According to a paper just out at the JCA website, authored by Youngwon Cho of the Department of Political Science, St. Francis Xavier University in Canada, the answer is, predictably a political one.
In “When $262 Billion Is Not Enough: Rethinking Reserve Accumulation in South Korea” (DOI: 10.1080/00472336.2015.1025818), Cho looks at the sudden reversal in capital flows from South Korea in the wake of the 2008 global financial crisis. The result was a severe credit crunch and extreme exchange-rate instability despite the fact that the government had accumulated large reserves to hedge against such capital account shocks. The government ultimately abandoned its defensive position and asked for external assistance.
As stated in the abstract:
This article provides a critical examination of the broader forces behind Korea’s reserve accumulation and its problematic consequences. In addition to explaining reserve accumulation as a financially induced phenomenon, the economic costs of reserve hoarding are estimated and its efficacy evaluated in light of the crisis. It is shown that Korea’s reserve accumulation, undertaken as a costly form of self-insurance, was neither sufficient nor efficient in guarding against the volatility of global financial markets. To navigate the pitfalls of financial globalisation more successfully and cost-effectively, Korea needs to go beyond focusing exclusively on the asset side of its vulnerable international liquidity position by blindly hoarding more reserves at ever-escalating costs. It needs to also tackle the liabilities side of the ledger by reducing its heavy exposure to short-term, flight-prone foreign capital.
