Can Developing Countries Afford to Hold Dollar Reserves?
IMF Warnings of Dollar's Overvaluation Should be Heeded, Say Economists
For Immediate Release: September 29, 2004
Contact: Debbi Karr, 202- 387-5080
When the G-7 finance ministers meet in Washington later this week, followed
by the IMF and World Bank meetings, exchange rates will be on the agenda. In a
new Center for Economic and Policy Research (CEPR) report, "Going
Down with the Dollar: The Cost to Developing Countries of a Declining
Dollar " by Mark Weisbrot, David Rosnick, and Dean Baker, the authors
find that developing countries can be expected to incur substantial losses from
holding dollar reserves. These losses are comparable with the gains that
developing countries would get from complete trade liberalization by the rich
countries, including the removal of all rich country barriers to developing
countries' merchandise exports.
"The IMF has been warning that the dollar is overvalued, but they should
do more," said CEPR co-Director Mark Weisbrot, a co-author of the report.
"The institution was established 60 years ago to manage global exchange
rates, and these are seriously out of alignment right now."
Developing countries now hold an amount of reserves that is on average more
than 10 percent of their GDP, and in many cases exceeds 20 percent of GDP. The
current overvaluation of the dollar, and thus its impending decline, means that
those countries that hold large amounts of dollar reserves will not see the
expected return from holding those reserves.
The dollar is widely recognized to be seriously over-valued. The United
States current account deficit expanded to $660 billion in the second quarter of
2004, or 5.7 percent of GDP. This deficit can only be brought down to a
manageable level through a sharp decline in the value of the dollar.
Looking at a sample of reserve holdings among developing countries, the
authors find that the drop in the dollar will lead to a loss in the value of
reserve holdings of between 1.8 percent and 5.6 percent of GDP, for the typical
These are enormous potential losses, but easily preventable. If developing
countries simply traded the bulk of their dollar reserves for a currency more
likely to maintain its value, such as the euro or the Japanese yen, they could
insulate themselves from the effects of a falling dollar.