We next look at the global financial architecture as it stands today. Since there are too many details to discuss all aspects of the global financial architecture, we focus on a few features that affect capital flow and regulation and currency volatility. These features include:

Existence of a Global Reserve Currency Hegemony Comprised of Limited Countries or Regions

Currently, the dollar is the most widely used global reserve currency. The willingness of foreign governments to hold dollar-denominated foreign currency securities has allowed the US to operate under prodigious national and trade deficits. Because of this, the US has had de facto unlimited credit to purchase goods and services from abroad. Some scholars and financiers, such as George Soros (see Chinn and Frankel 2008; Conway 2008) predicted that the euro would overtake the dollar as the largest international reserve currency (although this has been a subject of debate due to Europe’s deep involvement in the global crisis of 2008), but this may simply shift the balance of financial and purchasing power to another region, and concentrated reserve currency power will continue to exacerbate trade and financial imbalances. A better solution would be what Frankel (2009) promotes as “a multiple international currency system.” In this type of system, the dollar would lose its dominance as a global reserve currency and other currencies, such as the euro, yen, and in time, the renminbi, could join the dollar as important stores of international reserves.

An associated problem is the issue of “original sin,” in which emerging markets in particular cannot borrow abroad in their own currency. Therefore, when these countries accumulate a net debt, they develop an aggregate currency mismatch on their balance sheets. As Eichengreen et al. (2004) show, “original sin” has important stability and economic implications in terms of both policies and outcomes. Developing country domestic policies cannot be used wholesale to encourage growth within the country; many of the policies must be oriented toward servicing the international debt and maintaining a stable exchange rate. Debt denominated in foreign currency, in emerging markets with pegged exchange rates, requires developing countries to balance foreign currency borrowing with the trade deficit and foreign currency reserves in order to maintain a pegged exchange rate. Foreign exchange reserves are necessary to sell in order to uphold the value of the domestic currency when exports decline or currency demand falls. Balance sheet crises can occur, either from holding debt in short-term foreign currency, or from a currency mismatch in corpoTable 1.1 International bonded debt, by country groups and currencies, 1991-2001

Total debt instruments issued by residents (%)

Total debt instruments issued by residents in own currency (%)

Total debt instruments issued in groups’ currency (%)

Major financial centers








Other developed countries




Developing countries













Note: Major financial centers include the US, Japan, the United Kingdom, and Switzerland.

Source: Eichengreen et al. (2004), Bank for International Settlements.

rate balance sheets (Jeanne and Zettelmeyer 2004). The label “original sin” is appropriate since denominating debt in foreign currency can cause many other problems originating from the currency regime.

As a mirror image of the problem, US data from 2001 show that developed countries are more often willing to expose themselves to developing country credit risk rather than developing country currency risk, which may be more financially fragile. Table 1.1 describes total debt issued in countries’ own currencies.

As seen in Table 1.1, the major financial centers are able to issue much or most of their debt in their own currencies, while other countries do not share that privilege. If developing countries experience “original sin,” developed countries encourage the sinners.

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