3.1 The Road to International Currency Status

It is useful to trace and evaluate the performance of the US dollar as an international reserve currency to draw lessons for assessing the case for internationalisation of the SDR. At the end of the second world war, the US was the only strong economy left in the world. Europe and the UK, in particular, had lost its economic and financial power which ended its role as a global hegemon. The US accounted for 60% of global output, owned 60% of the world’s gold reserves, had modest import requirements and was able to produce much of what the rest of the world needed to resume economic growth (D’Arista 2009). It is, therefore, no surprise that the Bretton Woods system recognised the US dollar as the international reserve currency in 1944-45. Thus, the gold exchange standard that came into being was in practice “a solar system in which the US dollar was the sun” (Dam 1982).

The ability to issue a currency that is used internationally confers obvious benefits to the issuing country. First, the acquisition of US dollars in currency form is, in effect, an interestfree loan to the US government. In addition, because foreign governments acquire interest-earning US dollar assets in the form of reserves, they lower the interest rate faced by US borrowers. In recent years, the seigniorage revenue of the US from having an international currency has totalled roughly $90 billion per year (World Bank 2011). Second, it is easier for American companies to engage in international activities because it reduces their forex risk. The growth of international trade automatically boosts demand for dollars. Foreign investors and central banks asking for more dollars can help compensate the US current account deficit. By the same token, attracting capital from abroad at low interest rates can compensate capital account deficits. Third, a potential advantage, though much more difficult to quantify, is the ability of the US to avoid the painful adjustment of macroeconomic policies – in fact, to run structural current account deficits without the US dollar depreciating. Yet, as time would tell, this advantage also carries costs. It required the US to subordinate fi scal and monetary policy to the objective of exchange rate stability, an objective that no country could meet over time (Gisselquist 1981). Allowing financial imbalances to build up sows the seeds of a more serious crisis down the road.

Turning back to the evolution of the US dollar as the dominant reserve currency, the first dollar crisis erupted in 1960 with speculative sales of US dollars for other currencies and some official demand for gold in expectation of devaluation. The US authorities attempted to counter pressure on the dollar through “Operation Twist” (buying long-term securities to depress their yields and raising the yields on short-term securities so as to shift the slope of the yield curve) in 1961. This was followed by a series of capital controls (such as the interest equalisation tax on as US residents’ holdings of foreign securities issued in the US) as the decade progressed.

The second run on the US dollar occurred in 1967, prompting the Fed to raise interest rates to attract foreign funds and dampen the economy. As rates declined, US banks ignored the voluntary restraint programme and moved funds back to the Euromarket – a move that prompted the next dollar crisis in 1969

– a “monetary jolt” as the French franc devalued by 10% and speculative flows pushed up the value of the deutschmark by 10%. The countries of the European Economic Community (EEC) responded to the renewed turmoil by imposing capital controls and recommending a revival of the credit system for settling balances under the 1950s Payments Union (Kindleberger 1984). As the unsustainability of the US dollar/gold exchange rate system became increasingly obvious in the 1960s, the credibility of the US dollar as the key reserve currency was increasingly called into question (Triffi n 1960).2 Strident calls for a post-Bretton Woods system led to the Rio Agreement in 1967, authorising the IMF to create and issue SDRs.

In 1971, the US dollar came under pressure from actions by Germany and France and the Bank of England to convert US dollar balances into gold to alleviate pressure on their currencies. Foreseeing a run on the dollar, President Nixon closed the gold window in August. This effectively ended US dollar convertibility and potentially undermined its role as the global reserve currency since it was technically tantamount to a default by the US. At a meeting of the G-10 nations at the Smithsonian Institution in December, the US announced a devaluation of the dollar to $38 to an ounce of gold, imposed a 10% tariff surcharge on Japanese imports and negotiated upward revaluations of the deutschmark, the yen and the Swiss franc. It also negotiated smaller revaluations of the Belgian franc and the Dutch guilder and even smaller revaluations of the pound, the Italian lira and the Swedish krone. The Smithsonian Agreement was short-lived. Another, much larger run against the dollar took place in February 1973, prompting $10 billion of intervention by central banks in an attempt to stabilise foreign exchange markets. Exchange markets were closed in March and the US took unilateral action, devaluing the dollar to $42.50 for an ounce of gold, letting its currency float and, in 1974, ended capital controls. Those who had argued that the market should set the price of the dollar had prevailed (Dam 1982).

The 1970s also saw the advent of a number of so-called reserve currencies which formed the SDR basket, based on the criterion of “free usability” defined by the IMF.3 The US dollar’s hegemony as reserve currency was being tested.

3.2 The Tumultuous Decades: 1980-2000

The next two decades would witness a roller coaster ride for the US dollar and numerous other currencies. After falling precipitously through the 1970s, the US dollar regained strength in the 1980s following the election of the Reagan administration. This phase ended in 1985 with the Plaza Accord as the strong US dollar was causing structural imbalances with the growing US twin deficits – fiscal and current account. In less than two years thereafter, the US dollar lost half its value. The 1990s was the decade of currency crises – the UK pound sterling (1992); the Mexican peso (1994); the Asian crisis (1997-98); the collapse of the Russian ruble and Long-Term Capital Management (1998); and to a lesser degree, the Turkish lira crisis (2000-01), the Brazilian real (2002) and Argentina. By 1994, the world was mired in a global recession with Japan almost in an outright depression. From 1995-2000 the stated goal of the Clinton administration was a strong dollar. During each and every currency crisis, the Federal Reserve stepped in and either cut interest rates and/or provided massive doses of liquidity to the banking system, including and particularly during Y2K (1999) and 11 September 2001. With liquidity growing faster than the rate of economic growth coupled with a debt boom, the excess liquidity found its way into the stock market, eventually leading up to the dotcom bubble and bust (1995-2000).

In the interregnum, a challenger to the throne was being born. European economists issued a manifesto on 1 November 1975, calling for monetary union in Europe. An EEC study group report issued in 1977 supported the commitment to resolving monetary instability by the leaders of Germany (Helmut Schmidt) and France (Giscard d’Estaing).4 The next step was the formation of the European Monetary System (EMS) in December 1978 and the introduction of a new unit of account

– the European Currency Unit (ECU) – based on a basket of currencies. Twenty years elapsed between the introduction of the EMS and the full monetary integration – with the ERM crisis5 in between – that occurred at the end of the millennium with the adoption of a single currency by a majority of the states in the EU. The single currency appeared to have provided stability within the euro area during 2000-08. However, by no means did it shelter it from effects of monetary developments outside the eurozone, or as the recent sovereign debt crisis has shown, from the lack of unifi ed fiscal policy within.

3.3 The Euro under Fire

Since early 2010, when the modern tragedy of Greece started to unfold, financial markets have battered the edifice on which the euro came into existence. The ability of the eurozone economies to mount a credible rescue is being severely tested even as we write. A long shadow now clouds the future of the Euro as an international reserve currency. At one time or

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another, every country in the eurozone has broken fi scal rules intended to ensure that no country takes advantage of monetary union for national purposes. Indeed, they were enabled to do so because the founding agreement of monetary union included no enforceable mechanism for harmonising fi scal policy. Yet, the lack of fiscal union is not a mere question of governance or institutional design. It is a basic problem of legitimacy. It reflects very real differences of culture, language and history across Europe, as well as citizens’ real, if loosely articulated, concerns about surrendering control over their pocketbooks to a distant bureaucracy.

Even if Europe overcomes the political obstacles, the costs, economic and political, are steep – higher taxes and interest rates in rich nations such as Germany; seemingly endless austerity in less-rich nations such as Greece. A new sense of realism about the goals of European unity is needed along with the means of achieving them. So far, the only widely discussed approach, especially by non-Europeans, has been to launch a far bigger bailout – the only way to stop a fi nancial crisis is to overwhelm it. However, there is a fear that the measures announced by euro leaders recently may prove inadequate and underfunded. Investor concerns have also now turned to Italy, the euro area’s third largest (the world’s seventh largest) economy. The fire power of the European Financial Stability Fund is very much in question. All of these have implications for euro as a currency. There is already a talk of some member-countries leaving euro.

3.4 Back to the US Dollar?

While the emergence of the euro has resulted in a small decline in the role of the US dollar over the past decade, the latter has maintained its dominance. Over time, the ease and security involved with investing in US markets has led the rest of the world to take on massive levels of fi nancial exposure to the US. The value of foreign residents’ investments in US companies, real estate, capital markets, and government debt was nearly half of non-US global GDP as of end-2008. Changes in US monetary policy and financial conditions have had a direct wealth impact on foreign residents, infl uencing their expenditures, and posing a difficult dilemma for foreign investors. Individually, foreign investors have an incentive to diversify their portfolios as a matter of prudent risk management. Collectively, however, foreign investors have a strong incentive to maintain their holdings of dollar assets to avoid the risk of dollar depreciation that could undermine their investments.

Developments since 2008 have challenged the international financial architecture and the pre-eminence of the US dollar. In the aftermath of the global financial crisis of 2008-09, confidence in the US economy has been shaken by its persisting structural imbalances. The US current account has been negative for the past 20 years, reaching 5% of GDP before the global crisis before declining to 3.1% in 2010. The budget defi cit stands at more than 9% of GDP and will be difficult to reduce. These deficits are not offset by sufficient levels of domestic saving. On the contrary, the savings rate of private households

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is a mere 4% of GDP. Capital inflows from the rest of the world have financed these deficits. Foreign investors account for more than 50% of new subscriptions to US government bonds. This makes the US by far the most highly indebted country in the world. Reducing these imbalances will take many years and will require a highly cautious political strategy if shocks are to be avoided. Any disruption of confidence in the sustainability of the US economy would make it impossible for the dollar to play its role as international reserve currency.

The growing sense around much of the world is that we have lost both relative economic strength and more important, we have lost a coherent successful governing model to be emulated by the rest of the world. Instead, we’re faced with broken financial markets, underperformance of our economy and a fractious political climate..... The question is whether the exceptional role of the dollar can be maintained (Volcker 2010).

Like in the 1970s, the Triffin dilemma is back to haunt us again. The world is in a sense hostage to the reserve issuer’s ability to preserve its currency’s value. Reserves concentration in the government debt of one country introduces idiosyncratic risks to the international monetary and fi nancial system stemming from conditions and policy in that country. Policies designed to meet domestic concerns typically do not consider effects on the wider world (e g, a loose monetary policy may be warranted for domestic stability purposes, and yet induce unwanted demand at the global level). Moreover, the system is left vulnerable to policy mistakes as the US debt ceiling gridlock showed.6 The run-up to the crisis showed that IMF surveillance is a very weak substitute, if at all. In fact, the lesson of the crisis is that the IMF like others failed to see it coming, as was evident in glowing Article IV staff reports for the US and the UK in 2007.

Finally, the challenge of organising international reserve currencies does not stop with the dollar and the euro. There are new economic giants on the horizon. China’s impact on world markets is already one of the biggest political challenges facing the international community. China, India, Brazil and Russia together outstrip Europe in terms of share in global GDP in purchasing power parity terms. As their growth rates are at least double that of the US, together they will soon overtake the US in size. How likely is it that China, which is set to become the world’s biggest economy over the next few decades, will continue to accept the supremacy of the dollar or the euro as international reserve currencies? Financial markets are already anticipating this future event. Although the shares of emerging economy currencies in global currency markets are still limited relative to the US dollar and the euro, prospects for internationalisation of these currencies are being increasingly recognised. Currency internationalisation in respect of key emerging economy currencies has added a whole new dimension to the ongoing debate on the future of the world’s reserve currencies. This is, however, a nascent and evolving process currently, and outside the scope of this paper. Nevertheless, it may be noted that the claim of any emerging market currency to evolve as a reserve currency will require in the first place that the country dismantles all

86 65 64 59 52 46 24

sponse to the Asian financial crisis of the late

1990s. Five top reserve holders are also major

of which:

oil exporters. An interesting fact that emerges

and Mexico. Traditionally, reserves have been

held with a view to ensure financing of the

capital controls and allow the currency to be determined by market forces.

4 Some Stylised Facts

In recent years, international reserve accumulation has accelerated rapidly. At $9,695 billion at end-March 2011, the global level of reserves recorded a sixfold increase over 11 years measured from March 2000 (Table 1). By contrast, this level

Table 1: International Reserves: Important Facts

outstrip those of other reserve currencies such as the yen and euro. More widely, the depth of US capital markets, offering a large variety of products and high volumes of trading, can reduce diversification and portfolio management costs.

By end-2010, the top reserve holders were mostly emerging and developing countries, the largest being China’s, larger than the next five reserve holders – Japan, Saudi Arabia, Russia, Taiwan and the euro area – taken together (see Charts 2a and 2b).

Ten of the top 18 reserve holders are from Asia

countries and 39% in 2011 and 56% in 2000 for emerging and developing countries. Source: COFER Database, IMF. 7

rose only 1.7 times over the 1990s. Emerging and developing countries have driven this accumulation. Their reserve levels have gone up more than ninefold between March 2000 and 2011, as against less than threefold for advanced economies. The currency composition of reserves has remained concentrated in US dollars, although over the last decade, the share of the US dollar has actually declined by 10.8 percentage points, almost matched by a 9.1 percentage points gain in the share of the euro. The yen has lost ground by about 2.5 percentage points, while the pound sterling has gained 1.2 percentage points in share. Interestingly, the switch out of the US dollar is largely by the Emerging Markets and Developing Countries (EMDCs) with a 15.7 percentage points decline in the US dollar’s share in their reserves and a 9.5 percentage points gain in the share of the euro. For advanced economies, the shedding of US dollar is about 7.3 percentage points with a 8.2 percentage point gain in the euro’s share.

Chart 1: The Dollar in International Finance (2010, % of World Totals)

Foreign exchange transactions

Bank notes held overseas

International reserves

Cross-border deposits

Cross-border bank loans

Debt securities

US GDP

0 20 40 60 80 100 Source: Adapted from IMF (2010a).

The dollar’s continued preponderance reflects its central role as an international unit of account and medium of exchange for cross-border trade and financial transactions with extremely desirable characteristics of the dollar in terms of liquidity, safety and yield (Chart 1). The US Treasury market volumes far

current account deficit or specifi cally, imports. Accordingly, the standard norm for adjudging adequacy of reserves was equivalent of three months of

import cover. As countries globalised and progressively opened up their economies to international trade to smooth domestic consumption and investment, reserve adequacy became larger and a level equivalent to 12 months of imports was considered precautionary. Yet, the fact that the major reserve holders have current account surpluses suggests that these holdings could be nonprecautionary – the desire to boost public savings to ensure intergenerational equity in the context of eventual depletion of oil reserves for oil exporters, and the counterpart to an export-led growth strategy in the case of some Asian economies (Subramanian 2009). Alternatively, reserves are being held for other purposes – the most obvious being the cushion against sudden stops or reversals of the surges of capital flows that emerging and developing economies have been subject since the 1980s. Reserves also fulfil the need for accumulating liqui dity as

Chart 2a: International Reserves in $ Billion (2010) 0 1000 2000 3000

China Japan Saudi Arabia Russia Taiwan Euro area South Korea Brazil India Hong Kong Singapore Switzerland Thailand Algeria US Mexico Malaysia Indonesia

Chart 2b: Current Account Balance/ GDP (2010)

-5 0 5 10 15 20

China Japan Eurozone Russia Taiwan Saudi Arabia India Korea Brazil Hong Kong Switzerland Singapore Thailand Algeria US Mexico Malaysia Iran

Source: WEO Database IMF.

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a backstop for a potential banking crisis, and also for boosting policy credibility. According to some estimates, such insurance motives account for about two-thirds of current reserve holdings, or over half of the increase over the past decade (Obstfeld, Shambaugh and Taylor 2008).

The stocks of reserves are high relative to a variety of metrics such as GDP, imports, gross capital formation and short-term debt, especially for emerging economies (Table 2). These numbers exclude substantial foreign assets of the official sector invested in liquid, dollar denominated financial instruments but not recorded as reserves, including in sovereign wealth funds (SWFs), that have grown even more in recent years.

Table 2: Reserves in Relation to Selected Metrics in 2010

Global Emerging Economies

Months of imports	7.6	13.6
Per cent of GDP	14.7	28.6
Per cent of gross capital formation	64.4	92.0
Per cent of money supply	13.3	28.0
Per cent of short-term debt	–	840.5

Total reserves (gold at SDR 35/ounce as reported in the IMF’s IFS; short-term debt is available only for emerging and developing countries. Source: IFS, IMF, various issues; “World Development Indicators 2011”, World Bank.

More recent data suggest that the pace of reserve accumulation is recovering after the global crisis of 2008-09.8 Some countries will inevitably draw from the crisis experience and build even more reserves. The IMF projects that even if global reserves growth falls steadily to 8.5% per year by 2035 from an average of 15.4% in 1999-2008, their level will reach 690% of US GDP. Shorter term extrapolations suggest reserve levels approaching 120% and 200% of US GDP in 2015 and 2020, respectively (IMF 2010a).

5 Alternatives?

Every crisis leads to a catharsis. In the context of the recent crisis, this appears to have taken the form of a search for alternatives. This time around, however, it is not just back to imagining what could be a substitute to the US dollar-based system. It has a broader form, going beyond self-insurance through reserves. Several have been put on the table: third-party insurance (the most infeasible); global or regional reserves pools; and, creating a truly global lender of last resort that is able to deploy its resources rapidly in a crisis – an obvious refl ection of what the IMF is still not perceived to be, due to concerns about governance and stigma – complete with large resources, precautionary and automatic/high access lending/swap lines (the IMF’s Flexible Credit Line (FCL) meets substantially these criteria but has qualification prerequisites that could render it of dubious value in being regarded as a true reserve substitute) and an open mind. At the height of the crisis, the IMF’s outstanding lending commitments were of the order of SDR 100 billion or $150 billion while the US Fed’s swaps amounted to US 600 billion! This suggests that a pure liquidity line should be a better prospect for a reserve substitute and also as a game changer for the way in which the emerging world views the IMF.

A more recent alternative is a global financial safety net combining all these aspects and coordinated by the IMF. It is important that the IMF treats national reserves also as a part of

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this safety net if it has to succeed. In this context, it is also conceivable that several broadly substitutable reserve currencies could emerge over time without any one of them being clearly dominant. The euro, the yen, the Chinese RMB, the Brazilian real, the Russian rouble, the South African rand and even the Indian rupee may be candidates to this multiple currency pool of the future, but absent political will, as stated earlier, this will remain in the realm of imagination. Such a system would impose policy discipline on reserve issuers. Close policy coordination among key reserve issuers would be necessary to keep exchange rate volatility at bay as portfolio selection and management of reserves becomes more active.

7 Conclusions

In the final analysis, the SDR is not a currency; it was never intended to be one. It was created as an international unit of account and that is what it is best suited to be. It is diffi cult to conceive of an international monetary system based on a unit of account without an actual currency role.

Why is the SDR being resurrected? The main reason can be correction of global imbalances by the IMF and de-concentration of reserve holding patterns by large reserve holders. The SDR is not the remedy. It might become a part of the problem. In the absence of a global adjustment mechanism, this role is best played by active, incisive and equitable surveillance by the IMF. The surveillance function has a critical pre-emptive role in the context of crises in contrast to its lending function which is a crisis mitigation tool. Early warnings that have traction with its membership, drilling down into the specific aspects of macroeconomic policies of members with special emphasis on inconsistencies that can have external effects, equal emphasis on multilateral and bilateral surveillance, and addressing of risks to global financial stability wherever they may lie are the hallmarks of the desired surveillance role of the IMF. If reserve accumulation is a by-product of exchange rate policy, the cause must be addressed unequivocally. If reserves are the counterpart of quantitative easing or of persistently high defi cits by a reserve issuing country, the IMF should call a spade by its name. The IMF was designed to be an institution that leverages its relatively small financial resources with its relatively large human resources. The IMF must decide what it wants to be – the global policeman that it has failed to be or honest and trusted policy advisor, a role it must explore and aspire for. It is said that no one can hold back an idea whose time has come. For the time being, the SDR must await its moment of reckoning.

Despite shocks and sometimes acute differences in view on the US dollar, the current system has been resilient over decades. Arguments continue to be made that there is no necessary connection between US deficits and reserve accumulation, and that relatively favourable demographic trends in the US and the likely persistence of high savings in emerging markets are consistent with sustainable growth (Truman 2009, 2010; Cooper 2008). As global demand for reserve assets grows in relation to the US economy, a more acute trade-off between domestic priorities and international monetary stability is conceivable. Yet, in the near future, factors such as inertia in currency use, the large size and relative stability of the US economy, and the dollar pricing of oil and other commodities will help perpetuate the dollar’s role as the dominant medium for international transactions. The hard facts predicate this outcome. The US dollar is a major form of cash currency around the world. Roughly 75% of 100 dollar notes, 55% of 50 dollar notes, and 60% of 20 dollar notes are held abroad, while about 65% of all US banknotes are in circulation outside the country (Goldberg 2010). In 2010, eight countries used the US dollar as legal tender, nine countries has currency board using the US dollar, 15 had conventional pegs against the US dollar, 12 had exchange rate arrangements that stabilised their currencies against the US dollar, two had crawling pegs, two had crawl-like pegs and three other managed arrangements linked to the US dollar (IMF 2010b). A shift away from dollar assets, including Treasury securities, could be a concern for the US if divestiture triggers higher funding costs. However, such a drastic outcome appears unlikely.

The future of the dollar in this context continues to be the subject of discussion and policy statements, but the currency’s status has been maintained and is likely to remain so for some more years. As the size and structure of the global economy change, international currency use may change as well, and the currency’s pre-eminence could diminish in the future. Indeed, historical precedent exists for the rise and fall of the international status of currencies. The question is not “if” but “when”. Accordingly, it seems important in the context of global stability to monitor the role of the US dollar in international economic activity and to understand the potential causes and consequences of the dollar’s changing international role.

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Notes

1 For a fuller exposition, see World Bank (2011).

2 Testifying before the US Congress in 1960, Robert Triffin pointed out that if the US stopped running balance of payments defi cits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral. However, excessive US deficits (dollar glut) would erode confidence in the value of the US dollar. Without confidence in the dollar, it would no longer be accepted as the world’s reserve currency. The fixed exchange rate system could break down, leading to instability. Triffi n proposed the creation of new reserve units, not dependent on gold or the US dollar, to enable global economic expansion without chronic US deficits. “A fundamental reform of the international monetary system has long been overdue. Its necessity and urgency are further highlighted today by the imminent threat to the once mighty US dollar.”

3 In addition to the US dollar, these currencies were Deutsche Mark (DM), Japanese Yen, French Franc, Pound Sterling, Canadian dollar, Italian Lire, Netherlands Guilder, Danish Krone, Belgian Franc, Swedish Kroner, Australian Dollar, Norwegian Krone, Spanish Peseta, Austrian Schilling, and South African Rand. The number 16 was chosen because it happened to be the cut-off point for countries accounting for at least 1% of world exports. In 1978, the IMF dropped the Danish krone and the South African rand from the SDR, added the Saudi Arabian riyal and the Iranian rial. Only nine currencies had well developed financial markets. In addition to the G-5 currencies, these included the Italian lira, the Netherlands guilder, the Canadian dollar, and the Belgian franc. Effective 1981, the SDR basket was reduced to the G-5 namely, the US dollar, the DM, the French Franc, the Pound Sterling and the Japanese Yen (de Vries, 1976). The IMF defines a freely usable currency as on the IMF determines is “(i) widely used to make payments for international transactions, and (ii) is widely traded in the principal exchange markets” (Article XXX, Section (f) of IMF Articles of Agreement).

4 Economic and Monetary Union – Draft Communication to the Council, European Commission, 1977, October.

5 The European Exchange Rate Mechanism, ERM, was introduced by the European Community in March 1979 to reduce exchange rate variability and achieve monetary stability in Europe, in preparation for the introduction of a single currency, the euro, which took place on 1 January 1999. A grid of bilateral rates was calculated on the basis of the central rates expressed in ECUs, and currency fl uctuations had to be contained within a margin of 2.25% on either side of the bilateral rates (with the exception of the Italian lira, which was allowed a margin of 6%). Shortly after the launch of the ERM, the pound sterling, which was not an ERM currency, appreciated against all ERM currencies. The UK entered the ERM in October 1990, but was forced to exit the programme within two years after it came under major pressure from currency speculators, including George Soros. The UK spent over £6bn trying to keep the currency within the narrow limits. The ensuing crash of 16 September 1992 was subsequently dubbed “Black Wednesday”. In 1993, the margin had to be expanded to 15% to accommodate speculation against the French franc and other currencies. On 31 December 1998, the European Currency Unit (ECU) exchange rates of the countries were frozen and the value of the euro, which then superseded the ECU at par, was thus established. In 1999,

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ERM II replaced the original ERM. EU countries that have not adopted the euro are expected to participate for at least two years in the ERM II before joining the eurozone.

6 The world has found the dysfunctional political wrangling on raising the debt limit baffl ing, given that it is reported to have been raised 102 times by Congress since 1917. Doomsday scenarios of the aftermath of a US default that fl ooded the media do not inspire confidence in the US recovery or in the credibility of US public fi nances. US financial markets generate the maximum outward spillovers and the global consequences of a US default or even a downgrade would be disastrous. In terms of the US fi scal position alone, they would imply a question mark on the ability to fund future deficits however small they may be, even fuel flight to safety out of US paper, additional interest payments on Treasury debt hitherto considered riskless, and eventually threats to business investment, consumer spending, employment and confi dence.

7 COFER is an IMF database that keeps end-ofperiod quarterly data on the currency composition of official foreign exchange reserves. Foreign exchange reserves in COFER do not include holdings of a currency by the issuing country. The definition of foreign exchange reserves in COFER is the same as that in the IMF’s International Financial Statistics (IFS). Currently, 139 countries report to COFER. The unallocated reserves in COFER refer to the difference between COFER reportings and the total reporting for the IFS which comprises all 187 member countries of the IMF.

8 Data from the IMF’s International Financial Statistics indicate that between end-2008 and end-2010, global reserves increased by almost 30%. Reserve accretion by advanced economies during this period was of the order of 31.2%, faster than the global rate and that of emerging and developing countries (29.4%).

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