Forex Reserves Backfire

Prevailing wisdom has long held that the accumulation of foreign exchange reserves has helped stabilize emerging market economies by cushioning them against economic shocks. The economies of Asia, in particular, were praised by economists for responding to the 1997 Southeast Asian economic crisis by building up their reserves to guard against runs on their currencies in the future. In hindsight, however, the accumulation of reserves may have actually contributed to the current economic crisis, by facilitating the formation of massive global economic imbalances. High savings rates in Asia, for example, enabled western countries to run continuous current account deficits. Now, the chickens are coming home to roost, and developing economies are once again finding themselves vulnerable to recession, since their forex reserve policies came at the expense of developing domestic economic bases. The Times of India reports:

Re-balancing means that Asian countries must stop piling up ever-rising forex reserves (and trade surpluses). Such reserves represent excessive saving, excessive exports and insufficient imports.

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