New-look IMF could stabilise world's volatile money markets
The international financial body should be reinvented as global reserve manager, writes HAROLD JAMES
THE world economy is increasingly threatened by volatile market reactions to global imbalances at a time when the International Monetary Fund has largely lost its original raison d'tre as the world's central monetary institution. These two developments should stimulate the fund to claim a new purpose as the world's reserve manager.
In the 1960s, the IMF managed the problems of all the major economies, and in the 1980s and 1990s it developed as a crisis manager for emerging markets. But that job is much harder now, because of the size of some of the big emerging economies. And, in any case, the focus of financial nervousness is shifting back to the world economy's core countries, such as the United States, the United Kingdom and Australia, which are funding large current-account deficits with surpluses from much poorer countries.
These surpluses reflect high savings rates, both in the private and the public sector, in oil-producing and emerging Asian economies, which have resulted in their rapid accumulation of foreign reserves. But this is hardly a blessing for these countries. Their reserves have become so large that even the announcement of a small shift in assets – say, from euros to dollars – can move markets and cause disruptions and panics.
Like past reserve regimes that offered a choice of assets (for example, the dollar, the pound and gold in the inter-war period), instability is inherent.
The new surplus countries' attempts to find alternative reserve assets have been problematic. Most of the attention has been fixed on China's $1 trillion in reserves, and its efforts to maintain the value of those assets. Diversification from US treasury bills by investing some $3 billion in the Blackstone private equity fund this summer was swiftly followed by an embarrassing collapse in value.
On the receiving end, industrial countries' governments are anxious that new sovereign wealth funds (SWFs) are being used strategically, rather than simply following the logic of the market. Even the successful model for SWFs, Singapore's Temasek, which for a long time went largely unnoticed, is now attracting a level of attention that its owners and managers never wanted.
The growing anxiety is understandable. After all, given that emerging market economies' central banks and SWFs nowadays effectively dominate capital markets, outcomes no longer result from the interplay of millions of independent guesses, decisions or strategies. When entities of such a size make decisions, they are bound to act in a strategic way. All the parties begin to suspect political manipulation.
But the resulting controversies can be resolved, and the political venom neutralised, through surveillance by multilateral institutions that are committed to achieving an overarching good. That should be the IMF's core function. Today surveillance means, in effect, merely giving advice. But in the 1960s – when the IMF still supervised the rules of the Bretton Woods order's par value system before its disintegration in 1971 – surveillance was linked to the fund's effectiveness as a major financial intermediary.
The IMF's ability to give powerful advice to the most important countries, such as the UK, was enhanced by these countries' dependence on IMF resources. It was the IMF's financial power that gave it its bite, and that power was enhanced by fund borrowing, at first from the G-10, which established the General Arrangements to Borrow.
In the years after the collapse of Bretton Woods, the IMF reinvented itself as a principal vehicle for managing the surpluses that followed the oil price shocks of the 1970s. It borrowed from the new surplus countries, which thus partly managed their new assets through the intermediation of the IMF. As a result, the fund could lend to those countries that suffered shocks from the increase in petroleum prices.
Indeed, a large financial actor can play a stabilising role. In the past, the counter-cyclical behaviour of large private institutions stabilised market expectations during panics.
The house of Rothschild made the first half of the 19th century stable. In the great panics of 1895-6 and 1907, JP Morgan calmed the US economy. At the time of the Great Depression in the 1930s, there was no equivalent power. Today, there are some signs that Goldman Sachs feels obliged to lean against the wind in order to stabilise markets.
The IMF could be a powerful financial stabiliser if it managed a significant part of the new surplus countries' reserve assets, for it would be well placed to take bets against speculators. This would ultimately benefit the reserve assets' owners, who, by virtue of accumulating large surpluses, have a similar interest in world economic and financial stability. At the same time, the management of reserve assets by an internationally controlled asset manager would remove suspicions and doubts about the use of assets for strategic political purposes.
But, to carry out this completely new task, the IMF would need to regain the trust of its members. The rise in reserves in many Asian countries was a deliberate response to the 1997 financial crisis, which fuelled disillusion with the IMF. So, before it could assume the role of global reserve manager, new surplus countries would need substantially more influence over the fund's governance. Only then could they be confident that they would not be subject to politically motivated manipulation.
• Harold James is professor of history and international affairs at Princeton University in the United States and author of The Roman Predicament.
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