China is not the only emerging market in which the central bank has been accumulating reserves. In Latin America, as well as in other emerging markets, central banks have been accumulating reserves.

The most dramatic run-up in Latin America is in Brazil, where reserves, which were a cause for IMF concern in 2000, now top US$150bn. The big economic questions, addressed by the Bank for International Settlements (BIS) in its recent annual report, are; what purpose do reserves have in a modern economy and are central banks the appropriate institutions to manage reserves?

Asia, especially China which has been accumulating reserves at what even the BIS hints is a destabilising rate, is starting to believe that perhaps central banks are not the right institutions to manage reserves. Worth noting is that China has formed links with a US private equity firm, Blackstone, which astutely floated on the New York Stock market just before the current bout of financial jitters. The plan seems to be that Blackstone will help China's central bank diversify its reserves which are assumed, by financial markets, to be almost entirely invested in US Treasury securities. Blackstone reportedly advised China to back (the failed) take-over by the British bank Barclays of ABN-AMRO a leading Dutch bank. More interesting still is that influential economic officials in China have also hinted that some the reserves will be used in fund to buy strategic stockpiles of commodities.

The US has no use for reserves as it prints dollars, which has been the world's reserve currency since the eclipse of sterling. It has been managing strategic stockpiles for the past 50 years. The management of its stockpiles of oil and base metals has a major effect on commodity markets. The US tends to buy when prices are low and sell when they are high.

What the table overleaf shows is how reserves have changed in the past six years. For Latin America (which the BIS define as Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela) the big change has been in the ratio between reserves and short-term debt. Reserves are now twice the value of these countries short-term (up to one-year) debt. Eastern Europe is the only region where the ratio has moved in the opposite direction: this is probably because so many East European countries have joined, or are on their way to joining, the Euro.

Another interesting point from the BIS table is how little monetary illusion has changed in Latin America. In 2000, when convertibility in Argentina was still the rage, reserves were equivalent only to 23% of broad money. Under convertibility the central bank tied money supply to reserves. These reserves were supposed to be generated in the traditional way by exports but as convertibility decayed foreign borrowing was used to beef up the money supply.

Now the figure for the whole of Latin America is up, but only to 25%. Compare this with the changes in China (10% to 24%) and Russia (44% to 77%). This suggests that depositors in China and Russia have little confidence in the banking system. Odder still is the data received from Japan, which suggests that the authorities are still continuing to pump out money into the economy to try to get it moving. In industrialised countries monetary illusion is complete: Bank of England bank notes still promise to pay the bearer, but what the bearer will get is unclear. Reserves are a negligible backing to the money supply in industrialised economies.

Bizarrely, the only Latin American economy to have addressed these issues discussed by the BIS is Venezuela. President Hugo Chávez has an undervalued reputation as an economist. His instinct that central bank reserves -which are reaching 25% of GDP- were far too high is clearly correct. Orthodox economists may quibble at the way he raided the central bank's reserves to pump up public spending, but the policy is clearly right.

What is odd about Chávez 's lead is how few other governments have followed. Peru, a country with pressing social problems, has the equivalent of 12% of GDP sitting in the central bank. The big question is what Brazil will now do; its reserves, by far the biggest in the region, will, on current trends, be equivalent to the whole of the public sector's foreign debt in 12 months time.

Brazil's choice will be particularly interesting because the Real is slowly internationalising as a currency. The BIS notes that in several emerging countries where reserves exceed liquidity needs, domestic monetary policy is becoming more closely watched than central bank reserve levels as a measure of a country's credit-worthiness.

Other Latin American countries, notably Chile, have already set up funds outside the central bank to manage windfalls. These funds are used mostly to ensure that the budget does not become unhinged. The surge in reserves across the region poses a completely new set of questions that will demand new answers.

Source: BIS