Developing Countries Should Diversify Out of U.S. Treasury Bills: Lawrence Summers

June 19, 2006

Lawrence SummersHarvard President Lawrence Summers, a former U.S. treasury secretary and World Bank chief economist, has suggested that developing countries with unusually high levels of reserves shift part of their holdings from U.S. government debt to a diversified international stock and bond portfolio. Such a shift, he said, would generate higher returns that developing countries could use to improve the lives of their people.

"Think about it. If a country is able to deploy ten percent of GNP in a way that produces an extra five percent return, that is half a percent a year in free money to the central government," Summers told a packed Center for Global Development (CGD) audience last week. "This, in societies where hundreds of millions of people are still desperately poor," he said.

Summers presented a series of slides showing that developing country reserves had reached historically unprecedented levels, not only in the very large economies such as China and India, but even in some smaller African economies, such as Botswana, Lesotho and Nigeria. Nearly all of these reserves, which total some three trillion dollars globally, are invested in U.S. Treasury bills that earn about two percent per year after accounting for inflation, he said. (Access the full transcript or watch the video.)

By comparison, he said, a diversified international portfolio of stocks and bonds could earn a return several times higher, especially if a widely predicted depreciation of the U.S. dollar against foreign currencies is taken into account. The speech represented a further development of ideas he first proposed at a recent lecture to the Reserve Bank of India in Mumbai.

"Developing country reserves are far in excess of what is necessary to defend against the possibility of financial crisis," Summers told the CGD audience. "They certainly dwarf, in some cases by more than an order of magnitude, any imaginable IMF program."

Summers, who was speaking at the first annual lecture in memory of CGD founding board member Richard Sabot, said that by diversifying even a small portion of their reserves into an international portfolio, developing countries could diversify their foreign currency exposures. If history is a reasonable guide, returns would vary more year-to-year, but over the long run would almost certainly beat U.S. Treasuries, he said.

Summers said that moves to diversify reserves out of U.S. Treasury bills were already underway in a handful of countries, including Norway, Singapore and, at a lower level, South Korea. Diversification by other developing countries had been impeded, he said, by a lack of agreement about what constituted adequate reserves, and by understandable concern that without sound guidelines a little diversification could put countries on a "slippery slope" that would lead to unsound, speculative investments.

Central bank governors who might otherwise have diversified their countries' reserves face an "agency problem," he said. That is, if the investments earned high returns the officials would receive minor recognition; but if the investments went badly, which might well happen in the short-to-medium term, the officials would be harshly censured.

Summers said that these problems could be addressed if an international body were to establish appropriate guidelines. He also suggested that countries with limited financial management capacity could pay a small portion of the increased returns to an entity that would manage these new investments on behalf of the developing countries. These fees, he said, could be used to pay for international public goods (i.e. global responses to global problems, such as avian flu).


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