Last weekend, finance ministers of the world's leading industrial countries agreed to enlarge the role of the International Monetary Fund and equip it to help resolve global "economic imbalances." The deal was acclaimed, by the ministers and their officials at any rate, as a transformation of the institution—a great and overdue reform. Unfortunately, it wasn't.
This problem of international imbalances is not exactly new. Back in 2002, the then-chief economist of the IMF declared that America's current-account deficit and the flow of credit from overseas needed to finance it were unsustainable. U.S. borrowing from abroad was on an unprecedented scale, he said. It could not continue at such a pace. At some point, foreigners would lose their appetite for American investments, the global demand for dollars would fall, and the exchange rate would slide.
The great danger was that this would happen abruptly—with a crash in the dollar, not a gradual depreciation—followed by a spike in interest rates and a sudden crisis of confidence in financial markets. With so many American consumers already financially overextended, and the economy stressed in a variety of other ways as well, the potential for damage was great. The outcome could be a bad recession at home and around the world.
That, as I say, was four years ago. The unsustainable has been sustained a while longer. And there is no point in denying that this might go on for another four years, or more. That is quite possible. Timing the ends of episodes like this one is notoriously difficult. But it would be a grave error to believe that the past four years have refuted that earlier analysis. In fact, those earlier fears are better grounded now than before. Massive extra debts have accumulated, the willingness of foreigners to continue to lend to America is visibly under strain, and in some ways (overinflated housing prices and the galloping cost of oil, to name but two), the economy is more vulnerable to economic stresses than it was back then.
So it is important not to be reassured by the mere familiarity of the issue. The problem is all too real: Imbalances in global trade and finance are exposing the United States and the world to some serious economic hazards. The changes at the IMF indicate at least that governments are recognizing the issue. If they are not yet doing anything meaningful to address it, at least they see that they ought to pretend to. That is progress, of a kind.
The IMF's new mandate is to oversee a mediated negotiation among the countries with the biggest external imbalances—on one side, America with its colossal deficit; on the other, with their offsetting surpluses, China, Germany, Japan, and the main oil-exporting nations. First, the IMF will prepare and publish an analysis of the issues. (Publication is important; it gives the IMF a bit more clout than it would otherwise have.)
We already know what it will say, because the IMF and many others have been saying it for so long. Still, the new mandate is a license to speak more frankly.
Once the analysis is done, officials will aim to reach agreements with the governments concerned on the policies needed to put things right. No surprises there, either.
There will be two main points. The United States will be advised to increase its domestic savings, preferably by cutting the government's budget deficit (this will discourage imports and reduce the need for foreign capital). China will be advised to let its currency appreciate (thereby causing the dollar to be devalued, further reducing American imports and making the country's exports more competitive).
There will be recommendations for other countries too, partly to spread the blame around and show that everybody is chipping in. The European Union, for instance, will be told to stand ready to stimulate demand as curbs on America's budget deficit take hold. The idea there is to keep global demand roughly steady. As demand in America is trimmed back, it needs to be stimulated elsewhere—otherwise, by trying to forestall a global recession, governments might start one instead.
Even if all this is unsurprising, and overdue as well, what is wrong with it? Better late than never, you might think. Well, yes, the agreement is better than nothing. But all the heavy lifting remains to be done. Policies have to change, especially in the United States and China. If governments are reluctant to change course, as they have been for the past four years, the real question is what the new IMF mandate will do to convince them. What kind of pressure can be brought to bear?
The short answer is, none. The IMF's power over financially delinquent, and invariably poor, countries comes from threatening to withhold its lending unless the governments concerned change their policies. A typical IMF borrower has no other recourse. In fact, if the Fund refuses to lend, private lenders, such as they may be, often turn tail as well. In other words, IMF officials (subject to oversight, in effect, by the governments of America and other big powerful members) call the shots.
This does not arise in the case of the United States, China, and the global economic imbalances. The IMF, if it cared about its continued existence, would never issue threats to the United States—or to China, for that matter—even if it could. Imagine the reaction in Congress to the IMF's dictating the country's fiscal policy. But the fact is that the Fund has no levers to apply in these cases, even if it were foolish enough to want to. Neither the United States nor China needs the IMF's financial assistance. It is impossible at the moment even to imagine circumstances in which either might. So the Fund can only advise and cajole. The United States will cut its budget deficit when it wants to. And China, similarly, will let the renminbi float higher when its government believes that this will suit China, and not before. There is nothing the IMF can do or say to change that calculation of self-interest.
Of course the IMF knows this. One of its officials told the Financial Times, "It is perfectly reasonable to be skeptical as to whether the members will actually allow us to do what they say they want us to do." Agreed. But according to the paper, this official then went on to talk of "encouraging signs that policy makers in all big economies were starting to realize the need to deal with imbalances even as they aired their differences of views." Oh really? I think I missed that.
Where in the United States is the willingness to deal with the budget deficit? An optimist could point to Rob Portman's move from U.S. trade representative to director of the Office of Management and Budget. Portman's political skills are universally held in high regard. That is fine. But where in Congress, in an election year, is the willingness to cut spending or raise taxes? And those actions are under Congress's jurisdiction, not OMB's.
Can anybody see signs of genuine concern on Capitol Hill about the budget deficit or the external deficit?
Congress would like to see a stronger Chinese currency, because that would boost American exports. But reducing the budget deficit significantly is going to be painful. To get moving decisively on fiscal policy, Congress will need to be scared of the consequences of doing nothing. Or else it will need to feel real pressure from voters on the issue. At the moment, neither is true. Foresight and political courage will be needed. Where are the signs of those?
It is easy to imagine how the new IMF mandate might even make matters worse. There is no sense among the main players that the problem and its solution lie to any significant extent in their own hands. Each blames the others. The United States blames China for its currency peg and Europe for its benighted regulatory regime and neurotic central bank. China and Europe blame America for its budget deficit.
All are hoping, one may surmise, that they will be able to recruit the IMF to their side, to increase the pressure on others to act and, accordingly, reduce the pressure on themselves to act. If that happens, the new procedures might actually serve to delay the policies that are needed. The whole thing might become a grandiose displacement activity—diplomatic cover for doing nothing.
No government is yet at the stage of thinking, "The solution is largely in our own hands, but the remedy will be less painful, more effective, and politically easier to dispense if we act in concert with others." If or when that stage of thinking can be achieved, an exercise like the one the IMF is conducting would be potentially quite useful. We are not there yet.