Currency reserves are to central banks what spare tyres are for cars: a source of comfort in a crisis. But are South Korea's threatening to create a market blow out? The dollar tumbled on Tuesday after signs that the Bank of Korea wants to diversify its reserves. Although the BoK on Wednesday denied it planned dollar sales, markets remain jittery.

No wonder. Asian central bank reserves almost doubled to $1,900bn between 1999 and 2003, and swelled further in 2004, mostly in dollars. This is starting to resemble a pyramid scheme. If nobody dumps dollars, banks may avoid losses on these holdings, but if any bank tries to protect itself from possible losses by selling dollars, everyone will be hurt. The New York Federal Reserve, for example, estimates that Singapore would suffer a capital loss equivalent to a tenth of gross domestic product if its currency rose 10 per cent. For China and Korea, the hit would be 3 per cent.

Right now, it is hard to see any central bank breaking rank. Japan does not wish to offend the US. China has a dollar peg. Meanwhile Korea's comments describe an existing policy of slow, minor diversification not a U-turn. Its ratio of US Treasuries to all reserves, for example, is already falling. However, just because everyone has a tactical interest in playing the current game now, that does not make it structurally stable in the long term. If or when the distortions linked to these pumped-up reserves unravel, the “pop” will be painful.