The Basics of Reciprocal Currency
What is a Reciprocal Currency? It is a currency pair between two countries, with one of them acting as the base currency and the other as a reference currency. The reciprocal currency is quoted in dollars per unit of its base and quote currency. The exchange rates between the two currencies are determined by several factors, such as the country’s interest rates, inflation, and balance of payments. Before the crisis, such agreements were not common.
In response to these events, the US Federal Reserve and Bank of Korea have agreed to establish a US$30 billion temporary reciprocal currency arrangement. Canada’s move is part of an effort to widen the range of available US dollars worldwide. The US Federal Reserve announced plans to establish $20 billion and $10 billion reciprocal currency swap lines with the European Central Bank and the Swiss National Bank. In addition, the ECB and SNB have agreed to set up a $50 billion and $10.5 billion bilateral monetary scheme.
While the Federal Reserve and other central banks around the world have worked to provide global monetary stability, this rarely-used tool has also proven useful. The paper below describes the basic idea of a Reciprocal Currency and its use in the foreign exchange market. This type of arrangement is used in trade with smaller countries in developing countries. Unlike a conventional exchange rate, it is the cheapest way to trade internationally. But it does come with risks.