Jan. 31 (Bloomberg) -- Statistically speaking, there's nothing `normal,' or bell-shaped, about the way $6 trillion in foreign-exchange reserves is distributed around the world.
The top five holders control more than half of these assets, with China alone accounting for 24 percent of the total.
At the other end of the spectrum, the combined official reserves of 70 nations add up to less than 1 percent.
To the extent the monetary authority's impetus to accumulate foreign-currency assets stems from a desire to seek a competitive advantage in foreign trade, why isn't mercantilism a more evenly shared trait?
An interesting new study by Mariusz Sumlinski, an economist at the International Monetary Fund in Washington, shows that the observed inequality in reserve buildup may be quite predictable. In fact, the asymmetry is just what one would expect to see under Zipf's law.
Harvard linguist George Kingsley Zipf postulated in 1949 that if we rank words by the incidence of their occurrences in speech or text then the number of times a word is used will be inversely proportional to its place in the frequency table.
From the population of U.S. cities to traffic on the Internet and stock-market returns in South Korea, researchers have plotted all kinds of rank-size distributions on log paper and found evidence of Zipf's law, which shows up as a straight line running from the top-left to the bottom-right corner.
Distribution of Reserves
Mathematician Benoit Mandelbrot, who discovered such a relationship for U.S. cotton prices in 1963, used it as a building block of a new ``fractal'' theory of financial markets.
Sumlinski has now extended the analysis to foreign reserves, and he finds that Zipf's rule, when applied to the distribution of as much as 90 percent of worldwide official assets, fits the data very well. And that isn't all.
Zipf's prediction is found to be valid across different exchange-rate arrangements, from the post-World War II period of fixed (but adjustable) currencies to the more flexible system that began in 1978 and continues until now.
The characters change; the plot remains the same. In 1948, India had 20 percent of the world's reserves; by 1955, the top slot had gone to Germany.
At the time of the collapse of the Bretton Woods regime of exchange rates in 1971, Japan and Germany together controlled 31 percent of reserves.
``As the evidence of Zipf's law is robust over time, it can be viewed as a useful predictor of the distribution of projected international reserves going forward,'' Sumlinski says.
If massive inequality in the distribution of reserves is an inviolable empirical truth, then there needs to be a mechanism to redistribute at least part of the mercantile gains reaped by a few nations amid a large number of have-nots.
Precaution or Manipulation?
The Asian financial crisis of 1997-98 so badly damaged the region's confidence about its ability to sustain capital inflows that it decided to build a war chest as an insurance policy.
But the precautionary motive can't be limitless.
``Eventually reserves are enough to protect against everything except Armageddon,'' former IMF Chief Economist Raghuram Rajan and Cornell University's Eswar Prasad noted in an October 2005 paper. ``With the precautionary value falling, and explicit financing costs rising, reserve accumulation creates a growing strain on government finances, in addition to creating a perception of exchange rate manipulation in some cases.''
In the past two years, China's reserves have doubled to $1.5 trillion. India's war chest has swelled by a similar amount to $285 billion. Russia, whose official foreign-currency assets include tax revenue on oil wealth, has seen reserves triple to $478 billion. The global total has gone up by 56 percent.
No Return
If Sumlinski's analysis is right, it may be quite futile to expect a return of emerging-market reserves to any ``optimal'' level in relation to either the size of the economy or any measure of openness to trade and capital flows.
Just as wealth gaps in society have been -- and perhaps will remain -- much larger than, say, the differences in adult heights, the dominance of reserves by a small set of countries (albeit with changing membership) may also persist indefinitely.
Who can say if politicians in China won't one day be squirming about U.S. sovereign wealth funds buying strategic Chinese assets using the Federal Reserve's yuan reserves?
The top five holders control more than half of these assets, with China alone accounting for 24 percent of the total.
At the other end of the spectrum, the combined official reserves of 70 nations add up to less than 1 percent.
To the extent the monetary authority's impetus to accumulate foreign-currency assets stems from a desire to seek a competitive advantage in foreign trade, why isn't mercantilism a more evenly shared trait?
An interesting new study by Mariusz Sumlinski, an economist at the International Monetary Fund in Washington, shows that the observed inequality in reserve buildup may be quite predictable. In fact, the asymmetry is just what one would expect to see under Zipf's law.
Harvard linguist George Kingsley Zipf postulated in 1949 that if we rank words by the incidence of their occurrences in speech or text then the number of times a word is used will be inversely proportional to its place in the frequency table.
From the population of U.S. cities to traffic on the Internet and stock-market returns in South Korea, researchers have plotted all kinds of rank-size distributions on log paper and found evidence of Zipf's law, which shows up as a straight line running from the top-left to the bottom-right corner.
Distribution of Reserves
Mathematician Benoit Mandelbrot, who discovered such a relationship for U.S. cotton prices in 1963, used it as a building block of a new ``fractal'' theory of financial markets.
Sumlinski has now extended the analysis to foreign reserves, and he finds that Zipf's rule, when applied to the distribution of as much as 90 percent of worldwide official assets, fits the data very well. And that isn't all.
Zipf's prediction is found to be valid across different exchange-rate arrangements, from the post-World War II period of fixed (but adjustable) currencies to the more flexible system that began in 1978 and continues until now.
The characters change; the plot remains the same. In 1948, India had 20 percent of the world's reserves; by 1955, the top slot had gone to Germany.
At the time of the collapse of the Bretton Woods regime of exchange rates in 1971, Japan and Germany together controlled 31 percent of reserves.
``As the evidence of Zipf's law is robust over time, it can be viewed as a useful predictor of the distribution of projected international reserves going forward,'' Sumlinski says.
If massive inequality in the distribution of reserves is an inviolable empirical truth, then there needs to be a mechanism to redistribute at least part of the mercantile gains reaped by a few nations amid a large number of have-nots.
Precaution or Manipulation?
The Asian financial crisis of 1997-98 so badly damaged the region's confidence about its ability to sustain capital inflows that it decided to build a war chest as an insurance policy.
But the precautionary motive can't be limitless.
``Eventually reserves are enough to protect against everything except Armageddon,'' former IMF Chief Economist Raghuram Rajan and Cornell University's Eswar Prasad noted in an October 2005 paper. ``With the precautionary value falling, and explicit financing costs rising, reserve accumulation creates a growing strain on government finances, in addition to creating a perception of exchange rate manipulation in some cases.''
In the past two years, China's reserves have doubled to $1.5 trillion. India's war chest has swelled by a similar amount to $285 billion. Russia, whose official foreign-currency assets include tax revenue on oil wealth, has seen reserves triple to $478 billion. The global total has gone up by 56 percent.
No Return
If Sumlinski's analysis is right, it may be quite futile to expect a return of emerging-market reserves to any ``optimal'' level in relation to either the size of the economy or any measure of openness to trade and capital flows.
Just as wealth gaps in society have been -- and perhaps will remain -- much larger than, say, the differences in adult heights, the dominance of reserves by a small set of countries (albeit with changing membership) may also persist indefinitely.
Who can say if politicians in China won't one day be squirming about U.S. sovereign wealth funds buying strategic Chinese assets using the Federal Reserve's yuan reserves?
Commentary by Andy Mukherjee, Bloomberg
Posts
0 comments
Post a Comment