Because reserve currencies are held by foreign central banks they do leave the home country, in contrast to non-reserve currencies where there is no net outflow or inflow from or to the home country as discussed above. The balance of payment accounts for reserve countries therefore have an entry in the financial account called 'Reserves held abroad' or something similar - being the quantity of home country reserves held outside the country.
Following the 1973 Bretton Woods breakdown and in response to growing faith in neoliberalism countries began to remove capital controls - restrictions on the movement of money between countries for other than trading purposes - in the belief that capital allocation should be subject to unfettered market forces just like everything else. The US, Canada, Germany and Switzerland removed controls between 1973 and 1974, and the UK followed in 1979. Most other developed and emerging countries followed, mainly in the 1980s and early 1990s.[280]
Throughout all these major international changes the US dollar retained its position as the favoured reserve currency. Note that there is no international agreement as to which currencies should take the role of reserves; it is up to individual countries to decide for themselves. However when a particular currency finds favour as a reserve it is used more widely, and that strengthens its reserve position, so it grows in favour. The US dollar has taken this role ever since the Second World War and its position is both reinforced by and reinforces the pricing of many raw materials in dollars. Also as mentioned earlier many foreign exchange transactions use dollars as an intermediate step, because all freely floating currencies are tradable against the dollar whereas they aren't all directly tradable against each other.
Why do countries keep reserves in foreign currencies? It is to safeguard their own currencies. It suits a country to have an exchange rate that enables it to export and import wealth at prices that don't threaten to disrupt its economy. If a country's currency becomes too weak (drops in value against other currencies) then imports become expensive, causing knock-on price increases for all associated goods and services in the case of essential imports such as oil. For countries that depend heavily on imports this can have a destabilising effect as more of the country's spending flows abroad to pay for them so there is less to sustain the domestic economy. Conversely exports are cheaper so export industries are stimulated, as are domestic producers for products that can be made at home because they are now more competitive against equivalent imported products. Much more dangerous however is when a currency becomes very weak and domestic and foreign investors take fright and sell off their investments in order to get as much of their money out of the country's currency before its economy collapses completely. This of course makes the situation very much worse as others see what is happening and do the same. Having plenty of foreign exchange reserves, especially US dollars, allows countries to buy their own currency to maintain demand and hence provide support when external conditions threaten to depress it. Those countries that suffered most in the East Asian crisis during the 1990s (see chapter 73) in particular keep large stocks of reserves to protect themselves from currency attacks.
Rather than keep reserves as currency countries prefer to invest them, but opportunities for investment are limited for countries in danger of currency attacks, because they must be able to liquidate - sell quickly without significant loss - their investments at short notice. Therefore short-dated government bonds are the preferred option, but they pay very little in interest because they carry minimal risk, and often pay less than the prevailing rate of inflation, in which case the reserves lose value over time, as do the debts of the reserve home country.
If a country's currency becomes too strong (too high in value against other currencies) then its exports become expensive to foreign buyers so they decline. Conversely imports increase because they are cheaper than equivalent domestic products. Export industries suffer so foreign earnings fall, and domestic producers also suffer because of increased competition from cheaper imports. If this goes on too long then the economy can stagnate as workers are laid off. If this threatens to occur the country sells its own currency in order to reduce demand for it, which builds up foreign reserves as it exchanges its own currency for them.
In order to avoid the dangers associated with floating currencies China doesn't trade its currency on the open market and therefore the renminbi isn't exposed to high demand from outside China. Instead it keeps its currency at a value below the market rate and its exports cheaper than they would be if its currency floated. As a result it keeps its export industry strong by amassing great quantities of reserves, particularly US dollars, the full value of which aren't passed on to Chinese workers. Instead the reserves flow back to the US from China in return for US government bonds, and are recycled in the US economy, often by buying yet more Chinese imports. In effect Chinese workers work for the US at poor rates of pay, but the Chinese economy enjoys enormous growth fuelled by their work and that is what the Chinese authorities want. The way it works is that the Chinese state limits the return on its population's savings, of which there are plenty because there isn't a welfare state to speak of so people save for their own security. It recycles the savings to industry, which borrows at cheap rates and is strongly encouraged to invest in wealth creation, so the rate of wealth creation increases year by year. At the same time there is high employment so enough is returned to the workers to keep them fed, clothed, housed and in good health, and the surplus wealth they create is sold to the US for dollars.
However the situation is very dangerous both for the US and for China. They have become mutually dependent - China produces and sends wealth to the US in return for contracts that promise an entitlement to US wealth in the future, and the US promises more and more of its future wealth to China. The danger for China is that its high employment rate is dependent on export earnings, there isn't enough internal demand to keep everyone employed, so without earnings from abroad there would be widespread unemployment and the economy would collapse. Therefore if US demand for imports falls for any reason (as it did after the 2008 crash) then its export industries can't sell their output and lose their income, severely damaging China's economy. China is well aware of the dangers and since 2005 has been taking steps to rebalance its economy by allowing the renminbi to appreciate against the dollar.[281] However after the 2008 crash exports did indeed falter, so China embarked on a massive state funded (from people's savings) investment programme on infrastructure (roads, railways, airports, irrigation) and social welfare.[282] This provided a stopgap but the state became much more indebted to its people as a result, and therefore programmes like this aren't sustainable for the long term. The danger for the US is that sooner or later it will have promised more wealth entitlement than it is able to make good, and when investors begin to fear that this may be the case then they will offload the dollar and its value will fall, probably rapidly, damaging not only the US economy but the world economy as well - all countries depend on the soundness of the US dollar because so many commodities are priced in dollars.
The 2008 crash may yet turn out to have stopped the process; it has certainly brought about a significant unwinding of the mutual dependency, so far harming China's economy more than the US's, but the long-term fallout can't yet be judged. Hopefully it won't all start up again as the US economy continues to improve.