at the end of 2005. one factor contributing to this buildup of reserves is that some of these countries, most notably china, have been operating with fixed or tightly managed exchange rates ( vis - a - vis the u. s. dollar ) that are widely considered to be undervalued. these large imbalances are not sustainable over the longer run. no country, even one as big as the united states, can keep increasing its external indebtedness as a share of its gdp. ultimately, these imbalances will have to be resolved. but this won't be simple. first, resolving the imbalances is not a short - term issue — it will take time. second, what is needed is multi - faceted international policy action. part of the solution involves an increase in u. s. national savings. but higher u. s. savings means lower u. s. consumption, which would likely mean lower canadian exports to the united states. to avoid the dampening effect that lower u. s. spending could have on overall global demand, other industrialized countries need to adopt policies that promote stronger domestic demand. but this won't be enough. when significant global imbalances last emerged, in the mid - 1980s, they largely occurred among the industrialized economies. that is not the case today. as i said before, major new players have appeared on the global scene. i'm referring primarily to the emerging economies of asia. so, the resolution of today's imbalances requires that these countries, too, contribute through stronger growth in domestic demand rather than exports. but this shift towards greater domestic demand growth in asia will not come about smoothly if those countries currently operating under fixed or tightly managed exchange rates do not begin to promote greater nominal exchange rate flexibility. if this does not happen, there is a risk that countries with floating exchange rates, like canada, may have to bear more than their fair share of the burden of resolving the imbalances. there is also a risk that protectionist measures could be taken worldwide, hurting all trading nations, including canada. for these reasons, the bank of canada has been on the side of the debate that advocates greater exchange rate flexibility for china and other asian countries. but equally importantly, we have also argued that greater exchange rate flexibility in those countries will, in fact, best serve their own needs, in terms of promoting sustained economic growth through stronger domestic demand and an efficient allocation of resources. now

this manner. the alm framework, which allows us to earn a positive net return, is consistent with our floating currency. indeed, if we intervened continuously, we would not be able to match assets to liabilities. this approach has proven to be an effective way to minimize interest rate and foreign exchange risk to the government ’ s fiscal position. however, there is still residual market risk that is derived from the credit - spread exposures inherent in the assets and liabilities — and the lack of perfect correlation between the two. since the efa is predominantly funded with cross - currency swaps, there are non - zero levels of basis risk. there is also an element of credit risk, both with regard to the issuers of reserve assets and swap counterparties. we conduct our own risk assessments, including credit risk, which we have significantly enhanced in response to the financial stability board ’ s call to reduce reliance on credit rating agencies. in large measure, the difference between our approach to reserve management and those of other reserve managers is related to the relatively small size of our reserves, our alm framework and our focus on liquidity. in their pursuit of higher returns, many countries are pushed to explore alternative asset classes, such as higher - yielding bonds and equities. moreover, most countries have a net asset position, which means they have outright exposure to currency movements. this increases the need for diversification into other currencies. because our portfolio is assetliability matched, volatility in currency markets is a lesser concern to us. i should say a brief word here about gold. some countries continue to hold portions of their reserves in gold, sometimes for symbolic reasons. canada doesn ’ t. in 1980 the government implemented a policy of selling its gold at a gradual and controlled pace to enhance the return for the efa. gold bullion is not considered as liquid as, for example, us treasury securities and, to the extent that physical delivery may be involved, could entail significant costs for secure transport and storage. as such, gold doesn ’ t fit well within the asset - matching framework. proceeds from gold sales were invested in high - quality, interest - bearing, foreign - currency assets. while these assets may not have the reassuring physical heft of a gold bar, we believe they are better suited to the purposes for which we hold reserves. the last of the government ’ s gold bullion was disposed of in 2003. the gold reserves that remained were coins, which have