Moreover, those countries most at risk from capital flight are not necessarily those with the highest reserves. Scaling countries’ reserves by measures of their external short-term indebtedness suggests a highly-uneven pattern (Chart 16), with a number of countries holding less than would be needed to meet a year’s worth of capital outflows. Third, this pattern is broadly mirrored when moving from measures of self-insurance, such as reserves, to official financing measures. Chart 17 scales IMF resources by external assets. Since the 1980s, this measure has roughly halved from 3% to 1.5%. And fourth, even once we augment multilateral financing with measures of regional official financing, total official resources relative to external assets are still shy of their levels in 1980. Taken in combination, this paints a picture of an international monetary system whose underlying topology has fundamentally changed shape and scale – much larger, much more connected. But it is also a system whose architecture may have failed to keep pace with those changes. Therein lies a key potential fault-line. Strengthening the system This naturally begs the question – what might be done to close this fault-line, to improve the resilience of the international monetary system? One response would be to retreat from financial globalisation by re-imposing barriers to capital movement, unravelling the tightlywoven knitting of the global financial web. We have seen this movie before. It opened in the aftermath of the Great Depression and ended in disaster.

For example,  BIS central bankers’ speeches  7  a negative shock to a country’s income prospects will tend to raise debt sustainability concerns and hence borrowing costs, thereby worsening sustainability. Another friction is that, once internationally-held debt becomes unsustainable, restructuring it is usually a messy process because of the lack of an internationally-agreed legal framework. In part for that reason, countries have tended to delay tackling unsustainable debt. But if debt is truly unsustainable, delay tends to further worsen debt dynamics, ultimately increasing costs for both debtors and creditors (Krugman (1988)). These contractual frictions can make debt a fickle friend. They will tend to aggravate debt sustainability and debtor prevarication problems, thereby encouraging investors to withdraw credit at the first sign of trouble – so-called “sudden stops” (Calvo (1998)). These frictions are well-illustrated by historical sovereign debt restructuring experience, most recently in emerging market economies such as Argentina. Yet it is widely accepted that there are straightforward contractual solutions to these debt problems. One is to issue debt instruments whose contractual features reduce pro-cyclicality, such as GDP-linked bonds. Their repayment profile adjusts with a country’s ability to pay, thereby acting counter-cyclically and quasi-automatically to defuse repayment risk (Shiller (1993 and 2003), Barr et al (2014)). The impact of such instruments on debt dynamics could be significant. A recent Bank of England study considered the debt-to-income ratios of the G7 countries, given shocks to growth and real interest rates, comparing conventional and GDP-linked debt. The latter cut the variability of G7 debt-to-income ratios in half.