One frequently repeated mantra by optimists in the current global financial turmoil is that ‘such-and-such-country has massive foreign currency reserves’ with which to protect itself from a bigger crisis. Among emerging markets, China, Russia, India, Taiwan, South Korea and Brazil are often cited as examples.

However, this ignores a crucial point, namely that these reserves are rarely available for rapid deployment, as this article in yesterday’s Financial Times highlights. For example, around 60% of China’s US$1.9 trillion of forex reserves are invested in US Treasuries or other American government securities. Yet if China were to cash these in immediately to support its financial system (or other countries’ financial systems), it would risk creating far bigger problems. Firstly, a sudden withdrawal of hundreds of billions of dollars from the US bond market would cause US Treasury yields to spike, raising the cost for Americans of financing their deficit. Secondly, converting all those dollars into Chinese yuan would cause the latter to soar in value – precisely something that China wishes to avoid. Indeed, Beijing has been halting the yuan’s appreciation of late.

Another problem with reserves is that governments may be overstating them, for all I know. In his memoirs, In An Uncertain World, Robert Rubin, who was US Treasury Secretary at the time of the emerging markets financial meltdown in 1997-98, stated that…

‘the [Thai] government had been hiding the extent of its currency intervention [to prop up the baht] by selling dollars on the forward market. This meant that although the Thai central bank showed reserves on its books, almost none of those reserves were usable: the central bank had already promised to deliver them to someone else in future, at a price that was by now highly disadvantageous for Thailand’ (p221, paperback edition).

Barely 10 pages later, Rubin states almost the same thing about South Korea’s nominal US$30 billion reserves, namely that they were basically gone by the time the IMF pored over the books.

This leads me to my next point, namely that reserves can dwindle with surprising rapidity. South Korea has already spent tens of billions this year in a futile effort to prop up the won. Elsewhere, Russia has seen its reserves fall from US$596 billion to US$531 billion in the space of just nine weeks, as the government has acted to prop up the currency and banking system. In other words, a few more months of frenetic intervention can take reserve levels below that required to pay short-term foreign debt coming due. While having massive reserves is better than having none or very little, a degree of caution is merited.

As Karl Marx once wrote, ‘All that is solid melts into air’.