What if foreign governments diversified their reserves?

World financial markets paid close attention when officials from both South Korea and Japan said that their governments were considering diversifying their holdings of foreign reserves. Since then, officials in both countries have insisted that they were not considering any major changes to the policy of reserve holdings. Nonetheless, the potential for a sell-off of dollar-denominated assets by foreign governments has raised some questions about the consequences of such a move. This Economic Letter attempts to put these issues into perspective. It begins with a review of recent trends in the holdings of such assets by foreign governments and a description of how these governments use them. Then it explores some of the risks the U.S. economy might face if foreign governments sold off large quantities of their dollar-denominated reserves. It concludes with a discussion of some of the costs such a sell-off would pose to foreign countries themselves.