Marginal Revolution: Reserve Reverse?

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Reserve Reverse?

Around the world, reserves of US dollars and Treasury securities have more than doubled over the past 5 years. It's nice for us when we get to buy goods and pay in paper but what will happen when we face reserve reverse? And why, asks Eduardo Porter, do poor countries continue to fund our consumption?

The amount that poor countries are giving up by holding low yield Treasuries is not inconsiderable. Larry Summers calculates that India has reserves in excess of those required for prudent insurance in the realm of 100 billion dollars - if invested in higher paying assets those reserves could raise Indian GDP by 1-1.5%, more than double the amount that India spends on health care.

Posted by Alex Tabarrok on May 1, 2006 at 07:09 AM in Economics | Permalink

Comments

The problem is that estimates of the "optimal" reserves are wrong. In India, China and most developing country with barriers to invest abroad, central banks are in charge of diversifying the investment of domestic banks´portfolios by investing part of their deposits abroad. Given the many weaknesses of domestic banks and their domestic borrowers, I´d say that they should invest abroad at least 25% of their total domestic deposits. Without looking at the data, I bet that their reserves are well below that percentage. I´m sure they will continue investing in US bonds as long as their domestic deposits continue to increase, and they will do as long as their economies continue to grow.

Posted by: edgardo at May 1, 2006 7:44:41 AM

from the Porter article:

"Moreover, years have gone by without new financial disasters, and the
memory of past crises is fading. If this continues, governments across
the developing world will question the value of such costly insurance
when there are so many other things to do with the money."

There are certainly plenty of excellent uses for the money, but do these
countries have the financial and legal systems in place to channel the
money to these uses without it being wasted or stolen? Would people know
what to do when they woke up in the morning if not for that long to-do
list from Wal-Mart? I'm just asking: I don't pretend to know whether, to
what extent, or in which countries this may be true.

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Posted by: jiuwgl8uiv at May 1, 2006 5:17:57 PM

I'm not an economist but...

I thought the answer was simple: China needs to print renminbi to hoover up US dollars and
US bonds because of underemployment. Even in a boomtown like Shanghai I saw a lot of
workers with little actual work to do and we know there are many more workers even worse off inland.

The US Treasury bonds aren't so bad, they yield more than euro area and Japan bonds right now.
If China's central bank thinks the US dollar will depreciate, then they would have a reason sell some US bonds
but then that might raise US interest rates which isn't in China's interests right now.

Posted by: Brian at May 1, 2006 8:58:30 PM

I'm with Brian, at least as regards China.

Now, certainly a significant change in reserve policy by any of China, India or Japan would cause U.S. asset inflation, and probably CPI inflation as well. Does that mean that when one of them moves, they will all rush for the exits at once?

Posted by: sammler at May 2, 2006 9:30:25 AM

There are surprisingly few investment opportunities outside the U.S. on the reward/risk basis. Chinese equities are mostly cr*p, bonds are virtually non-existent. In most emerging markets there are huge currency reserves but thin equity and bond markets. Little wonder that American securities, T-bonds in particular, are favored to other choices.

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