from Follow the Money

Record reserves, Record reserve growth, record reserve currency angst -

March 25, 2008

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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Over the past several weeks:

Thailand’s reserves topped $100b. Thailand, lest anyone forget, basically ran out of cash reserves back in 1997 (counting its forward commitments) - sending a clear signal to all emerging economies that they needed to hold far more reserves than had been the case previously.

Brazil’s reserves marched steadily closer to $200b. They are about a month away. And Brazil was under-reserved and close to default as recently as 2002.

India’s reserves topped $300b (counting gold).

Russia’s reserves topped $500b. Russia was out of cash in 1998.

As impressive as Russia’s $500b is - and on a per capita basis, it is huge - it is nothing compared to China’s reserve growth. China is on track to add well over $500b to its reserves in a single year. Right now China is adding about $50b to its reserves every month, or $600b a year.

January reserve growth was a bit higher than $50b, even after adjusting for valuation gains. February’s $57b in reported reserve growth falls to around $48b after accounting for (likely) valuation gains. But China’s trade surplus was also small in February - so $48b in reserve growth is still quite impressive.

Moreover, the $600b pace of growth likely understates the real increase in China’s foreign assets, since it doesn’t count the foreign exchange the banks have been asked to hold as part of their reserve requirement.


With all these countries setting records, the IMF’s data on reserve growth for 2007 (which should be out at the end of March) will certainly show record global reserve growth. It also will show record dollar reserve growth among the emerging economies that report data to the IMF. And it is reasonable to think that the countries that don’t report data to the IMF - who are adding a record sum to their reserves -- bought at least as many dollars than the countries that do report. Adding in a reasonable assumption about their dollar reserve growth would bring total dollar reserve growth to a new high as well.

China of course is the most important country that does not report data. The latest survey data is consistent with a fall in the share of China’s reserve growth that is going into dollar assets or a change in the way China manages its reserves that has reduced the share of China’s dollar assets that shows up in the US data. I’ll have more on this soon.

But in some deep sense it doesn’t matter. Even if China reduced the share of its new reserve growth going into dollars, the increase in the overall pace of its reserve growth means that China almost certainly added far more dollars to its reserves in 2007 than in any preceding years.

Yet angst about the dollar’s status as a reserve currency has never been higher.

Wolfgang Munchau - keying off work by Dr. Frankel and Dr. Chinn -- is the latest to worry. Such concerns aren’t unfounded. The US has become unusually dependent on the growth in central bank holdings of dollars to support its deficit. There aren’t many other foreign investors willing to lend to the US in dollars (unhedged) for ten years at 3.5%.

The euro doesn’t need to displace the dollar as a global reserve currency for the US to feel squeezed. If the world’s central banks suddenly stopped adding to either their dollar or euro portfolios, the US would be in a bit of trouble.

That said, it isn’t entirely obvious to me that the willingness of other countries to continue to add record sums to their dollar reserves is quite the strategic asset Munchau argues.

The low cost financing provided by reserve growth is traditionally seen as a source of power for the country receiving the financing - i.e. the borrower. Munchau writes:

Losing the dollar as the world’s leading international currency not only leads to a loss of political power. It constitutes loss of power.

The global supplier of the reserve currency gets cheap financing that the creditors cannot realistically stop providing, because they have to hold liquid financial assets for their own financial stability.

But in other contexts the provision of financing usually enhances the power of the creditor not the debtor, especially if the debtor has no obvious alternative sources of financing on similar terms. The creditor can - after all - decide to stop providing the financing and force the debtor to adjust. That gives the creditors’ leverage. Adjustment is unpleasant.

I am not quite sure when the switch flips.

But it would seem like a stretch to argue that the current record dollar reserve growth is correlated with a peak in the United States’ global influence. And if I had to guess, I would bet that the more the US relies on reserve growth from countries that no longer need to hold more reserves, the more power will flow to the creditors.

The United States’ creditors all have their own (diverse) reasons for adding to their reserves. But those now adding to their reserves most rapidly also have more reserves than they need for their own financial stability. Indeed, in some countries rapid reserve growth is contributing to macroeconomic instability, notably rising inflation even if it supports employment in their export and import-competing sectors. The fact that the countries adding to their reserves have more reserves than they need seems to me to be a key when assessing the balance of power between the supplier of the world’s reserve currency and those supplying financing to the world’s biggest borrower in a clearly interdependent relationship.

This is a topic that I am trying to think about more thoroughly, so I would be very interested in alternative views.

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