from Follow the Money

Sometimes, it is worth listening to what policy makers in emerging economies are saying

April 6, 2005

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The Koreans, I suspect, let the cat out of the bag.

Korea knows the value of reserves, and the risks of holding too few reserves. Indeed, absent an IMF loan and a last-second deal with their creditors (put together with a little help from the US Treasury and other G-7 countries), Korea would have run out of reserves in late December 1997, and been forced to default.

Ben Bernanke may think that Korea, and other Asian economies, still want to keep on accumulating reserves, and thus will continue to contribute to the global savings glut -- or at least to the glut of savings chasing US and European bonds.

The Koreans themselves, however, seem to think that they already have as many -- actually more -- reserves than they really want. Right now they hold $206 billion in reserves. They think the right number for their reserves is closer to $150 billion.

Consider this excerpt from a Dow Jones story, which Glory brought to my attention in the comments:

South Korea has been encountering a new set of problems with such a huge store of reserves [$205.45 billion at the end of March]. Prime Minister Lee Hai Chan said last week the country’s reserves were beyond a "reasonable level" of about $150 billion-$170 billion ... .

Korea’s growing reserves are making it harder to conduct domestic monetary policy, and they lost a decent sum on their reserves last year as well. Dow Jones, again:

In a report yesterday, the Bank of Korea said the increase in bond issues to fund currency interventions has raised interest costs for the central bank and may also lift market rates, affecting its monetary policy.

Outstanding issues of monetary-stabilization bonds rose to 153.2 trillion won ($151.31 billion) at the end of February from 142.8 trillion won at the end of 2004 and 105.5 trillion won at the end of 2003. Issuance of monetary-stabilization bonds increased sharply as the central bank was trying to sterilize its dollar-buying efforts and ease inflationary pressures.

The government’s foreign-exchange-stabilization funds account incurred a net loss of 10.22 trillion won last year due to intervention costs. The won has outperformed most currencies in recent months, not only because of the dollar’s global weakness but because of dollar selling by local exporters. The won has gained 14% against the dollar since Oct. 6.

Depsite Korea’s complaints about already holding too many reserves, they have yet to find a way to avoiding adding to their reserves. Their reserves grew by $6 billion or so in the first quarter, despite valuation losses on their holdings of euros.

Still, reserve accumulation by central banks who don’t want any more reserves hardly seems like a stable foundation for the global economy.

The World Bank, incidentally, agrees. This year’s report on Global Development Finance explores the consequences of relying on developing countries’s reserve accumulation to finance the United States.

It includes a useful discussion of the costs of reserve accumulation -- including the risk that central banks will lose money should their currencies ever appreciate against the dollar. Such losses are not the end of the world, but they are not just "paper" losses either. At a minimum, the central bank won’t make a profit (or will have to use any profit to rebuild its capital), and thus will contribute less to the national Treasury.

The World Bank also lays out a few fun facts about China:

1)Reserves exceed its short-term external debt by a factor of fourteen. A factor of four would generally be considered much more than enough.

2) China’s central bank is keeping its sterilization costs down by forcing the state banks to buy central bank paper at low rates, thus adding to the banking system’s troubles, in a sense. 3) China’s stock of sterilization bonds grew by 300% during the course of 2004 -- an unsustainable increase.

We don’t know what happened to China’s reserves in March, but when Taiwan complaints about hot money flows, it is reasonable to suspect that a fair amount of hot money also went into China ...

The Bretton Woods 2 system of Asian reserve financing of the US continues, no doubt. But I also think it is fair to say that many -- both in Asia and in the World Bank -- are beginning to reassess the cost/ benefit ratio of this system.

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