Policy makers were looking to trade finance as a major channel. However, contagion takes time and cannot fully account for the exceptional synchronisation in the drop in output. With hindsight, the phenomenon may best be seen as a global liquidity shock. Net supply of liquidity dried up at the same time everywhere in the world. International banks faced a sudden and ample shortage of dollars. Firms started to hoard liquidity. Investment and, in part, production, came abruptly to a halt. When such a shock occurs, public provision of liquidity has to replace private provision. In a domestic context, this is the function of the lender of last resort. But when there is a shortage of foreign currency liquidity, this role has to be played by foreign exchange reserves. Following the 1997–98 crisis, emerging countries constantly sought to expand their foreign exchange reserves. The average reserve ratio of emerging markets has more than quintupled from 4 percent to over 20 percent of GDP since 1990. One cannot assume, however, that equilibrium has been reached and that the demand for reserves will stabilise. On the contrary, there are strong indications that this trend will persist, or even be amplified, following the crisis. This may be seen as undesirable but also unavoidable in the current financial architecture. No amount of reserves will fully protect a financially open economy against a systemic shock.

First, countries could come to a common understanding about the core elements and principles governing their financial markets development and regulations. Full harmonisation is neither desirable nor feasible. But policy‐induced divergences may prove very destabilising and lead to a reduction in welfare. It should be possible to agree on the core principles governing, for instance, capital account regimes, the treatment and resolution of internationally‐active financial institutions, deposit insurance, and the organization and functioning of securities markets. Divergences in financial development are a fact of life. Some of them reflect true social choices and preferences that must be respected and accommodated. Others result from deliberate or inadvertent policy‐induced distortions, which should have been reduced or eliminated. Disentangling these two sources of divergences in financial development should be a priority in the international agenda. Second, the search for an efficient and powerful “financial safety net” should be pursued. Stabilising the demand for international reserves would bring huge benefits in terms of world welfare. At present, reserve accumulation can only occur through a conjunction of balance of payment surplus and some degree of exchange rate intervention. In addition, if sterilisation proves difficult or impossible, it also leads to unwanted changes in monetary policy. Precautionary reserve accumulation, however legitimate, unavoidably creates side effects for domestic macro policies as well as spillover effects on other countries. All countries, therefore have a common interest in finding ways to disconnect reserve accumulation from exchange rate management and, more generally, from balance of payment situations and monetary policies. The difficulties, however, are huge.