What a moment we are in. Economic power is shifting. Geopolitical tensions are rising along with fragmentation. We see geopolitical rifts widening. And there are some positive things. Financial markets are serene, at least as of this morning, Singapore time. Technology is taking us to a better place. And all of this is leading to an interesting world. If you're a policy maker, it's probably befuddling and perplexing and challenging. If you're a citizen of the world, it is terrifying. And of course, if you're an academic, it is intriguing.
Now, it's worth thinking about what this moment represents in terms of the possibility of change. It should be a moment of cataclysmic change in many dimensions. And yet, there are certain things that don't seem to change. So that's one of the elements that I'm going to talk about: the international monetary system, which by all logic ought to be on the cusp of very dramatic change, and yet things are not changing that much. So one of the themes of my talk is going to be that this is not a glorious story about the triumph of good over evil, or even about good alternatives versus not so good alternatives. It is a story about a set of miserable alternatives, each one miserable in its own way, which I think is why we are where we are.
The second theme of the talk will be that while there might be change coming, it might not exactly be along the lines of what you might think is going to happen. And more importantly, perhaps you should think about what you wish for before you wish for it, because some change may not be that good. And the third theme of the talk, because I don't want to be the prince of darkness here, is to tell you that there is possibly a way out. It is going to take a lot of work from individual countries, from the system as a whole, and we need to think about creative solutions, and I will propose one for some of these problems.
So that's the panoply of the talk. We have a lot of ground to cover, and we will start with some changes which again conform to logic. We'll then talk a little bit about why, in fact, on the ground there doesn't seem to be as dramatic change as you might expect. And then I want to talk more broadly about certain features of the international monetary system which are keeping us stuck where we are. And then I will talk about a variety of outcomes, again, which might bear some thinking, because while we might aspire to have change, it turns out that some change may lead us from a bad situation to an even worse situation. So we should think very carefully what we wish for, and then I will propose a solution to at least some of these problems. So first, the expected change.
Now, as you may have noticed, the United States isn't quite the country it used to be. Macroeconomic policies in the United States are, to use a technical term, a mess. If you think about policy volatility and uncertainty, that is the rule of the day. And of course, there are elements that go beyond economics that are very important. I've argued in some of my previous writings, and other prominent economists here have as well, that what is really important in terms of thinking about the strength of the dollar is not just the size of the economy, not just the size and depth of US financial markets, but the institutional framework, including the rule of law, which even the government has to be subservient to, the independence of the central bank, a system of checks and balances, a free and fearless press that holds even public officials to account. And all of these are fraying before our eyes.
So it should be logical that the dollar has an erosion of its dominance, and those who believe in the story will, of course, point to these data, which tell a very compelling story. The US dollar share of global foreign exchange reserves has declined quite substantially. Now, again, how you interpret this depends on what your frame of reference is. One might say, my God, the US dollar share of global foreign exchange reserves is 57%. It used to be a much larger number. But there are two things to remember. First of all, even this number of 57% does not make much economic sense if you think about portfolio diversification to have so much of your money, if you think about global foreign exchange reserves in one asset class and in one currency, doesn't make sense. So even if the US was the paragon of efficiency, of institutional strength, there would be good reasons for the dollar to have a declining share of foreign exchange reserves, and perhaps the puzzle is why it's still at 57%.
The second thing worth noting is that the two major ostensible rivals haven't done terribly well. The euro, in fact, has seen a decline in its share since 2007, and especially in the last few years. If you think about the renminbi share, it hasn't changed very much after an initial period of amazing promise, which stalled pretty quickly. Now, Professor Eichengreen, whom you'll be hearing from later, has made a very important point that the shares of smaller reserve currencies have gone up a lot. This includes the Canadian dollar, the Australian dollar, the Swedish krona, even some emerging market currencies, including the Indian rupee. Each of these does not amount to very much by itself, but collectively their share has gone up. So this means a lot more fragmentation, and despite the presence in this room of my good friend Philip Lane, I will put the euro in the second tier of currencies. So this is leading to a lot more competition in the second tier, and I will come back later to the implications of that, because there are some very important implications.
Now, if you look at other elements of the declining trust in the dollar, Venkat Viswanathan, Viral Acharya, and many others have talked about the declining convenience yield on US treasuries. This is using some domestic measures. If you look at it in any way, there is no doubt that there is much more concern about the stability of US finances, and therefore the US Treasury's role as the dominant safe asset does seem to be declining. Now, it's worth parsing the numbers on debt a little bit, because these numbers do tend to get thrown around. And just to bring some clarity to this, the overall gross federal debt in the US is about 38.5 trillion. I repeat, 38.5 trillion. That's about 130% of GDP. You know, we economists have notions of fiscal sustainability about what might make sense for an economy, whether it is emerging market or advanced. All of those notions are out the window when you look at a number like this for an economy as large as this. Now, of course, some of this debt is held by the social security trust funds, and some of it is held by the Federal Reserve. So if you take all of that out, what is called the privately held debt, which is a bit of a misnomer because it's not really all privately held, is about 26.5 trillion. And this number is sort of important as we think about the international dimension of US debt. So about 17.5 trillion is held by domestic investors, and the rest by foreign investors, both official and private. So when you hear the number of US debt having exceeded 100% of GDP, that is the net debt, which again is a misnomer because it says debt held by the public, which is a technical term the Treasury uses, but it includes holdings on the Fed's balance sheet. Now, of course, Kevin Walsh, the distinguished Kevin Walsh, might change that number if he has his way, but we will see. But that certainly means that the financing needs of the US government are going to become even stickier.
Now, what is striking about the US, of course, is how eager foreign investors have been to accumulate US debt. This goes back to the period of the global financial crisis and even before. So the dark blue bars are the total amount of privately held debt, this last category that I showed you on the previous slide, that is the amount that is issued each year on net, and the thinner blue bars are the amount that foreign investors accumulate. So if you look at the global financial crisis period, 2008 to 2010, you will see that in each of those years, the United States issued $1.3 trillion each year of additional privately held debt, and foreign investors happily gobbled up about 60% of that. Since then, it's been a little more mixed. And of course, dollar doomsayers always jump at numbers that look negative. So if you look at 2015, it looked like foreign investors didn't buy any US Treasury debt. In 2016, they sold US Treasury debt. What is going on? Did people suddenly lose their love for the dollar? Not quite. Remember, a lot of these holdings are by foreign central banks. And the reason they hold foreign exchange reserves is because they need rainy day funds. And when the rainy day comes, you need to use the money. And if you might recall, 2014, 2015 were very difficult years for China. There were huge depreciation pressures on the currency. China's holdings of foreign exchange reserves fell from a peak that almost hit 4 trillion in June of 2014 to about $3.1 trillion in 12 months. Now, that is very important to keep in mind, and it is important to keep in mind because we're going to look at notions of reserve adequacy, and I think the world, especially emerging market central bankers, have taken some very important lessons from that. Number one, at the time, $4 trillion sounded like an outrageous number, astronomical to the point that it made no sense at all. Why would a central bank park $4 trillion in such low-yielding assets? And suddenly the answer turned out to be because when you have a lot of reserves, they can dissipate very quickly. And once the market turns against you, those reserves, they may seem like a mountain, can very quickly erode. So China was losing about a hundred billion dollars in reserves each day to protect the value of its currency.
So I think the lessons that emerging markets have possibly taken from this are: you can never have too many reserves, and second, anytime you have the opportunity to accumulate them, you take them, because nobody else is going to look out for you. Again, an issue that I will come back to later in the talk. Now, of course, this figure of foreign investors embeds both private and official investors. Official investors include central banks, sovereign wealth funds, and other official agencies. It does not technically include state-owned banks. And of course, that's an interesting twist sometimes in looking at foreign exchange dynamics and reserve accumulation, what role state-owned banks are playing. But certainly there's been a very significant shift. In this figure, the green line shows you the number from the previous chart about the total amount that foreign investors were buying in each year. The red bar is the private investors' accumulation. The blue bar is the official investors' accumulation, and consistent with the story I told you, you can see that in 2015 and 2016 there was negative net accumulation of US Treasury securities by official investors. But in the last few years, certainly, it is private investors that have accumulated US treasuries to a very significant extent.
So although there is this notion, which seems very plausible, very logical, that the world should be shifting away from the dollar, it's not quite happening. In fact, even if you think about shifting away from US treasuries, the price data do suggest that there is a shift, but the quantity data suggests that it's not quite as dramatic as one might think. So if you look at the overall foreign ownership of US federal government debt, and this basically shows you the data from the previous chart, accumulated in terms of how much of US federal government debt is held by official investors, private investors, and how much that share is as a percentage of privately held debt, which is the height of the overall bar, and it's a share of overall gross federal debt, which of course is a much higher number. So the red line is a lower number. Now, there are a couple of striking things from this chart. First is that the numbers certainly have gone down. But the second is that in the last three or four years, it's not like they have collapsed. This is a period when, again, the notion is that the world is desperate to diversify away from the dollar. And yet if you look at the holdings of treasuries, it's not quite happening. Of course, every little twist in the data does get picked up because the doomsday story is a much more compelling one. The story I'm going to tell you for much of the rest of the presentation lacks logic. The world should not be like this. But it is like this. And again, we will come back to what the alternatives are. And of course, the US is special in this respect. A lot of US debt is held by foreign investors, much more than in most other reserve currency economies. Although the foreign ownership of public debt in the UK has actually soared in the last few years, and even in the euro area, the share of ownership by foreign investors has gone up. But the US has always been a little special, especially if you look at the absolute amounts here. And as we think about the possibility of change, it's worth thinking a little bit about what the alternatives are.
And one of the key elements that enters into thinking about alternatives, of course, is the availability of instruments that are seen as safe and liquid. Now, there are many distinguished central bankers in the room. I have learned from them. What I have learned is that there are three criteria that are very important as they think about foreign exchange reserves. One is safety, the other is liquidity, and a third, usually a distant third, is yield, because the first two tend to be the critical ones, which is why fixed income securities are the preferred asset that central banks hold, and as you can see, the US still remains dominant in that dimension. Now, there are other twists to note here. If you look at the overall size of bond markets in China, including government and corporate bonds, China certainly measures up to the euro area. And if you add up China and the euro area together, it seems like these should at least collectively be serious competitors to the US dollar. So one question that we will come back to is why are they not? Because yes, the US is dominant, but that dominance is not as dramatic as it once used to be.
Let's think about how much change there is in other areas of currency dominance. And this is where the story will take a bit of a twist, because it turns out that if you look at other dimensions of what a currency is used for—international payments, denomination of cross-border trades—there it turns out that it's a very different story. Let's take the share of international payments that are intermediated through the SWIFT network. So the SWIFT network, of course, is just a messaging network, but it's a good source of data because practically all international transactions are conducted through SWIFT network messaging. Not all. It turns out there are some alternatives that are coming up. So this gives you, based on the SWIFT data, an indication of the shares of the dollar, which is the dark blue line. The light blue line is the euro, and then the dotted line at the bottom is the Chinese renminbi. Again, a couple of things worth noting here. It looks like 2023 was a terrible year for the euro. It turns out it wasn't as bad as it looks. SWIFT in 2023 apparently realized that some messaging categories that it was using in order to look at cross-border payments were in fact being used by European banks to do some messaging about their daily balances. So SWIFT realized this problem. Who knows what other problems are out there, but at least it fixed this problem, and the euro doesn't look quite as good. Now, of course, these lines for which we have historical data going back to the early 2010s include payments within the Euro area. And one might argue, you know, the Eurozone is a currency union. So, of course, payments within the Eurozone are going to be in euro. So maybe we should take those out. If you take those out, it looks like the euro share is even lower. These are the dashed lines at the bottom for the euro, at the top for the dollar. And what is remarkable here again is that despite the US weaponization of the dollar, something that the world, including Europe, hates, it doesn't look like the dollar's share of global payments has eroded very much at all. In fact, it stayed pretty stable at about 60% for the last two or three years. And looking over a longer horizon, and unfortunately we cannot do that using the data that excludes the Eurozone, the dollar really doesn't seem to be doing too badly. And of course, the Chinese renminbi, for all the drama related to it, hasn't really picked up too much. Now, there is one quirk worth noting here. China has developed the Cross-Border Interbank Payment System, or CIPS, and CIPS is very important not just in terms of connecting China's payments with other countries' payment systems, but it also has messaging capabilities. So maybe there are some messages that are not going through the SWIFT network. Now, it turns out that there may be a strategic reason why China doesn't tell us how much of these payments are going through the SWIFT-CIPS network and that are denominated in renminbi. But the word on the street is that perhaps it's about a quarter to a third of China's trade transactions with other countries. This is only China's trade, and also it does not include financial transactions, which are a far more important part, rather than those just related to cross-border trade. So perhaps the renminbi share is slightly larger, but one interesting question again is whether that share is coming out of the dollar or out of other currencies like the euro. Going back to the reserve composition chart, it turns out that in fact it is the British pound sterling and the Japanese yen that have done not too well if you look at payments. So again, it's the dollar that is holding up very well. Professor Maggi has done phenomenal work, and he's responsible for two of the lines in this chart, the dotted lines, showing that over the period from 2005 to 2017, if you look at the issuance of international debt securities, it looked like we were in a period of very significant dollarization. So with some colleagues from the BIS and the Fed, Swapnil Srivastav, Prasanna Gai, and Ujjal Hati, we've got data on practically every debt security ever issued. Professor Maggi's fantastic work is based on holdings by institutional investors from the Morningstar data. This is practically every debt security ever issued. And as with many other phenomena, what we see here is that when the euro emerged on the stage, many of us had great hopes for the euro. I know Andy Rose, Professor Rose, has done work on the euro, and many others here as well, including Professor Eichengreen. We all had this promise, and then that promise sort of dissipated. And this is the story: if you look at reserves, if you look at international debt securities, that the euro starts playing a bigger share, and then it sort of peters away, leaving the dollar very much on the perch. Another interesting question is whether there are indicators that the dollar might be losing prominence in other respects. So there was this dramatic moment, at least some of us who are aficionados of this arcane stuff, you know, treasure, which is when the renminbi became part of the IMF's SDR basket. This was a very important moment because it was the first time an emerging market currency became part of the SDR basket. The SDR, or Special Drawing Rights, are basically a unit of account created by the IMF whose value for the last couple of decades before the renminbi was included came from the four major currencies in the international monetary system: the US dollar, the euro, the British pound sterling, and the Japanese yen. So this was a dramatic moment. Now, the SDR is constructed based on weights of the underlying currencies. So when the Chinese renminbi entered the SDR basket, it got a weight of about 10.9%. Now, this weight is based on things like your country's share of global trade, the share of global foreign exchange reserves, GDP, and so forth. And it is a zero-sum game. And that weight had to come out of somewhere. So guess where it came from. And I know this because I was privy to some internal discussions with the IMF. It wouldn't have looked good if the US didn't lose any share at all. And the entire share came out of the other currencies. So the IMF worked mightily to make sure that the formula would at least give the US a bit of a nick. So rather than 41.9%, it went down to 41.7%. The entire remainder of the 10.9% came from the euro and the Japanese yen. In 2022, the IMF redid its calculations. The renminbi share went up. Guess what other currency's share went up? The US. So for all the concern about the US economy, all the notion that the US should be playing a smaller role in global finance, the US dollar share has gone up, not down. And again, this is an equally important mirror image of it. The other major reserve currencies have lost share. So this is, I think, a very important fact to keep in mind. Even if the dollar might be losing dominance in an absolute sense, again, in some very limited dimensions, in a relative sense, it is far from clear that there are serious rivals to the dollar.
Now, we've talked a lot about reserve currencies, and the question is: what is the source of demand and what is the source of supply for safe assets? And again, there are many people in the room who've done phenomenal work on safe assets. Now, it used to be the case that there were very simple rules of thumb, and rules of thumb are good because they work until they stop working. And it used to be the case that there was this very clear rule of thumb that a country, especially an emerging market country, needs to have enough reserves to cover about six months of imports, so that you wouldn't have to tighten your belt too much if foreign investors are not in favor of your country anymore and you cannot finance your trade or current account deficits. After many of the debt crises that emerging markets faced, there was a new rule, which is that you need to have enough reserves to cover about one year's worth of your short-term debt securities that are maturing over that period, because we learned from many of these crises that short-term foreign currency-denominated debt, in particular, is very pernicious for emerging market economies. But it turns out there are other concerns. China is a very important example. China does not have a lot of external debt, had a lot of reserves, but the concern in countries like China could be of deposit flight. China has a very large amount of money floating around, M2, and there was a concern that serious frailties in the financial system could trigger deposit flight, which in turn might lead to significant pressures in the currency. So my good and wise friends at the IMF have come up with a notion of reserve adequacy, the ARA metric, and wisely they have made the point that countries with flexible exchange rate regimes need to hold fewer reserves because they're not trying to protect a particular value of the currency. But still, a huge amount of currency volatility is not good for an emerging market country. So even countries with flexible exchange rate regimes that have the buffer of a flexible exchange rate need to have reserves. So these are the criteria that go into the reserves, and one can think about what this means for how much the world needs in terms of reserves. So this exercise is conducted by the IMF, and the most recent exercise for the 61 economies, mostly emerging market, but also some small open economies that are included there, suggests that the total amount of reserves that these countries ought to have is something like 9.3 trillion, while in fact they have 8.2 trillion. This sounds worrying now. Maybe some countries don't have enough reserves. But going back to China, there is a very important qualification. China has capital controls, and capital controls can play a very useful role when you're trying to limit capital flight. In this episode of 2014-2015 that I referred to earlier, that was the tool that China used to manage capital flight. So if you control for capital controls, and of course this is where things start getting a little judgmental, it turns out maybe the world has enough reserves, but still the world has continued accumulating a lot of reserves. If you look at the emerging market and developing countries in particular, which is in the lower panel here, they have continued accumulating reserves after that initial dip that you see here in 2014-2015, which is largely because China reduced its reserve holdings because it was forced to do so. Now, of course, all of you have heard about central banks, again, desperate for diversification. So they are buying gold, and the value of gold reserves has certainly increased enormously. If you look at the total value of gold reserves held by emerging market and developing economies, which is the last row on this chart, that has jumped from 603 billion to 1.6 trillion in 2025, with most of this increase coming over the last three years. Again, my God, central banks are ditching the dollar, getting into gold. It turns out that a lot of this change actually comes from the price effect. If you break this down, and this requires a couple of assumptions because you cannot do as clean a break as suggested here. One is to attribute the residual interaction term equally to the price and quantity effect. So take this seriously, but not too literally. But what it suggests is that most of the increase in the value of gold holdings for the world at large has come from the price effect. If you limit it to emerging market economies, the quantity effect is larger, but still it is the price effect that dominates. Now, one can argue that from a portfolio composition perspective, this is fine. If central banks are getting diversification through price increases, that's fine because they're shifting the share of their reserves in mark-to-market terms towards gold. So what's the problem with that? There is one problem. I spoke about the criteria for foreign exchange reserves: safety, liquidity, and yield. And on the first two, gold doesn't look terribly good. And I think for central banks, this is a very worrying prospect because now they have a lot more gold. But imagine what this chart is telling you. What it is basically telling you is that relatively small increases in demand, because supply is inelastic, can lead to very large jumps in prices, which is good if you're holding gold, but if you're trying to sell gold, it's not a good thing. And especially if you have a situation where many emerging markets are trying to sell their gold holdings at the same time, this is going to be a pretty illiquid asset, or one that is going to be sold at substantially falling prices. One other point worth noting as one thinks about the landscape of global reserve currencies is who is supplying the reserves. And it's worth recognizing now, this is a slightly crude and not technically very precise calculation, but just for fun, I thought, let's think about which countries are actually providing reserves to the world on net, because there are some countries, including Japan, Switzerland, and of course China, that are providing some reserves but are also accumulating a lot of reserves themselves. So if you look at the net supply of reserves, and again, this is a slightly funky calculation, what it shows is that really there are two key providers of safe assets to the world in net terms, and here the US is completely dominant, and of course Europe plays an important role as well. But many of the other reserve currency economies don't play a key role here.
Now, of course, there are lots of changes in prospect. One of my pet topics is what is happening with technical changes in terms of payment systems, in terms of the accessibility of cryptocurrencies, both decentralized and stablecoins, and of course tokenized versions of various assets. My view is that all of this could create a more level playing field, because after all, if you have digital versions of your own currency, then in principle you can set up a more robust domestic payment system, connect your payment system with the global payment system. But I think there is an equally worrying possibility that, as with many other technological changes, rather than creating a level playing field, rather than giving smaller countries the tools to compete, we end up in a world where there is even greater concentration of economic and financial power. I'm sure all of you have noticed and are aware of the fact that while the issuance of stablecoins has increased a great deal, a little more than 99% of stablecoins are still denominated in dollars. The second largest issuer of stablecoins, Circle, issues a yen coin, a euro coin, and you talk to them in public, they will tell you we just haven't worked very hard to promote them. You talk to them in public, they'll tell you nobody wants this stuff. It's still dollar-denominated stablecoins that the world wants. And so we might end up with the dollar becoming even more important indirectly as a payment currency.
Now again, one should not take away from the good. All of these conduits for financial capital flowing with fewer frictions are going to be phenomenal. They're going to be phenomenal for exporters and importers. They're going to be phenomenal for economic migrants sending remittances back to their home countries. You could have even entrepreneurs in emerging market countries having access to global pools of capital. But it's going to mean pretty significant risks in terms of fewer frictions on capital flows, meaning much greater capital flow and exchange rate volatility, which is always a concern for emerging market economies in the best of times. And for some currencies, this even poses a threat of displacement. If you have a country with a non-credible currency and non-credible central bank, the prospect of displacement by US dollar-backed stablecoin is now very real. So this poses a lot of threat, and when there are threats, especially of volatility, what happens? Central bankers, being wise and prudent, are going to want even more reserves. So we might end up actually leading to a world where things get even more complicated.
Now let me step back a little bit and think about the broader perspective on the international monetary system. We could be moving to a world where there is much more balanced competition, and competition, as we economists know, under most circumstances, certainly not all of them, is very good for discipline, because then no country can go all rogue with its policies. It's good for efficiency and it's good for stability. That would be an ideal world. One could imagine a different world where there is much more fragmentation, where some of the currencies that we've spoken about, including the smaller reserve currencies that Barry has written extensively about, start creating a more level playing field. We have a broad dispersion of currencies with no currency dominating. Sounds like a much better world. But let me take you back briefly to the moment that we had in 2008 when the global financial system was falling apart and it looked like financial markets around the world were basically crunching up. At the time, we had one advantage in a very dark period. We had one currency, one central bank that the entire world could coordinate on. So you had a currency that the entire world trusted and a central bank that could provide it in essentially infinite quantities, which in my view made things a little less worse. If you had an alternative situation where in a time of financial panic you have a bunch of currencies that nobody is quite sure about, and at the slightest whim, again, in this world with fewer frictions, you could have capital moving very aggressively between currencies, leading to even more uncertainty. So I think that is not a good outcome. The other not-so-good outcome is the one we have right now. We have very great concentration, but with a very different kind of fragility, and that fragility comes from the fact that you have a country that can continue with apparently no major consequences. Yes, the 30-year yield is above 5%, but you know the US dollar is not plunging. You don't see US financial markets being roiled like any other country would if it presented with these macroeconomic fundamentals. So the US ability to cause havoc in the rest of the world is going to continue. And of course, the US very graciously says that if things go wrong, I will be the global lender of last resort, which is great, but with certain political and geopolitical strings attached. And of course, with the president we have in the White House right now, it's far from clear that the Fed will be able, with political support, to provide the sort of support for the rest of the world that it provided back in 2008-2009. So I think right now we face this very unfortunate situation, and I've called it the currency doom loop. Either we move to a world with great fragmentation, which has a lot of risks, or we stay with the current situation, which has a lot of risks. There are ways out. And here I'm looking at you, Europe, I'm looking at you, China, Japan, and so on. Get your act together, people. So I hear a lot of complaints, you know, about the dollar. People say we don't want a dollar-dominated financial system. We want a system where the US cannot wreak havoc. It's everybody else's fault because you are letting the dollar maintain its dominance because you are not providing alternatives. And what it's going to take to provide alternatives, again, are fairly well known. You need countries basically to get their acts together in these dimensions. And of course, we need to think a little bit more about the rules of the game more broadly, including the international governance structure. But I think the reserve demand is a very important issue, and that is going to keep pervading the structure of the international monetary system.
But what are reserves at heart? If you think about it, it's insurance. Insurance against very bad things happening on the capital flow front. But it is self-insurance, and as we know from every context, whether it is insuring your life or your house or your boat or your yacht, self-insurance is not efficient, either from the perspective of an individual country or from the perspective of the world at large. But once one keys in on the word insurance, maybe there is a solution. So I have proposed, and good ideas take time to win their way through. So this is not a new idea. It's an idea I've been peddling for a number of years. The solution is simply to have a global liquidity insurance mechanism. And the idea here is that you set up an insurance pool, and basically you charge each country a premium, and that premium, and this is very important, would be based on observable fundamentals. So when I pay for car insurance, you know, the insurer knows my age, my drinking habits, whether I have kids, one of whom remarkably is present in the room listening to my lecture and so far is still awake. And it turns out that one can come up with these criteria, but the critical thing is that it needs to be publicly known. The moment you say that, like a credit rating agency or the IMF, that there will be an unclear rule that is going to determine if a country can get access to this insurance, all hope is gone, because then there is a stigma effect associated with their insurance. And then one can dress up this scheme. You know, countries with poorer policies, you know, higher deficit-to-GDP ratios, higher debt ratios, higher current account deficits, pay a higher premium. If you want more insurance, you pay a higher premium, and you can jazz this up with nonlinearities in the premium schedule and so on. But what is critical is also that this is not going to deal with solvency problems. This would give countries in the pool access to a one-year line of credit. So if you have a liquidity problem, you get access to this line of credit. And maybe just the fact that you have access to a line of credit reduces the pressure that financial markets put on you. If you have a solvency problem, it won't work. If you're Greece, first of all, your premiums would be through the roof. And second, you have a solvency problem. So a one-year line of credit would not really help you very much. There is still some element of cooperation that is needed here in my original vision of this proposal, but I think this can be worked around. Essentially, the premiums are collected, and you know, a few of us in this room can do it. You know, Michael, Sumit, Philip, and I can get together in a room and we can run this pool by ourselves, because you just collect premiums based on the schedule, invest in high-quality government bonds, and that's done. From the point of view of the insuring countries, this could be cheaper than the quasi-fiscal cost of sterilizing reserve accumulation, and it's a relatively modest premium.
And of course, to deal with the stigma effect, one would have to put in some conditions that, you know, if you as a country don't sign up to this, maybe you cannot be part of some international institutions. So one would have to come up with a way of dealing with this in terms of increasing collective membership. One might ask, why can't the IMF do this? It could. The IMF has very good people working for it, but the IMF also has a surveillance function. So despite all the IMF attempts to put in place these lending programs that are based on ex-ante conditionality, there isn't much demand. There are just three countries that took on what was called the flexible credit line: Mexico, Poland, Colombia. And after a great deal of hand-wringing, one year the IMF might say you are eligible for the flexible credit line, next year it might decide you are not because you're not so good, and then markets start coming to your door, the wolves come to your door. The IMF wisely set up a second line called the Precautionary and Liquidity Line. These are for countries that have not perfect policies, but pretty good. Guess how many countries signed up for that? One. Who wants to be in a group where you're told that, you know, you don't have the best policies, but you're kind of okay? So in a sense, you end up with this world where it's impossible, in a sense, for the IMF to reconcile its surveillance and conditionality functions. So I think what we need to do is take the politicization out of this, because at one level one could argue that setting up bilateral, multilateral swap lines would be the way to do this, but I think we need a much more transparent mechanism. So all that's needed really is to come up with agreement on what sort of variables would go into this formula, determine the premium schedule, and you're off to the races. Now, of course, I'm oversimplifying a little bit here because the devil is in the details, trying to think about exactly how you would set up the premium schedule, but one could argue that is a technical problem, not a policy or political problem. So again, this is not to say that we have very clear paths out, but I think we are at a juncture right now where we have to recognize that the alternatives are not good.
The ideal world is certainly one where major reserve currency providers get their acts together and we have serious, credible, trusted alternatives on the table. That does not seem likely right now. So that leaves us with two very unsavory alternatives. And you know, as I speak to emerging market central bankers, the general notion is that there is this volatility out there. This is becoming the norm. We have to deal with it, and we have to find ways, you know, individually or collectively within the region. I know Asia has this Chiang Mai Initiative Multilateralization. So these are very second or third best alternatives, I think, to a world where either individual countries get their acts together and we come up with a more stable system, or we start fixing the rules of the game in a way that can engender more stability. So again, this is not a great story about, like I said, the triumph of good over evil, but I think there is still some good in individual countries, in international financial markets. The challenge before all of us really is to pull it all together and make it work. Thank you. [applause]
