Many central bankers believe that some central banks hold too much foreign currency in reserve. Raghuram Rajan, head of the Indian monetary authority, and William Dudley, who runs the New York Federal Reserve, both recently spoke out on the topic. Their sentiments are certainly worthy.
International reserves have risen seven-fold in 15 years to a record $11.67 trillion, roughly 15 per cent of global economic output. Most of this increase can be traced back to emerging economies. Some run current account surpluses and receive more hard currencies than they sell. Their central banks soak up the funds and invest most of these in low-yielding foreign government bonds. Others built up huge buffers after the Asian financial crisis of the 1990s to ensure they could cope on their own with any sudden capital outflows.
Critics say this hoarding is inefficient and ineffective. The hoarders sometimes admit to inefficiency but can cite good economic logic. If a cheap currency creates jobs and speeds development, reserve accumulation could be a reasonable price to pay. And, the money is available to deal with fleeing foreign investors. That's much better than taking out stigma-laden and expensive emergency loans from international institutions. Rajan and Dudley would like to create mechanisms to neutralise the safety motivation, but there's scant sign of the necessary international cooperation and mutual trust. Emerging economies feel continually caught in the backwash of monetary policy shifts in big advanced countries. Developed economies accuse emerging ones of mercantilist currency manipulation.
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Such ructions are a far cry from the unity displayed during the financial crisis. In 2008, China joined developed countries in a coordinated rate cut. Economies and financial markets are no less intertwined now. But as the crisis faded, so did the spirit of international cooperation. Fine words about a better global financial system will not easily be translated into reality.
