Asia's reserves are fine where they are
It probably does not seem like it to the 900 million Asians who live below the poverty line, but the continent is suffering from an embarrassment of riches.
Speaking yesterday in Sydney, Reserve Bank of Australia governor Glen Stevens criticised Asian governments for their massive accumulation of foreign exchange reserves.
Since the regional currency crisis 10 years ago, Asian central banks have amassed more than US$3.5 trillion in reserves, almost all of which is invested in developed country bonds.
'Is it optimal for so much saving to be funding investment in the developed world when the social return to investment at home surely ought to be higher?' asked Mr Stevens, according to wire service reports.
The implicit answer is a resounding 'No!'. Clearly, Mr Stevens and his colleagues at the Reserve Bank of Australia think it is dumb for Asian countries to be lending such huge sums of money to the rich world, when so many of their own citizens eke out a living on less than US$1 a day.
Of course, Asian countries need some foreign reserves. According to traditional wisdom, a prudent level equals three months of a country's import bills plus cover for its short-term foreign debt. Adding up Asian countries' quarterly import bills together with their total foreign debt maturing over the next 12 months suggests the region's central banks need to hold reserves of just US$1.1 trillion - and that figure probably errs on the side of safety.
In other words, Asia is holding US$2.5 trillion more than it needs. Instead of lending this money to rich countries, says Rajat Nag, managing director general at the Asian Development Bank, regional governments should consider investing the excess at home in physical and social infrastructure. He estimates that Asia needs infrastructure investment of US$300 billion a year for the next 10 years to help lift its people out of poverty.
The trouble is that it is not possible simply to take foreign reserves and invest them usefully in domestic infrastructure. That would involve converting the money into domestic currencies, which would cause massive appreciation, undermining manufacturing competitiveness and pricing farmers out of their own markets. The investment would hurt the very people it was intended to help.
Just as bad, Asia's domestic financial sectors are not sufficiently developed to intermediate such huge investment. Inevitably, much of the money would be misallocated, either stolen or frittered away on white elephants. Before Asia can invest its money at home, regional countries need to strengthen their financial systems and drastically improve their governance.
In the meantime, if Asians cannot spend their money at home, many observers believe they could do better by investing it in assets that yield a higher return than rich country bonds.
In reality, buying developed country government bonds performs a very useful function. It helps to keep down long-term interest rates in the rich world. That encourages people in North America, Europe and Australia to go down to the mall and max out their credit cards on consumer goods, which more often than not are made in Asian factories. That keeps Asia's export industries in business and supports the employees who work for them.
So, in effect, the region has merely outsourced its financial intermediation to the developed world. And, although it may not seem like it at first, lending foreign reserves to rich countries really is helping to lift Asians out of poverty. That is nothing to be embarrassed about.