The People's Bank of China and the Bank of Japan -- as well as other central banks in Asia -- are in trouble. They have accumulated vast foreign exchange reserves, estimated at more than US$2 trillion. The problem is that almost all of it is in US dollars -- a currency that is rapidly losing its value.
All policy options for Asia's central banks appear equally unattractive. If they do nothing and simply hold onto the dollars, their losses will only increase. But if they buy more, in an attempt to prop up the dollar, they will only have a bigger version of the same problem. If, on the contrary, they try to diversify into other currencies, they will drive down the dollar faster and create greater losses. They are also likely to encounter the same sort of problem with other possible reserve currencies.
ILLUSTRATION: YU SHA
The euro has been touted as the replacement for or alternative to the dollar. Some enthusiastic Europeans encouraged Asians to diversify their reserve holdings. But the same scenario might well be repeated with the euro in a few years. Large fiscal deficits and slow growth might convince foreign exchange markets that there is little future in the euro, fueling a wave of selling -- and hence losses for central bank holders.
There is a historical parallel to today's concern about the world's major reserve currency. The interwar economy, shattered by the Great Depression of the early 1930s, offers a whole series of painful, but important, lessons for the present.
In the 1920s, the world economy was reconstructed around a fixed exchange rate regime in which many countries held their reserves not in gold (as was the practice before World War II) but in foreign exchange, especially in British sterling. During the course of the 1920s, some of the official holders of pounds grew nervous about Britain's weak foreign trade performance, which suggested that, like today's dollar, the currency was over-valued and would inevitably decline.
Foreign central banks asked whether the Bank of England was contemplating changing its view of the pound's exchange rate. Of course they were told that there was no intention of abandoning Britain's link to gold, and that the strong pound represented a deep and long commitment (in the same way that US Treasury Secretary John Snow today affirms the idea of a "strong dollar"). Only France ignored British statements and substantially sold off its sterling holdings.
When the inevitable British devaluation came on Sept. 20-21, 1931, many foreign central banks were badly hit and were blamed for mismanaging their reserves. Many were stripped of their responsibilities, and the persons involved were discredited. The Dutch central banker Gerard Vissering resigned and eventually killed himself as a result of the destruction wrought on his institution's balance sheet by the pound's collapse.
Some countries that traded a great deal with Britain, or were in the orbit of British imperial rule, continued to hold reserves in pounds after 1931. During World War II, Britain took advantage of this, and Argentina, Egypt, and India, in particular, built up huge claims on sterling, although it was an unattractive currency. At the war's end, they thought of a new way of using their reserves: spend them.
Consequently, these reserves provided the fuel for economic populism. Large holders of sterling balances -- India, Egypt and Argentina -- all embarked on major nationalizations and a public sector spending spree: they built railways, dams, steel works. The sterling balances proved to be the starting point of vast and inefficient state planning regimes that did long-term harm to growth prospects in all the countries that took this course.
Could something similar be in store for today's holders of large reserves? The most explicit call for the use of dollar reserves to finance a major program of infrastructure modernization has come from India, which has a similar problem to the one facing China and Japan. It will be similarly tempting elsewhere.
This temptation needs to be removed before the tempted yield to it. Reserve holdings represent an outdated concept, and the world should contemplate some way of making them less central to the operation of the international financial system.
To be sure, reserves are important to smooth out imbalances in a fixed exchange rate regime. But the world has moved since the 1970s in the direction of greater exchange rate flexibility.
Reserves are also clearly important for countries that produce only a few goods -- especially commodity producers -- and thus face big and unpredictable swings in world market prices. Dependency on coffee or cocoa exports requires a build-up of precautionary reserves. But this does not apply to China, Japan, or India, whose exports are diversified.
Today's big surplus countries do not need large reserves. They should reduce their holdings as quickly as possible, before they do something really stupid with the accumulated treasure.
Harold James is professor of history at Princeton University and author of The End of Globalization: Lessons from the Great Depression.
Copyright: Project Syndicate
The saga of Sarah Dzafce, the disgraced former Miss Finland, is far more significant than a mere beauty pageant controversy. It serves as a potent and painful contemporary lesson in global cultural ethics and the absolute necessity of racial respect. Her public career was instantly pulverized not by a lapse in judgement, but by a deliberate act of racial hostility, the flames of which swiftly encircled the globe. The offensive action was simple, yet profoundly provocative: a 15-second video in which Dzafce performed the infamous “slanted eyes” gesture — a crude, historically loaded caricature of East Asian features used in Western
Is a new foreign partner for Taiwan emerging in the Middle East? Last week, Taiwanese media reported that Deputy Minister of Foreign Affairs Francois Wu (吳志中) secretly visited Israel, a country with whom Taiwan has long shared unofficial relations but which has approached those relations cautiously. In the wake of China’s implicit but clear support for Hamas and Iran in the wake of the October 2023 assault on Israel, Jerusalem’s calculus may be changing. Both small countries facing literal existential threats, Israel and Taiwan have much to gain from closer ties. In his recent op-ed for the Washington Post, President William
A stabbing attack inside and near two busy Taipei MRT stations on Friday evening shocked the nation and made headlines in many foreign and local news media, as such indiscriminate attacks are rare in Taiwan. Four people died, including the 27-year-old suspect, and 11 people sustained injuries. At Taipei Main Station, the suspect threw smoke grenades near two exits and fatally stabbed one person who tried to stop him. He later made his way to Eslite Spectrum Nanxi department store near Zhongshan MRT Station, where he threw more smoke grenades and fatally stabbed a person on a scooter by the roadside.
Taiwan-India relations appear to have been put on the back burner this year, including on Taiwan’s side. Geopolitical pressures have compelled both countries to recalibrate their priorities, even as their core security challenges remain unchanged. However, what is striking is the visible decline in the attention India once received from Taiwan. The absence of the annual Diwali celebrations for the Indian community and the lack of a commemoration marking the 30-year anniversary of the representative offices, the India Taipei Association and the Taipei Economic and Cultural Center, speak volumes and raise serious questions about whether Taiwan still has a coherent India
RSS