As dollar, markets crash where is the IMF? Fund chief supports fiscal stimulus and bigger budget deficits in the US
News||1 February 2008|update 59|
Amid a global financial market seizure, which the IMF proclaimed was not likely to happen as recently as October, EU leaders and international economists speculate about how the Fund could be tackling the crash of the dollar and financial market turmoil. At the World Economic Forum, the IMF’s managing director abruptly reversed the Fund’s advice to the US.
The collapse of the value of the dollar in the second half of 2007 prompted renewed concern about global imbalances. These imbalances mean that developing countries, by holding US dollars as reserves, are lending money to the US to fuel its current account deficit. Managing global current account imbalances and the misaligned exchange rates that may contribute to them is supposed to be the IMF’s bread and butter area of work, but the Fund has largely failed to make a dent in the problem in the last year.
Much time was spent in IMF-hosted multilateral consultations (see Update 54) to try to find a gradual solution for unwinding these imbalances. Despite clear IMF advice on how to do this – reduced fiscal and trade deficits in the US, greater domestic demand in China, more flexibility in euro area economies, greater liberalisation on inward investment in Japan, and more domestic investment in Saudi Arabia – achieving coherent policy reform has proven elusive. Imbalances worsened and the dollar depreciated quickly in the final quarter of 2007.
This deeply affects developing countries, especially those that import oil, because they hold the majority of their official reserves in dollars and must pay higher dollar prices for their energy needs. The worry is that countries are getting itchy to dump dollars and diversify their reserves, a trend the IMF identified in December.
Jomo K.S., the UN’s assistant secretary-general for economic and social affairs, was frank about the IMF’s failure so far to facilitate international macroeconomic coordination when launching the World Economic and Social Prospects (WESP) 2008 report in January. “The IMF, which should play a leading role in this regard, has not stepped up to the mark. This has partly been compromised by IMF governance, which has undermined its legitimacy and its ability to work more effectively.” The UN wants multi-year commitments and specific targets and schedules from the major economies in the short-run and fundamental reforms of the international reserve system in the long-run, including “an officially backed multi-currency reserve system.”
Fred Bergsten, director of the Washington think tank Peterson Institute for International Economics resurrected the idea of a ‘substitution account’, first broached in 1969 and fully debated by Fund members in the late 1970s. This account would strengthen the role of Special Drawing Rights (SDRs), the IMF-issued unit of currency, as a reserve vehicle and enable countries to cash in their unwanted dollars for SDRs.
On the contrary, Harold James, a history professor from Princeton University, thought that the IMF should take on the role of managing the reserve assets of the emerging markets who hold unwanted dollars. In one stroke he hopes to solve the risk of a dollar crash and allay the concerns of Western countries who fear the intentions of sovereign wealth funds (see Update 59, 58) set up by those countries to invest the reserves. His only caveat: the IMF needs massive governance reform to regain the trust of its members. James seems to have missed the worries about giving the IMF more power over developing countries that this exact proposal generated in 2006 (see Update 50).
Dollars out, financial markets crisis in
As the end-2007 dollar paranoia morphed into financial market fears in early 2008, concern has shifted. The panic in official circles after mid-January stock market slumps around the world was so marked that neoliberals were lining up to tout Keynesian economic theories about the need for monetary and fiscal stimulus.
The IMF is notorious for demanding belt-tightening and austerity in developing countries facing economic problems, but at the end of January IMF managing director, and French socialist party member, Dominique Strauss-Kahn threw past IMF analysis out the window. Despite an end to fiscal deficits in the US being the official IMF prescription for the dollar’s problems, Strauss-Kahn openly stated that “a new fiscal policy is probably today an accurate way to answer the crisis.” Writing in commentary on the IMF web site Strauss-Kahn continued: “Timely and targeted fiscal stimulus can add to aggregate demand in a way that supports private consumption during a critical phase. In a sense, medium-term fiscal policy is all about saving for a rainy day. It is now raining.”
It is unclear whether these declarations have the full support of the macroeconomists who make up the core of Fund staff. Some of them surely would like to recommend the same austerity programmes for the US that they have demanded of developing countries. Indian newspaper The Economic Times editorialised: “Strauss-Kahn’s call for a new (read looser) fiscal policy to get out of the present crisis is rather like a nun endorsing a red light district.” It remains to be seen whether Strauss-Kahn’s support of countercyclical economic policy, using both monetary and fiscal instruments, will be applied in the low-income countries that make up the majority of the Fund’s clients.
Earlier in January, UK prime minister Gordon Brown used a trip to China and India to call for reform to both the governance and roles of the IMF. In a speech in Delhi, despite arguing that the Fund should give more voting rights to emerging markets, he proposed that: “the IMF should act with the same kind of independence as a central bank in a national country.” Such proposals have been made in the past, notably by Princeton University’s Peter Kenen, but giving the Fund operational independence would run counter to UK government policy outlined in the government white paper on governance: “Developing countries need more influence in the World Bank and IMF. They are weakly represented on both boards, where voting rights are decided by financial contributions. This balance must change.” Civil society organisations and some developing countries would likely be even more distrustful of an IMF with less oversight by its member states.
In terms of tackling the credit crisis, Brown reiterated his desire for the IMF to “make its focus the surveillance of the global economic and financial system, its role should be to prevent crises and not simply to manage or resolve them as in the past. And in a wider role the IMF… should be at the heart of what we need - an early warning system involving regulators and supervisors in all countries for financial turbulence affecting the global economy.” According to UK newspaper The Independent, US regulators were less than enthusiastic for Brown’s plans, even though in actuality they represent little more than increased communication between the IMF and regulatory authorities.
Angela Merkel, the German chancellor, took an only slightly more proactive approach in mid-December when she called the heads of the World Bank and IMF to meet with the heads of other multilateral institutions: the World Trade Organisation, the Organisation for Economic Cooperation and Development and the International Labour Organization. Merkel hoped for the meeting to become a permanent fixture of the G8 agenda and to work towards globalisation under “fair conditions”. On the market turmoil, Merkel stressed the need for more transparency of financial markets and new financial instruments. That would include both private financial funds like hedge funds, which the Germans have been struggling to put on the G8 agenda, and public or sovereign wealth funds, for which the IMF is drafting a code of conduct.
Part of the problem is that large industrialised countries are unwilling to give an international agency jurisdiction to regulate financial markets based in their countries. Even Brown’s proposals would rely on a patchwork of different regulators and institutions. Malcolm Knight, the head of the Bank for International Settlements, the international organisation for central banks, called this the “Balkanisation of regulation”.
The IMF’s former chief economist Raghuram Rajan neatly identifies the reason for this lack of a single authority: “some of the largest industrial countries see themselves as more sovereign than others, and their politicians brook no interference in their own domestic policies, while being fully prepared to use multilateral agencies to intervene in the domestic policies of others.” Developing countries have been complaining about this for years at the IMF, but still no solution is in sight.
This pessimism is echoed by James Dean, emeritus professor of economics at Simon Frasier University: “Rescue from the current crises will not come from the IMF, nor from an international financial system ordered and managed by international institutions. Our much-touted ‘international financial system’ is now an emperor with no clothes.”
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Published: 1 February 2008 , last edited: 1 February 2008
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