ims which are particularly relevant in thinking about this question. the first is financial globalisation which has totally transformed the landscape over the past two decades. total financial wealth has risen sharply relative to gdp ; and investors are now able and willing to hold a higher proportion of their portfolios in external assets. the trend to larger external asset and liabilities has been particularly significant in industrial countries, whose external assets and liabilities relative to output roughly tripled between 1990 and 2003, reaching average levels of more than 200 per cent of gdp. this has two effects. first, the expansion in external balance sheets has relaxed the constraints on the financing of countries ’ savings and investment imbalances. and second, balance sheet effects can have material impacts – affecting the link between current account deficits and external debt burdens, as well as the external adjustment process itself. a corollary of financial globalisation has been the increased importance of market forces, rather than institutionalised inter government agreements, in providing incentives for policy makers within systemically important countries or regions to follow policies that are mutually consistent – notwithstanding the longevity of the bretton woods sisters ( the imf and the world bank ). the second important feature of today ’ s world is the rising economic importance of a group of asian emerging market economies who heavily manage their exchange rates. as a result, the international monetary system has mutated into a ‘ hybrid ’ system in which some systemic countries float their exchange rates while others fix or manage them. one implication is that the pressure for adjustment to any given shock can be very asymmetric relative to a floating rate world. thus, market driven exchange rate changes are likely to be concentrated on particular blocs rather than diffused across the system as a whole. as obstfeld and rogoff and others have pointed out, this is a situation which could create some difficult policy frictions. these have the potential to undermine free trade, and weaken world growth. the third feature is the continued dominance of the us dollar as both a reserve currency as well an anchor for those countries that choose to fix or manage their exchange rates. but nowadays countries have choices. they might fix against the dollar but choose to hold at least a portion of their reserves in other major currencies. since the advent of the euro, the dollar is no longer the only credible reserve currency. how do these features of the international monetary system affect the risks associated with today ’ s imbalances? financial globalisation has relaxed the constraints on

our respective financial systems. but the soundness of any of the global firms that are a major part of those systems is a function of the standards imposed on the group and its major subsidiaries in many jurisdictions. none of this necessarily argues for full harmonization of liquidity standards in the way that capital standards have been harmonized. but each jurisdiction inevitably relies to a degree on liquidity standards imposed elsewhere to ensure the soundness of potentially systemically significant firms. central banks and regulators need at least, therefore, to come to a common understanding of what they are individually seeking to achieve with liquidity regulation. are we, for example, seeking with such regulation to limit the likelihood of crisis, or the impact of a crisis should one arise, or both? what sort of liquidity problems are envisaged in the regulation? most importantly, we should seek a common understanding of the dividing line between ex ante insurance, and ex post resolution. 5. conclusion this is my last financial stability speech as deputy governor and i would like to leave you with several thoughts. first, i can ’ t help feeling that it is at times such as this, when we have a relatively benign environment, that we should seek to address difficult and contentious issues of the kind i have been discussing. it is certainly true that the risk transfer markets and the financial system have coped, with remarkable success, and with few signs of instability, with the various events and shocks in recent years. but we need to be sure that we are not complacent in placing trust in the ability of the financial system to continue to absorb shocks smoothly. second, policy makers have found it hard to discuss lender of last resort issues because they can so quickly raise the spectre of moral hazard : by giving too many clues to their likely response to instability, policy makers fear undermining market discipline and so making crises more likely. equally, public policy makers should recognise the distinction between clarity about processes — where transparency to my mind can only be positive for confidence — and transparency about how decisions might be reached in a particular case, where constructive ambiguity remains important as a mechanism to reinforce market discipline. on the other side of the fence, banks and financial institutions have made impressive strides in coping with these realities, but may be reluctant to move explicitly to transparent best practice standards. maybe this is for fear of giving up competitive advantage, or maybe it is a fear that regulators might seek to impose unwelcome prescription in how they manage liquid