INTERNATIONAL MONETARY FUNDReserve Accumulation and International Monetary Stability
Prepared by the Strategy, Policy and Review Department
In collaboration with the Finance, Legal, Monetary and Capital Markets, Research and
Statistics Departments, and consultation with the Area Departments
Approved by Reza Moghadam
April 13, 2010
"Box II.2. The Dollar as a Store of Value: A Summary of Views
There has been a long-running debate speculating on whether the dollar could collapse. Some commentators have focused on the sustainability of large U.S. current account deficits (e.g. Krugman, 2007, Obstfeld and Rogoff, 2004), and, particularly in the aftermath of the crisis, fiscal sustainability or the possibility of inflation (e.g., Ellis, 2009, Buiter, 2009). These concerns are in addition to long-standing worries on the challenge to long-term fiscal sustainability posed by the rising costs of healthcare and entitlements. Reinhart and Rogoff (2010) note that historically public debt levels above 90 percent of GDP have had an adverse impact on growth, and levels exceeding this threshold in the U.S. are now possible. Chinn and Frankel (2008) argue that a large or sustained trend depreciation would negatively impact the willingness of central banks to hold dollar reserves, imperiling the currency’s role as a stable store of value, thereby precipitating the loss of its status as the premier reserve asset.
Reserve holders’ intentions are unclear. As shown in Box II.1, just a handful of authorities account for more than half of global reserves, and the bulk of this is in dollar assets. This concentration could present big holders with a “Catch 22”— trying to switch out of dollar assets if they become concerned about the currency’s value could precipitate a disorderly adjustment. Chinn and Frankel (2008) argue the creation of the euro make such a switch possible. Central banks would, however, face large accounting losses if a run on the dollar materializes, which may deter them from action that could provoke one. Ultimately, incentives for the private sector holders may present more risks. With little transparency about official reserve strategies, fears of a change in policy away from the dollar—whether well-grounded or not—could lead to a run as individual agents and institutions try and exit before official sales materialize.
Others point to the dollar’s strengths. This is not the first time fears have been voiced over the dollar’s future, but instability has to date always been short-lived. As the U.S. holds foreign currency denominated real and financial assets, but has liabilities in dollars, moderate dollar depreciation helps to make net external debt more sustainable. Truman (2009, 2010) points out that a large proportion of reserve accumulation has been in currencies other than the dollar, over many years, and this has not led to protracted dollar weakness. Cohen"
A. Symptom of Imperfections in the System
8. Systemic imperfections.
Potential vulnerabilities and market failures in the international monetary and financial system have been important drivers of reserve accumulation, beyond the traditional motives for holding reserves (such as smoothing out the impact on consumption of shocks or ensuring inter-generational equity—e.g., for oil producers). These imperfections include uncertainty about the availability of international liquidity in a financial crisis; large and volatile capital flows; absence of automatic adjustment of global imbalances; and absence of good substitutes to the U.S. dollar as a reserve asset, which also reflects the fact that currency tends to be a natural monopoly. These issues are elaborated below.