amount of bitcoin is fixed and can be made into smaller units without losing its unit value; the support of underlying technologies such as blockchain makes bitcoin relatively stable and difficult to counterfeit. But compared with gold, its authenticity identification, division, carrying and storage are more convenient.
At present, the total market value of the global gold market is about 7.5 trillion US dollars, which is much higher than Bitcoin's current 13 billion US dollars. At the same time, as the price of gold rises, miners run into the market, and the supply of gold in the market increases, which puts downward pressure on the price of gold.
If Bitcoin is regarded as a currency, due to the scarcity of supply (determined by the principle of mining algorithm) and the continuous slowdown of supply, the market value of Bitcoin will become higher and higher. Therefore, while the supply of gold continues to increase, the supply of Bitcoin decreases year by year. In theory, Bitcoin is a better hedge against negative financial market effects due to the absence of structural downward pressure on its price mechanism.
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5. How does the central bank use Bitcoin to hedge risks?
According to the International Monetary Fund (IMF), global debt hit a record high of US$164 trillion in 2016, more than twice the global GDP. Global private and public debt have soared over the past decade. High levels of debt make the government's financial system more vulnerable to sudden changes in market sentiment and limit its ability to provide financial and other supportive policies in a recession.
From generation to circulation, the supply and value measurement of bits is independent of the central bank. Therefore, in a financial crisis, Bitcoin will be a significant hedge against financial market risks. More importantly, Bitcoin, as a payment system, is independent of the traditional payment system linked to the financial market. It can be both a store of value and a complement to traditional payment rails.
As a hedging tool that emerged after the financial subprime mortgage crisis in 2008, it makes sense for central banks in developed and emerging markets to allocate part of their foreign exchange reserves to Bitcoin. As a brand-new digital asset class, Bitcoin not only exhibits the characteristics of hard assets, but also facilitates global trade.
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5.1 Emerging market central banks seem to be more compatible with Bitcoin
The Central Bank of Barbados recently released a working study focusing on the costs and potential benefits of holding Bitcoin in international reserve portfolios in fixed-exchange-rate economies. As a representative of smaller emerging market economies dependent on the G7, Barbados presents itself as a case study, with a focus on local tourism.The first set of simulations usescounterfactual metric
to simulate the historical performance of various G7 currencies as well as Bitcoin.
Figure 1. Using 0.01% GBP to forecast foreign exchange reserve reserves and coefficient of variation
It found that if the Central Bank of Barbados had held a small amount of bitcoin between 2009 and 2015, not only would the bank have been “substantially rewarded” from the continued rise in the price of bitcoin, but fluctuations in foreign exchange reserves “were no different than those caused by other major currencies.” Big difference."
image descriptionThe second set of simulations utilizeshttps://baike.baidu.com/item/Monte Carlo Simulation/5160083
, taking 2015-2025 as the experimental time period, to study the impact of random shocks on the Barbados international asset portfolio. "Monte Carlo simulations yielded similar results," the report states.
Admittedly, data simulations have been applied for some time in bitcoin price charts that are unlikely to be reused, but would opt for the more practical idea of a central bank holding a certain amount of bitcoin to hedge against systemic risk, which has proven to work of.
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6. How do emerging market governments view Bitcoin?
2018 was a pivotal year for Bitcoin. Hundreds of billions of dollars of capital funds poured in as global financial regulators gradually established their regulatory framework.
Previously, we have described how governments and central banks can use Bitcoin to achieve these goals. Regardless of factors such as cost, anyone anywhere in the world can participate in mining, and the cost is much lower than gold mining. This means that regardless of whether there are gold resources in its territory, in the bitcoin game, all countries in the world are on the same starting line.
Governments and central banks can reserve Bitcoin as part of their diversified investment portfolios in two ways.
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Currently, the most economical way for governments to accumulate Bitcoin is to develop policies, economic incentives, and regulatory frameworks to attract global miners. Among the economic incentives are electricity subsidies for licensed miners.
As we all know, gold miners need to obtain mining licenses from relevant agencies before mining, and the same is true for Bitcoin miners. After obtaining the relevant licenses, miners can use national resources (such as electricity) for mining under the premise of following the regulatory framework. Government agencies can tax bitcoin miners, which in turn earn bitcoins.
https://baike.baidu.com/item/structural economic benefits/12750042?fr=aladdin
structural economic benefits
6.2.1 There is no need for a large amount of foreign exchange reserve expenditure
Unlike gold, governments that aren't lucky enough to sit on huge foreign exchange reserves can stockpile bitcoin at below-market prices without committing large sums of money. Before the government buys gold in the international gold market, it needs a large amount of foreign exchange reserves; and the acquisition of Bitcoin does not require a large amount of foreign exchange reserve deposits.
6.2.2 Hedging the risk of export decline
Rapid declines in export volumes can deplete a country's foreign exchange reserves, and commodity-based exporters are particularly affected by lower prices or lower export volumes. For decades, emerging market countries have been attacked by market speculators and international companies who can control the prices of a market's main export commodities in the international market, and emerging market countries are in a passive position.
Governments that mine Bitcoin are able to obtain a steady stream of assets that not only hedge against shrinking foreign exchange reserves, but also provide an alternative payment rail to ease international trade. In fact, with the help of Bitcoin, emerging market countries can effectively get rid of foreign political and economic factors, and provide another payment channel when traditional payment channels are cut off during political crises.
6.2.3 Hedging against currency depreciation
In order to solve the domestic budget deficit problem, most emerging market countries began to purchase debt from the international market. Almost invariably, this debt is denominated in a G7 currency (usually dollars or euros), especially if the loan is managed by the International Monetary Fund (IMF) or the World Bank.
If the foreign exchange reserves of emerging market countries shrink, economic activity will fall into a downturn. The country's central bank has no choice but to repay its debts by printing more of its own currency, which has a devastating effect on the domestic economy, devaluing the currency and shrinking the value of the country's GDP.
The sudden drop in foreign exchange reserves can be hedged by the stable supply of bitcoins from the mines, and the government can sell bitcoins to protect its currency and achieve the purpose of repaying loans on time.
6.2.4 Eliminate dependence on the international gold market
Emerging market governments can no longer rely on the requirements of gold markets controlled by advanced economies by mining Bitcoin as digital gold that is not pegged to fiat currencies. Through the stable output of bitcoins from mines, emerging market countries can design a diversified investment portfolio without too much interference from external market forces.
6.2.5 Offset the impact of foreign central bank interest rate policies
Dong He, deputy director of the International Monetary Fund (IMF), once mentioned the term "dollarization," which refers to the process by which foreign currencies replace domestic currencies in developing countries. This happens when emerging market countries run into debt crises, or when commodity exports lead them to have foreign exchange reserves that exceed their ability to effectively hedge. When this happens, central bank policy is disconnected from the real economy of the country, which is more vulnerable to foreign central bank policies and interest rates.
The continuous supply of Bitcoin can hedge the domestic central bank's dependence on the foreign exchange reserves of any trading partner, help the country repay its debts, and finally solve the debt problem denominated in foreign central bank currencies and dependent on foreign central bank interest rates.
6.2.6 Provide subsidies for energy infrastructure construction
6.2.7 Develop surplus power resources
Due to geographical conditions and other factors, surplus power resources cannot be transmitted to the national grid. For example, if the country has abundant hydroelectric potential in remote areas, or if large quantities of lignite unsuitable for transport are identified. In this case, the construction of power plants and bitcoin mines adopts the principle of "living by water" and other nearby principles, and mines with the help of abundant power resources.
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7. Conclusion
In general, emerging economies are more vulnerable to systemic financial risks that typically originate in advanced economies. These countries became more overleveraged and pursued various financial measures to monetize the debt. For emerging economies, it is crucial to seek a more diversified investment portfolio and avoid the risks of G7 central bank policies.
Traditionally, hard assets such as gold have provided emerging markets with a hedge against financial risk. In an era of widespread currency debasement and rising sovereign debt, Bitcoin offers an alternative store of value and payment system. Whether it is self-mining or taxing miners, the government can reserve Bitcoin through various channels to create a benign network effect.
On the other hand, the use of independent and safe Bitcoin as a hedging tool for foreign exchange reserves in emerging markets can strengthen the economies of various countries below the risk and malicious manipulation of global financial markets, and reduce dependence on foreign aid and exposure to foreign government monetary policies. mouth.
