Watch out for Osborne’s foreign currency plans

A few ears pricked up on budget day when George Osborne announced a surprising and potentially expensive plan to rebuild Britain’s foreign currency reserves.

There are two methods of executing this plan. The first is to print sterling to buy foreign currency. This could be regarded as quantitative easing (QE) by another method. Indeed, it might have been an effective way to execute QE in 2009, though it would probably have caused a riot in the Eurozone as other governments – ignorant of the fact that a fall in the exchange rate caused by loosening monetary policy brings no lasting effect – would have accused us of indulging in competitive devaluations.

The second method is that the Debt Management Office (DMO) or possibly the Bank of England (BoE) could issue bonds and use the funds raised to buy foreign exchange reserves for the government. This is expensive. The government pays interest on the bonds and earns no interest on the foreign exchange. It is possible that Osborne is intending that we buy foreign currency bonds rather than cash reserves. In that case, interest would be earned on those bonds but there would then be inter-governmental credit risk: today’s high quality asset is not necessarily tomorrow’s.

One gets the impression from the debt management reports that Osborne proposes the second route – however, it is possible that they were written before he decided to make the announcement.

Read the rest of the article on the City AM website.

" high quality asset is not necessarily tomorrow’s" Exactly he should not play speculator with the nations currency, he should buy commodities. The UK should of never sold half the country’s gold reserves. Brown was a that time spectatoring with the nations wealth and look where it got us, he sold it at the bottom of the market.
I'm confused by the above (anonymous) comment. If it makes no sense to hold foreign currency reserves, or indeed any other reserves, while the pound is free-floating, why does it then make sense to hold gold? As I understand it, there are just four statutory reasons for holding reserves: 1) for checking undue fluctuations in the exchange value of sterling; 2) for securing the conservation or disposition in the national interest of the means of making payments abroad; 3) for the purpose specified in Section 1(3) of the International Monetary Fund Act 1979 (payment of charges under Section 8 of Article V of the Articles of Agreement of the International Monetary Fund); 4) for carrying out any of the functions of the Government of the United Kingdom under those of the said Articles of Agreement which relate to SDRs. As Prof. Booth rightly points out, building reserves equates to speculating in the currency markets. Logically, this also holds for gold reserves. Therefore, one might argue that Brown was being LESS speculative by selling 55% of our gold. Indeed, given the very limited uses to which we can put the reserves, it behoves those who criticise the sale to tell us where they WOULD sell the gold. There seems little reason to simply sit on a hypothetical profit without specifying where you would take profit. Its is easy to criticise the manner in which the gold was sold, much harder to criticise the logic.

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