Endnotes

¹Monetary Independence is defined as: MI = ^{0.5[1-corr(i_i, i_j)]} , where i refers to home countries and j to the base country. Exchange Rate Stability (ERS) is defined as ERS = 0.01/[0.01 + stdev(Δ(log(exch_rate)))]. II also apply a threshold to the exchange rate movement as has been done in the literature. Financial Openness/Integration is the Chinn and Ito index, which is based on information regarding restrictions in the IMF's Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER) (see Aizenman, Chinn, and Ito [2008] for further details).

²I am grateful to Yeonho Lee for sharing the data. See Aizenman, Lee, and Rhee (2007), where I show that the 1997–8 crisis led to structural changes in the hoarding of Korea's international reserves—the Korean monetary authority gives much greater attention to a broader notion of ”hot money,” inclusive of short-term debt and foreigners' shareholding.

³The Bank of Russia adopted a bailout package similar to the Korean one, dealing with domestic banks' exposure. The Russian package was implemented in the context of intense involvement of the Russian state in managing its vast natural resources, including a willingness to impose what amounted to de facto capital controls. Russia's large stock of reserves before the crisis (exceeding US$600 billion) had prevented a complete collapse of its banking system.

⁴The EMs' sample is composed of the countries listed in the FTSE (The Financial Times and Stock Exchange) and MSCI (Morgan Stanley Capital International) emerging market indexes. It did not include Singapore and Hong Kong, China because of their special economic structure, specializing in entrepôt services. In addition, due to the dramatic effect of the IMF's aid on Hungary's reserves changes, it was excluded from the sample Hungary's IR had increased nearly by half in the two months after the IMF's stabilization package). The study also excluded Morocco and Pakistan due to unavailability of the relevant data.

⁵Countries facing large losses in stocks of IR include Brazil (BRA), India (IND), Indonesia (IDN), Malaysia (MYS), Korea (KOR), Peru (PER), Poland (POL), Russia (RUS), and Turkey (TUR).

⁶The ECB was a minor player in the provision of credit lines during the first quarters of the crisis. It provided Hungary and Poland with repo lines (Euros in exchange for eligible collateral), of €5 and €10 Billion, respectively. In contrast, the Bank Of China provided significant CNY swap lines to its trading partners—CNY70, 200, 100, 180, 80 Billions to Argentina; Hong Kong, China; Indonesia; Korea; and Malaysia, respectively (I am grateful to Shahin Vallee for providing the information). While useful, it's not clear that the CNY swap lines sufficed to deal with the US dollar shortages of some of these countries in the peak of the crisis.

⁷Our model follows the tradition of Bryant (1980) or Diamond and Dybvig (1993) in that the source of liquidity shock lies with the lender, rather than the borrower (Holmstrom and Tirole 1998). However, our model assumes away the market equilibrium among lenders (be it the risk of runs or the difficulty of the decentralized provision of liquidity). Abstracting from the question whether market-based liquidity insurance is available, I focus on the implication of large adjustment cost—including but not restricted to the liquidation cost—on the demand for reserves as self insurance. In a similar vein, no distinction is made between the private sector and the monetary authorities which maintain the stock of international reserves.

⁸Bhattacharya and Gale (1987) investigated this externality in banking, as did Caballero and Krishnamurthy (2004) in international finance.

⁹See Levy Yeyati (2008) for the moral hazard challenge facing the central bank in a dollarized economy.

¹⁰The design of the Federal Deposit Insurance Corporation (FDIC) deposit insurance scheme in the US may be viewed as generating similar outcomes as the tax-cum-subsidy scheme outlined in this paper. The FDIC charges insurance premiums on bank deposits at a rate that ideally should reflect the riskiness of banks' investments. The insurance premium is akin to a tax on banks' borrowing. The provision of insurance by the FDIC acts in ways similar to subsidizing hoarding liquid resources to provide self insurance.

¹¹This section overviews the discussion in Aizenman, Jinjarak, and Park (2009).

¹²See McKinnon (2007) for an upbeat view of the “dollar standard,” and Dooley et al. (2009) for Bretton Woods II.

¹³On the historical account of the early 19th century, Flandreau and Jobst (2009) find evidence in line with the prediction of Charles Kindleberger that currencies become international due to the importance of size (and thus the share in international trade), distance and inventory cost, consistent with the search-theoretic models of international currencies.

¹⁴Both trends are more pronounced for the emerging markets than for the non-emerging developing countries.

¹⁵See Obstfeld and Rogoff (2005), regarding the links between growing external debt-to-GDP ratio of the US and the future real depreciation of the US dollar as well as recent estimates of the deteriorating US external net liability position.

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