countries. One could imagine reasonable technical criteria for determining those exposures. Banks that are below the exposure thresholds would rely on national central banks for lender of last resort functions and presumably for regulatory and supervisory functions as well. However, in theory, it would be possible to establish this idealized international lender of last resort. In addition, perhaps it could function with the use of variety of existing currencies – in which case, this lender of last resort role could be similar to granting the IMF authority to lend directly to commercial banks rather than governments. However, to allow a global central bank to play the role of lender of last resort to individual banks, it would be necessary for the global central bank or other global institution to regulate and supervise the individual banks directly. Therefore, there are a number of additional advantages and potential complications with the creation of a global currency that will be discussed in the next section of the paper.

In terms of its use in a lender of last resort function, a new global currency would need to be “freely usable” by national central banks (if they were to continue to exist) and accepted by commercial banks for liquidity support and for settling claims between banks. It should be noted that the SDR at this point cannot serve this function: it is only a unit of account. SDR-denominated bonds—issued by international financial institutions or countries—perhaps over time could serve a role eventually, but this would require market development. This market development would imply costs due to the need to develop a liquid market for the new instruments and thus lower bid-ask spreads. The IMF has estimated that the initial cost would be about 80 to 100 basis points for this liquidity premium.<sup>103</sup> A coordinated effort by several sovereigns and/or several multilateral institutions could help reduce these costs substantially. Finally, to be an efficient instrument for conducting lender of last resort operations, the global currency would need to be at least as “credible” as existing national currencies that serve as reserve currencies.

In addition to these “internationalist” (or “regionalist”) proposals, there is another alternative for emerging market economies: go at it alone. They can accumulate reserves and take initial steps towards “internationalizing” their currencies. International reserves can be drawn upon to make payments on foreign obligations during times of limited access to foreign currency capital markets. If a country is able to take the steps necessary to make their currency acceptable to foreigners as payment for transactions, they can then borrow from foreigners in their own currency. In this case, there is no need to access foreign currency when confronted with external shocks. This process is not an easy one, and as the historical survey above revealed, very few countries have ever been able to fully internationalize their currencies—even if there have been some fairly rapid and dramatic shifts in the global status of currencies over time.

Why do countries hold foreign currency reserves at all? In principle, under a pure floating exchange rate and perfect international capital markets, there is no need for reserves. In that hypothetical setting, there are no central bank purchases or sales of foreign currency on the foreign exchange market, and if capital markets are perfect, central banks can always borrow whenever foreign currency needs arise. In earlier times, with the gold standard, a negative balance of payments due to some external or domestic shock would result in a loss of gold. If the imbalance persisted, the loss of gold would lead to an eventual parity adjustment or outright abandonment of the gold standard. In more recent years, with the advent of much higher international capital flows, international reserves can be a self-insurance against the “sudden stops” alluded to above. In a survey of central bankers, the IMF found that about 80 percent cited “buffer for liquidity needs” as a motivation for increasing reserves, and about 60 percent cited “smoothing of exchange rate volatility” as another reason for building reserves (IMF, 2011c).

Following the crises of the 1980s and 1990s, the fear of “sudden stops” led to policy guidance in the form of reserve adequacy. For example, the Guidotti-Greenspan rule suggests that countries should

> 103 See IMF (2011b).  In particular, Annex 2 provides details on the calculation.

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