An awful lot of water has passed under the bridge since the International Monetary Fund and World Bank last met in Asia. In 1997, when the annual gatherings were held in Hong Kong, power in the former British colony had only just been handed over to China, Gordon Brown had been British finance minister for only four months and Asia was in the grip of a ferocious financial crisis.
This month in Singapore, Brown was almost certainly presiding over his last annual meeting as head of the fund’s main policymaking body. Asia is booming and the global economy is enjoying the longest period of sustained growth since the early 1970s post-war boom.
Yet there was little sense of triumphalism in Singapore, merely a sense that things were not quite so good as they seemed. This is smart thinking. The fact that the world economy has been enjoying a long period of growth with low inflation is no guarantee that there will not be an almighty crash. Indeed, the Great Depression followed just such an epoch. The warning sign was not upward price pressure, but speculation and economic imbalances.
As Bill White, of the Bank for International Settlements, said earlier this year: ”Achieving price stability might sometimes not be sufficient to avoid serious macroeconomic downturns in the medium term.” His argument is that central banks have poured liquidity into the financial system to keep growth strong and deflation at bay. But he stresses that not all deflations are the same: history shows that there can be benign deflations caused by technological and productivity advances.
”Recognising that not all deflations are alike, the use of monetary policy to avoid the threat of deflation could have longer-term costs. The core of the problem is that persistently easy monetary conditions can lead to the build-up, over time, of significant deviations from historical norms — whether in terms of debt levels, saving ratios, asset prices or other indicators of imbalances.”
This, from the club that represents central banks, is a sobering thought. We are supposed to sleep easy knowing that the Federal Reserve, the European Central Bank and the Bank of England are on top of inflation. White says we might be kidding ourselves. The grotesque imbalances in the global economy, and the crucial part access to cheap money has had in underpinning growth — particularly in the United States and the United Kingdom — suggest we should take this argument seriously.
Certainly, the fund does not underestimate the risks. In its World Economic Outlook last week, it noted that the favourable outlook would only continue if inflationary pressures could be contained without big increases in interest rates, that domestic demand will be better balanced across the advanced economies, that developing countries can avoid capacity bottlenecks and that financial markets will be more stable following the corrections seen earlier this year. Well, no problem there, then.
The problem for the fund is that it lacks effectiveness and legitimacy.
IMF MD Rodrigo de Rato knows this, which is why he is pushing for two big reforms. The first would give more power to developing countries, the second would set up a system for preventing crises. These are linked. The reason many Asian countries have been building up huge foreign exchange reserves is that they do not want to be laid low by capital flight and have to submit to draconian conditions from the fund. They want to be able to manage any fresh crisis on their own.
De Rato, therefore, has proposed a two-stage process whereby four of the bigger developing countries — China, South Korea, Mexico and Turkey — receive an immediate increase in their voting power at the fund. There would then be an attempt over the next two years for a new formula to determine clout at the Washington-based organisation.
This is a zero-sum game, and more power for some means less for others. It is likely to be extremely contentious: nobody in an international organisation gives up power without a fight.
The second point, as the Treasury’s Ed Balls noted in a speech in Jakarta last week, is that the source of global imbalances is not the fund’s debtors but its creditors. The likely flashpoint for a crisis is the developed, not the developing world. Just as in the Great Depression, instability has moved from the periphery to the core of the global economy. So, as Balls said, it is important to broaden the move from crisis resolution to crisis prevention with reforms that ”enhance the accountability and transparency of the fund itself”.
This is easier said than done. The US has an effective veto at the fund, since big changes require an 85% majority, and the US Treasury controls 17% of the votes. It is hard to see how any reform that leaves this state of affairs intact is likely to tackle the fund’s legitimacy deficit.
The same, incidentally, applies to the World Bank, where the anti-corruption agenda being pursued by its president, Paul Wolfowitz, has stoked fears that he has been installed by the White House to slim the organisation down and bring it more firmly under US control.
Even if the long-overdue reforms are completed, there is no guarantee the crisis-prevention approach will work. There is a need for a replacement for the G7, which is ineffective in the modern world without China.
De Rato’s plan is to bring a small group of countries, on an ad hoc basis, to deal with particular problems. He is looking at the global imbalances with the US, the Eurozone, China, Japan and Saudi Arabia, and the idea is that they will jointly agree on the causes of the problem and the policies they need to adopt collectively to tackle it.
This all sounds fine until you remember that exactly the same is said about the stalled trade talks. On paper, it is clear Europe and the US need to cut support for farmers, and India and Brazil allow in more manufactured goods. There was much optimism that the Chinese will revalue their currency, the US will bring down its budget and trade deficits and the Europeans and Japanese will boost consumer spending. Believe it when you see it. — Â