IMF pours cold water on monetary reform

20 November 2009

As academics and NGOs call for reform of the international financial architecture, the international monetary system is the focus of scrutiny. Support for capital controls and a financial transaction tax has met resistance from the IMF.

Since a March paper from the governor of the central bank of China (see Update 67, 66), a flurry of discussions have taken place on replacing the dollar as the currency of choice for central bank reserves and commercial trade. World Bank president Robert Zoellick said, “the United States would be mistaken to take for granted the dollar’s place as the world’s predominant reserve currency. Looking forward, there will increasingly be other options.”

Cracks in the dollar’s dominance are beginning to appear. British newspaper The Independent reported in early October that, “Arab states have launched secret moves with China, Russia and France to stop using the US currency for oil trading.” Iran has already started invoicing for oil in euros. The ALBA grouping of countries in Latin America firmed up plans to launch a regional electronic currency called the SUCRE, “as an instrument to achieve monetary and financial sovereignty, eliminate dependence on the US dollar in regional trade, reduce asymmetries and gradually consolidate a shared zone of economic development.” The currency should be in use in 2010, while a working group will also be set up to explore option for regional reserve pooling.

reflects business as usual in terms of the IMF's intellectual approach to financial globalisation

The New York-based Initiative on Policy Dialogue (IPD), a think tank founded by Nobel laureate Joseph Stiglitz, hosted a meeting in early November on moves toward a world reserve system. One of the background papers by John Williamson of the US-based Peterson Institute argued that the IMF’s special drawing right (SDR) already has the characteristics of money and could replace the dollar as a reserve currency. He even argues that it could be in the interest of the United States to help an orderly shift away from a dollar-based reserve system.

The participants in the IPD meeting agreed that a shift away from the dollar must happen, but differed on how to do it. In a speech in London on the same day, former Indian central bank governor Dr. YV Reddy argued that, “One needs to take a less dogmatic and more pragmatic view of the merits of managed exchange rates among all countries.”

In October, the communiqué of the International Monetary and Finance Committee, the IMF’s direction-setting body of finance ministers, called on the Fund to “study the policy options to promote long-term global stability and the proper functioning of the international monetary system.” The IMF finally broke its silence on this issue (see Update 66) in a mid-November staff position note, which is not official Fund policy. The note lays out the debates and options on the international monetary system with more candour than is usual in a Fund paper, including indicting the Fund’s governance and conditionality policies as reasons for large reserve accumulation by some countries. But the authors dismiss the idea of a new global reserve currency. They argue instead for “making the best of the current system,” in an attempt to “nudge the system toward lasting stability.”

Capital controls back in vogue

Both Brazil and Taiwan have implemented new regulations on capital inflows, bringing the debate about capital controls back to the forefront of policy discussion. Announced at end October, Brazil’s 2 per cent tax on foreign capital invested in domestic equity and bond markets was designed to slow down so-called hot money flows and decelerate the steep appreciation of the Brazilian currency. Taiwan’s early November move was also aimed at preventing currency appreciation, but was more limited. It prevented foreign investors from putting funds into time deposits, with the central bank denying that the move amounted to capital control.

Academics Arvind Subramaniam, also of the Peterson Institute, and John Williamson argued in the Financial Times that Brazil’s move was of great symbolic and substantive importance. They quoted a Fund official being mildly negative about the controls, and then called the IMF’s stance “disappointing … because it reflects business as usual in terms of the IMF’s intellectual approach to financial globalisation.” They highlight that one of the biggest worries is that financial traders will react negatively and punish a country on financial markets. “By recognising that in some instances sensible curbs on inflows might be a reasonable and pragmatic policy response, the Fund can eliminate the market-unfriendly stigma that actions of the Brazilian type might otherwise risk incurring.” Finally, they suggest that, “the world needs a less doctrinaire approach to foreign capital flows.”

The IMF continues to avoid recommending the use of well-designed capital controls (see Update 58). In the October World Economic Outlook, the IMF’s flagship publication, the Fund briefly identified surges of capital inflows as a risk to stability in emerging markets but suggested only the remedies of tighter monetary policy and exchange rate appreciation, just what most emerging markets fear will choke off a recovery and increase the risk of sudden reversals of capital flows.

The IMF paper provided to the G20 finance ministers’ meeting in early November refers to capital controls as “unorthodox measures” despite their frequent historical use by most countries, and their having underpinned the Bretton Woods exchange rate system from 1945 to 1971. The same bland conclusions are made: exchange rates should appreciate and countries should have tighter fiscal policy.

This weak advice is despite the fact that, according to Jomo KS of the United Nations Department of Economic and Social Affairs, “the Articles of Agreement of the International Monetary Fund do not allow Fund staff to go around promoting capital account liberalisation … nonetheless this was precisely what many staff of the Fund were doing before the Asian crisis and also in the half decade preceding this crisis.”

His argument that the Fund needs to do less cheerleading for globalised finance was echoed by Harvard professor Dani Rodrik: “Emerging markets deserve the IMF’s help in designing better prudential controls over capital inflows instead of having their wrists slapped.”

IMF to study financial transaction tax

A financial transactions tax (FTT), inspired by the proposal for a tax on currencies made by economist James Tobin, has also been put forward to slow down speculative flows. The idea is to put a small tax on all transactions in financial markets, including purchases of equities, bonds, currencies and derivatives. The G20 leaders’ summit in Pittsburgh in late September called on the IMF to report on “how the financial sector could make a fair and substantial contribution toward paying for any burdens associated with government interventions to repair the banking system.”

French president Nicolas Sarkozy and German chancellor Angela Merkel made it explicitly clear that they wanted the IMF to make a thorough analysis of the FTT proposal. UK prime minister Gordon Brown came out in favour of the idea in early November, uniting most of Europe in support of the idea, though the US has continued to oppose it. The media generally focussed on the transatlantic divide and ignored developing country points of view on the issue. On the same day that Brown announced his support, Dr. Reddy warmly welcomed the proposals for an FTT, saying “the significance of this initiative lies in exploring the possibilities of moderating the unfettered freedom of global financial markets.”

IMF managing director Dominique Strauss-Kahn, however, called the idea unworkable in early November and pre-empted the report saying, “we’re not working on a Tobin tax at the IMF,” suggesting an insurance levy instead. The brief for preparing the report was handed to IMF first deputy managing director John Lipsky, formerly vice chairman of investment bank JP Morgan (see Update 51). Being both American and from a financial industry background, it is expected that Lipsky will do all he can to pour cold water on the FTT idea.

The IMF resistance prompted 60 NGOs from around the world to write to Strauss-Kahn demanding a more open process for the report, including strong consideration of an FTT, “a formal process for engaging civil society views in this initiative,” and collaboration with the French-led Taskforce on International Financial Transactions for Development. By mid-November Strauss-Kahn was backtracking on his statements after outrage over his stance. The IMF is due to deliver its report to the next G20 leaders meeting scheduled for June 2010 in Canada.