International Reserves and Local Currency Internationalization : An Empirical Study on the Japanese Yen

This paper employs the GMM estimator to empirically investigate the effects of Japanese international reserves on Yen internationalization from 1976 through 2009 by specifying the regression benchmark based on the long-run determinants of Yen internationalization with economic power, Yen appreciation, financial market development, inflation and currency inertia. We find that the highly imbalanced structure of Japanese international reserves has significant but complicated effects on Yen internationalization. Of the effects, the extremely high ratio of foreign exchange reserve to international reserves has a significant but negative impact, and both gold reserve and the SDR holdings significantly contribute to the internationalization of the Yen although their ratios are extremely low. In addition, the size of international reserves in Japan has a significantly adverse effect on Yen internationalization. After controlling for the Yen's exchange rate volatility and the once-in-100-year international financial crisis, the conclusions still hold. Also, our empirical results are robust to an alternative measure of financial market development. This paper highly suggests that, considering the feature that local currency internationalization is a long-run process and the evidence that the extremely high ratio of foreign exchange reserve has a significantly negative effect on the process, in the international monetary system based on the credit-based sovereign currencies and dominated by the U.S. dollar, when a rising power with a highly imbalanced structure of international reserves implements a strategy of local currency internationalization, it should dramatically improve the structure of its international reserves by greatly increasing the shares of both gold reserve and the SDR holdings through strategically purchasing gold and actively pushing forward the reform of the existing international monetary system, and sharply reducing the share of foreign exchange reserve, rather than only focus on adjusting its foreign exchange reserve structure. This study provides an important strategic reference for the Chinese government to promote the process of RMB internationalization and walk the road toward a great power through financial development