The International Monetary Fund's recent Spring Meetings confirmed yet again how far the IMF has strayed from its original mandate as guardian of the international financial system. For far from substantively addressing the present risks of a disorderly unwinding of global payment imbalances, the IMF chose to play the role of the world economy's cheerleader and to busy itself with IMF internal housekeeping matters. By so doing, the IMF not only risks further denting its already tarnished credibility, but it also risks raising anew fundamental questions about its continued relevance in today's global economy.
Set up in 1944 against the backdrop of the dismal international economic performance of the 1920s and 1930s, the IMF's original mandate was to promote exchange rate stability, to maintain orderly exchange rate arrangements among members, and to avoid competitive exchange rate depreciations. The basic idea in creating the IMF was to have a multilateral institution that would do everything in its power to prevent a repeat of the "beggar-my-neighbor" exchange rate policies that were so destructive to international prosperity during the inter-war years.
Sadly, today's global payment system displays many of the same dysfunctional symptoms that characterized the 1920s and 1930s. In particular, over the past sixty years, global payment imbalances have never been more pronounced than they are today. These imbalances are exemplified by the record US external current account deficit of around US$800 billion or over 6 percent of GDP, and the correspondingly large record Asian current account surpluses. At the same time, currency manipulation, especially in Asia, which thwarts orderly global payment adjustment, is all too prevalent, while protectionist pressures, especially against China, are on the rise in Europe and the United States.
Judging by today's Asian economies, it would seem as if each country is free to do as it likes with its exchange rate without raising real objections from the IMF. Indeed, China massively and persistently intervenes in its exchange market to the tune of US$250 billion a year to prevent any meaningful appreciation of its currency without incurring the IMF's wrath. For its part, Japan persists with a mix of tightening fiscal policy and extraordinarily low interest rates that ensures a continued weakening in the Japanese yen. By effectively keeping their currencies weak, the Asian economies shift the burden of adjustment of a weaker US dollar to Europe, even though Europe's balance of payments is presently not significantly in surplus.
Beyond today's global payment imbalances, a more immediate threat to the global economic outlook is the all too evident bursting of the US housing market bubble. In the period ahead, it is more than likely that US home prices will fall significantly following their spectacular 80 percent run-up between 2000 and 2006. They will do so not simply because of the present sub-prime mortgage lending crisis, but because of the generalized tightening of mortgage lending standards, the unwinding of speculative positions, and the resetting at higher interest rates of adjustable rate mortgages.
The unraveling of the US housing market could very well be the trigger that leads to a disorderly decline of the US dollar. Should the Federal Reserve be forced to cut interest rates to prop up a flagging US economy, the interest rate differential that presently favors the US dollar could be seriously eroded. More important still, should the US housing downturn diminish the attractiveness to foreign investors of both US mortgage and non-mortgage related financial assets, the US would have a major problem in financing its gaping current account deficit.
Seemingly oblivious to the mounting risks of a disorderly unwinding of global payment imbalances, the IMF had little to offer at its Spring Meetings by way of leadership towards a coordinated policy response to those risks. In its supposed exercise of multilateral exchange rate surveillance, the IMF cobbled together well-worn policy plans from its bilateral consultations over the past year with the United States, Europe, Japan, China and Saudi Arabia. Aside from being at the most general of levels, those policy plans offered virtually nothing new by the way of policy initiatives, especially in the vexing area of the greater flexibility needed in Asian exchange rate policy.
Unwilling or unable to exercise meaningful multilateral exchange rate surveillance, and bereft at least for now of its previous role as lender of last resort to the large emerging market economies, the IMF has taken upon itself the role of the world economy's cheerleader. In that role, the IMF counsels us not to be unduly concerned about the unusually large number of real risks presently confronting the global economy. It also assures us that, previous experience to the contrary, a significant downturn in the United States will not spread to the rest of the global economy.
This all has to leave one wondering what the IMF's founding fathers might have made of the spectacle of the IMF being reduced to the world economy's cheerleader. It also has to raise questions as to whether the IMF really needs quite as large a bureaucratic apparatus as it has today to exercise that limited role.
The author is Resident Fellow, American Enterprise Institute.