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1 In Reinhart and Reinhart (2008a and b), we refer to this act as a ‘capital flow bonanza.’
2 Such funding strains have frequently been sufficient to compel governments to default. This is why we find in
Reinhart and Reinhart (2008a) that episodes of capital flow bonanzas help to predict sovereign defaults.
prices spiralled upward only to crash. While the crash has constricted credit and
is redrawing the financial landscape, the US has not been punished by investors
in typical Act-Three fashion.
If this had happened to any other government in the world whose national
financial institutions were in as deep disarray as those of the US, investors would
have run for the hills – cutting off the offending nation from global capital markets.
But for the US, just the opposite has happened.
Rather than facing prohibitive costs of raising funds, US Treasury Bills have seen
yields fall in absolute terms and markedly in relative terms to the yields on private
instruments. This has been called a ‘flight to safety.’ But why do global investors
rush into a burning building at the first sign of smoke?
The answer lies in part with the exchange market practices of key emerging
market economies.
Since the last global market panic, the Asian Financial Crisis of 1998, many governments
have stockpiled dollars in their attempts to prevent their exchange rates
from appreciating. At the same time, the long upsurge in commodity prices has
swollen the coffers of many resource-rich nations. As a result, and as shown in the
latest forecast in the World Economic Outlook of the International Monetary
Fund, international reserves of emerging market economies are expected to have
increased $3.25 trillion in the last three years. According to the Fund’s survey of
the currency composition of those holdings, the bulk is in dollars (see Figure 1).
104 The First Global Financial Crisis of the 21st Century Part II
1995 1997 1999 2001 2003 2005 2007
All countries Industrial Developing
Figure 1 Dollar assets in allocated foreign exchange reserves
Source: IMF, Currency Composition of Official Foreign Exchange Reserves
share of total, percent
Is the US too big to fail? 105
The dollar portion of these reserves is most often invested in US government
securities, which offers excellent market liquidity, and US government debt is also
considered as safe as anything (following a precedent laid down by the first
Secretary of the Treasury, Alexander Hamilton).3 All this explains the dollar’s popularity
with foreign investors who might otherwise be expected to shun the US.
As the Figure 2 indicates, foreign official entities now own almost one-quarter of
outstanding government securities (the upper panel). These holdings of securities

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