ABSTRACT
This can be illustrated with a distinction McKinnon (1982) makes between direct and indirect CS. Direct CS refers to the phenom enon, outlined above, whereby economic agents have an incentive to hold a portfolio of non-interest-bearing currencies and substitute between such currencies on risk/return criteria. In practice it is likely that only a small proportion of a country’s non-interest-
bearing money stock would be held by non-nationals.4 Indirect CS, which arises because of the substitutability of non-money assets offers a potentially larger amount of currency substitution. Thus expectations of an exchange rate change will induce substitution between non-money assets, such as bonds, and this will result in currency substitution. For example, assume the world consists of two countries A and B and uncovered interest parity is maintained between their non-money assets.
