Singapore, 5 Sep 2008.

Foreign reserves in various Asian countries are enormous, and they are getting bigger. What does this mean to the rest of the world and the global economic landscape as a whole?

Right after the Asian financial crisis, East and Southeast Asian governments held around a trillion US dollars. Just half a decade ago, this amounted to around $2 trillion in foreign reserves. By the end of 2008, that figure is forecast to be twice that.

What are these piles of cash for? They are meant to be padding against any other financial crises, or “external shocks”. But let’s face it: They also serve as backup in the event of domestic political instabilities that could result in currency devaluation.

Every nation in the region is following suit: Singapore, with a population of a mere 4 million, holds $177 billion; Hong Kong, with 7.5 millon is sitting on $160 billion. China has more than $1.8 trillion, with Japan at half that. These are sharp increase from the past, when countries would hang onto about enough to cover three months of foreign trade – not a year-and-a-half as in these countries.

Why are these countries hoarding the cash so aggressively? If enough nations do this, they can effectively form a combined power separating them from the US dollar, although this would hurt exports. When a country buys up its own currency in the forex markets, it raises its value. But according to the Asia Weekly, nobody is entirely sure why these countries are stacking up so much cash.

Japan has a trade surplus – as do China, Malaysia, Taiwan, Singapore, and Indonesia – and this contributes to its foreign exchange reserves. Japan simply has more money coming in that out, in trade. But Japan is holding enough reserves that it is keeping the yen from rising, resulting in low domestic interest rates. This encourages foreign investment.

Ultimately, it is difficult to say what the real reason for such tremendous reserves are. But if this trend increases too much, it will result in a bubble causing inflation and eventually a loss to the country’s currency.

Charles Cole, EconomyWatch.com