Debate about ‘currency wars’ and capital controls has dominated global economic policy making this autumn, but serious talks to reform a crisis-prone and outdated international monetary and financial system remain elusive.
The term currency wars, essentially describing competitive holding down of exchange rates in major emerging markets and exporting countries, was used by Brazilian finance minister Guido Mantega in advance of the IMF and World Bank annual meetings in early October. The IMF’s mandate review process (see Update 72, 71, 70, 68), called for by the G20 in November 2009, was supposed to conclude by the annual meetings, but an international agreement to resolve global imbalances and deal with financial flows proved impossible.
The IMF executive board annual meeting report to finance ministers states: “While there are no easy solutions, an initial debate has at least yielded consensus on the questions that any guardian of the international monetary system must find answers before problems come to a head. [sic]” The board failed to spell out both questions and a timetable to find answers in their progress note.
IMF needs to establish credible and effective surveillance
Floods of money
Brazil was one of the first countries to feel the effects of a rush of capital exiting rich countries. Investors are searching for high interest rates in developing countries compared to the low interest rates in the advanced markets. The prospect of further quantitative easing in the US, which was announced in early November, has created even more liquidity in advanced markets pushing larger capital flows towards the developing world. Quantitative easing has been likened to printing money and is aimed at supporting the US economic recovery.
For countries with floating exchange rates, these capital inflows push up exchange rates, making it more difficult to export. Brazil has criticised the US for its monetary policy, but has also placed blame elsewhere. China’s virtually fixed exchange rate means that while other emerging markets’ exports to rich countries become more expensive, Chinese exports become relatively cheaper. This prompted a number of Asian countries, particularly South Korea and Japan, to intervene in the foreign exchange markets in late October to prevent appreciation of their currencies. In late October, Mantega criticised these interventions and called for the IMF to create an index of currency manipulation: “The IMF would have to come up with a method to measure which currencies reflect the structural situation of their countries, which are floating currencies, and which ones are forcing their hand.”
While Brazil was taking aim at rich Asian countries, China and the US were taking aim at each other. The US government and legislature both upped their media attacks on the fixed Chinese exchange rate regime in September and October, prompting senior Chinese officials to fire. Chinese central bank governor Zhou Xiouchuan, Chinese vice premier Li Keqiang and a leading article in the Chinese state-owned newswire Xinhua all castigated US monetary policy in October and November. The Chinese are worried about both exchange rate instability and the value of their reserve holdings, which are mostly held in dollar assets. Amid the simmering tensions, analysts looked to the late October G20 finance ministers’ meeting and mid November meeting of the G20 leaders to resolve the situation.
Because of its large trade deficit with China, the US has focussed on the exchange rate issue as a way to reduce global trade imbalances. During the annual meetings, the deputy governor of the Chinese central bank announced that China would, in the future, target a current account surplus of no more than 4 per cent. In the run up to the G20 meeting, the US pushed for a 4 per cent symmetrical limit on current account deficits and surpluses to be enforced through IMF monitoring and the G20 mutual assessment process (see Update 72). This approach was rejected by large surplus countries Japan and Germany, who argue that their surpluses are due to economic competitiveness rather than undervalued exchange rates. The communiqués of both G20 meetings called instead for a move “toward more market-determined exchange rate systems, enhancing exchange rate flexibility to reflect underlying economic fundamentals, and refraining from competitive devaluation.”
Calls for capital controls
Brazil was one of a dozen countries that took decisive action to stem capital inflows (see Update 72, 70), raising its capital inflows tax from 2 to 6 per cent in late October. In contrast to the reaction in January, when Brazil first instituted the tax, this time the IMF and its managing director made no comment.
The IMF has been making a concerted effort to be obliging to large emerging powers, including giving them more voice in the institution (see Update 73). In mid-October the IMF and the People’s Bank of China co-hosted a conference in Shanghai focussed on “Macro-Prudential Policies: Asian Perspectives”.
The South Korean finance minister Yoon Jeung-hyun has taken a lead in arguing for more IMF work on managing capital flows. In his speech at the IMF annual meetings, he said the Fund “should deeply explore various ideas and policy options to mitigate the side effects of the increased capital flow.” Korean academic Hyun Song-shin, who was on sabbatical from Princeton to help the Korean government’s G20 preparations, argued forcefully in a seminar at the IMF meetings that new types of capital controls were an essential part of the macro-prudential regulatory toolkit. In mid November Korea announced its intention to reinstitute a Brazilian-style tax on foreign bond holders.
Recently appointed World Bank managing director Sri Mulyani Indrwati, who previously served as Indonesian finance minister and as an IMF executive director for the Southeast Asian region, also argued for more acceptance of capital controls, but used language similar to IMF staff in calling for “a more narrow, targeted and less permanent sort of control”. In mid-November the Indonesian government prompted debate about whether it would follow in the footsteps of Brazil, Korea, Thailand, Taiwan and a host of others when it confirmed that it was studying the potential for new controls.
South Africa’s finance minister Pravin Gordhan was one of the first policy makers to openly advocate what many in the NGO and academic community have been calling for: source country regulation of volatile capital flows. In an early November speech before leaving for the G20, Gordhan called for “finding a multilateral formula which would enable us to have action taken both at the source of these funds (and) the destination.”
Ilene Grabel of Denver University and Ha-Joon Chang of Cambridge University called the recent embrace of controls “nothing short of the most significant transformation in global financial management of the past 30 years.” They credit the IMF with a rapid change of opinion in response to the recent financial crises and emphasise that in the past capital controls had been instrumental in pushing economic development by increasing financial stability. They conclude: “Those of us who have long advocated systematic financial reform look at current developments with excitement. Countries need the latitude to impose capital controls that meet their particular needs, and it is a relief to see that they are finally getting it after a long period of debilitating neoliberal ideology.”
Exchange rate system reform
However, Grabel and Chang give a word of warning about the need for international coordination and a revamped international financial framework. At the root of many of the capital flow problems is a monetary system that even the IMF recognises is poorly designed in many ways (see Update 72, 70). While large emerging markets can cope with its flaws, smaller and lower-income countries find it difficult to manage as they are rarely in a position to implement effective capital controls.
World Bank president Robert Zoellick stepped in to the debate in early November, calling for “the development of a monetary system to succeed ‘Bretton Woods II’,” the name given to the current hybrid system of countries using a variety of exchange rate systems from free floating to fixed. He felt “this new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalisation and then an open capital account. The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.”
Zoellick’s remark about gold drew a barrage of criticism about the inappropriateness of using it as an anchor for exchange rates, especially when much of the world faces deflationary risks. However, Robert Skidelsky, biographer of one of the architects of the original Bretton Woods fixed exchange rate system John Maynard Keynes, welcomed Zoellick’s recognition of the need to rebalance the global economy. Echoing the conclusions of the 2009 UN Commission of experts chaired by Joseph Stiglitz (see Update 65), Skidelsky wrote: “A ‘super-sovereign reserve currency’ should be the central aim of structural reform of the world’s monetary system. But it should be part of a wider package. This would include capital controls at least in the transitional period and agreement on a more stable system of exchange rates. Both are wanted by east Asian countries. There is justice in the American insistence that China expand its domestic demand; but also in China’s insistence that America learn to live within its means. This rebalancing of global demand would underpin a balanced monetary system. It is also fully in line with the evolution towards a more plural world order.”
A November research paper from the South Centre, an intergovernmental body of developing countries, adds a few more elements to the outline by Skidelsky. Authored by Yilmaz Akyüz, former chief economist at the UN Conference on Trade and Development (UNCTAD), it argues that the IMF should focus on crisis prevention rather than lending by working on a new reserve system, capital controls and a sovereign debt workout mechanism. He adds that the IMF needs “to establish credible and effective surveillance over national monetary and financial policies with global repercussions. This very much depends on introducing enforceable commitments and obligations regarding exchange rates of major currencies and adjustment to imbalances by both deficit and surplus countries.”
France, which took over the leadership of the G20 at the end of the G20 leaders’ summit in Seoul, has promised to put issues of international financial reform, including the monetary system, at the centre of the G20 agenda during its chairing of the club in 2011. While the IMF has now committed to “deepen” its work in this area, it has no specific timetable or end goal. Its final discussion on a policy for managing capital flows was scheduled for late summer, but has now been delayed until end November. The inability of IMF members to agree about even the acceptability and usefulness of capital account management techniques does not bode well for French efforts to rewrite the global financial framework.
How to insure against crisis: self, regional or international?
Generally countries seek to avoid the IMF rather than use it as an insurance mechanism against crisis. A November report jointly published by think tank German Development Institute/Deutsches Institut für Entwicklungspolitik and US-based NGO Center of Concern explores “efforts to establish or expand existing regional financing arrangements (RFAs) as a second line of defence”, after accumulation of reserves, to protect against financial crises. In the volume, a number of authors argue that RFAs cannot effectively supplant the IMF as an insurance mechanism and instead argue for a multi-layered approach that sees RFAs and the IMF cooperating together.
Other contributions in the report sought to distance RFAs and other types of regional cooperation from the IMF. Masahiro Kawai, head of the Asian Development Bank Institute, argues that Asia’s regional fund, known as the Chiang Mai Initiative, “needs to be expanded in size, should be de-linked from IMF programmes, and must offer more instruments − including precautionary credit lines − so that it can be activated in times of near-crisis.” Aldo Caliari of Center of Concern stresses that “regional mechanisms for reducing the demand for liquidity, particularly for intra-regional trade operations, may be just as important” as RFAs.
However, Barry Eichengreen of University of California Berkeley argues that “If countries are serious about establishing regional funds that make a meaningful contribution to global financial stability, they will have to ante up real money. They will have to create self-standing institutions with the capacity to engage in meaningful surveillance. And they will have to give the independent directors of those institutions, or someone else, the power to set the conditions that will be attached to emergency loans.” His conclusion is that so far the RFAs are just paper tigers.
This summer, the IMF discussed lending directly to RFAs, which would then lend on to their members, as part of plans for a so-called global financial safety net (see Update 72). The financial safety net proposals, including multi-country swap lines and financing for regional arrangements, were supposed to be finalised at the G20 summit in Seoul in November, but there was insufficient support for such ideas among IMF shareholders.