Once upon a time, those tracking international reserves focused on simple measures of reserve adequacy—enough to cover, say, 3 months of imports or all of the external debt maturing over the next year. However, the relevance of such yardsticks evaporated as a number of countries accumulated reserves that far surpass such levels, partly in reaction to emerging market financial crises of the 1990s and early part of this decade. Brazil’s reserves now exceed $200 billion, while Russia’s are more than $400 billion—and even these numbers are dwarfed by China’s reserves, which top $2,000 billion.
Reserves are rising, driven by emerging markets and, increasingly, low-income countries
While very high reserves may give comfort in times of crisis, they are not without costs—for the holder of the reserves, and also for the stability of the international monetary system:
- Reserve accumulation, by resisting currency appreciation, stimulates export-oriented production at the expense of domestic-demand oriented growth. For the reserve accumulating country, this may lead to unbalanced economic growth. By investing in foreign reserves, countries invest abroad rather than in their own economies. Countries with large stockpiles of reserves may therefore miss out on high-return domestic investments, like education, health and infrastructure.
- In the global context, massive accumulation by key emerging markets of reserves mostly held as dollar assets supported a relatively strong U.S. dollar in spite of a growing current account deficit in the US. By thwarting exchange rate adjustment, this contributed to prolonged global economic imbalances.
- In the long run, it is difficult to both meet the liquidity needs of the global economy and maintain macroeconomic stability in the reserve issuing country, a problem known as the Triffin dilemma. In effect, to meet the world’s ever-increasing demand for international reserves, reserve issuing countries such as the United States need to run external deficits that eventually undermine confidence in their currencies.
Self-insurance is not the only driver of reserve accumulation (an export-oriented growth strategy might be another factor), but it is an important one, and it is worth considering ways of reducing the need for it:
- More predictable access to official financing when capital flows are disrupted would help. The IMF’s new crisis prevention tool, the Flexible Credit Line, aims to provide just that for countries with very strong policies. The early experience with this new tool is encouraging—countries that signed up for it saw a marked improvement in market perceptions.
- Increasing the amount of available official financing would also help. The G-20’s April 2009 commitment to triple the IMF’s resources is a necessary complement to the reforms to our lending practices. The decision to provide these additional funds, which will increase the IMF’s lending resources from $250 billion to $750 billion, is a major step in the right direction. However, even with this increase, the IMF’s balance sheet remains much smaller relative to the global economy and members’ own reserves than it was at the time of the Fund’s creation.
- Special Drawing Rights (SDRs), a reserve currency issued by the IMF to its member countries, can provide countries with greater access to liquidity, making them a potentially powerful crisis response tool. Of the $283 billion SDRs allocated in August and September, about $110 billion will go to emerging and developing countries, significantly improving their liquidity positions.
While lowering reserve accumulation in some countries would provide benefits to them and to the global monetary system, to do so too quickly could be disruptive for a still-fragile global economy. For now, many countries will want to keep the security that their reserves provide. It is therefore also important to consider how the appeal of alternative reserve assets can be improved, to make the system less dependent on the stability of one currency—the U.S. dollar.
To some extent, the increasing significance of the Euro, and possibly a number of other currencies, is a natural means of doing this. Other options theoretically available include creating an international currency—akin to Keynes’s “bancor”—or expanding the role of SDRs. To what extent they may represent realistic alternatives, however, is another question.