Reciprocal Currency Arrangement
Categories: Forex
See: Reciprocal Currency.
It’s true: central banks talk to each other sometimes. They even collude...setting prices, in a sense. Well, not prices, but exchange rates of their currencies.
This is called a reciprocal currency arrangement. Say the central bank of Japan and the central bank of Brazil agree to maintain a certain money supply of each other’s currency, at an agreed upon exchange rate. Japan’s central bank gives Brazil’s central bank some yen, and Brazil’s central bank gives Japan’s central bank some Brazilian real. How much of each they’re swapping is the agreed upon rate. The contract includes future delivery, when the transaction is essentially reversed.
Why? Reciprocal currency arrangements are usually temporary. They’re also called swap line or swap network, if you’ve heard of those. Just like overnight lending between banks, reciprocal currency arrangements usually serve a similar purpose. That is: balancing reserve requirements and liquidity. And trade. Musical chairs for currencies.
