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Phase 1: Benign neglect
Starting mostly as debtors, they either ignore the growing reserves or treat them as found money.

Phase 2: Sterilization
Heavy Fx inflows drive the currency and inflation up, threatening export competitiveness and domestic welfare.

The knee jerk reaction is to sterilize the inflows and suppress the currency by issuing domestic debt or just printing money.

IOW, what Geithner called China's “currency manipulation” in a far too rare moment of political honesty.

Phase 3: Liability and asset management:
Paying off foreign debt and activating Sovereign Wealth Funds to invest the reserves abroad.

Of course, judging by the massive SWF losses incurred so far in resurrecting foreign banks, it's moot whether they managed or damaged whatever assets they started with.

Phase 4: Embracing change
Building domestic demand.

Excellent point Cog. It's actually interesting to watch countries go through some of these various phases and see how much time they spend in each phase, if they decide to skip any, etc. South Korea is a very developed economy, but it's still very dependent on exports and foreign currency flows.

How these phases play out for Vietnam and others will be interesting to see too. Hopefully the volatility of oil in the past year has Vietnam hedging its bets a little (they had budgeted for $90 oil in 2009).


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