IMF gains new mandate as world economic watchdog Fund adopts powers to avert global imbalances
Change likely to undermine influence of G7 meetings Larry Elliott in Washington Monday April 24, 2006 The Guardian The International Monetary Fund is planning urgent talks between the world's leading economic powers over the coming months after the organisation's biggest shake-up in four decades gave it new powers to avert the threat of a global crisis. The new role for the IMF heralds a drop in status for the G7 - the gathering of finance ministers and central bank governors from the US, Britain, Germany, Italy, France, Japan and Canada. The emergence of China and India in recent years has made the G7 unrepresentative of the new global economy and unable to offer solutions to global imbalances. Amid fears that this week will see further downward pressure on the dollar and higher oil prices, the IMF is to start curing imbalances in the global economy. Member countries moved swiftly at the weekend after the fund warned that strong growth in the global economy could be abruptly halted if financial markets took fright at the disparity between America's massive trade deficit and the surpluses built up by China and other exporting nations of Asia. In its biggest structural change since the break-up of the Bretton Woods system of fixed exchange rates in the early 1970s, the fund was given a mandate to conduct multilateral surveillance of the global economy and to suggest steps that the leading nations should take in concert to ensure better balanced growth. The surveillance unit will be modelled on the independent Bank of England, with guaranteed independence from political interference and an annual remit to look at the linkages and spillovers between monetary policy, fiscal policy, exchange rates and financial sector issues in key IMF member countries. Until now, the fund has only held bilateral discussions with individual member countries, but policy makers said they wanted the Washington-based institution to revert to its original role of ensuring global economic stability. Rodrigo de Rato, the fund's managing director, said: "It will be an important vehicle for analysis and consensus building." Gordon Brown, who chairs the IMF's key policy making committee, said: "We resolved to make the IMF more fit for purpose in a global economy, and more able to address challenges that are quite different from when the IMF was created." Mr de Rato believes the 7% trade deficit in the US is linked to the under-valued currencies of Asian countries such as China, and the slow growth in Europe caused by malfunctioning labour and product markets. He said: "There is clear agreement among the members that we are facing important and maybe increasing risks. We will start working immediately on how that process (of multilateral surveillance) is going to be established." In its post meeting statement, the G7 stepped up pressure on China by naming it as one of the "emerging economies with large current account surpluses" that need to allow more currency flexibility. Backstory The IMF and the World Bank were born out of a conference at Bretton Woods, New Hampshire in 1944. The idea was for a body that would help countries in short-term balance of payments difficulties in a world of fixed exchange rates, thus preventing macro-economic crises. The World Bank was supposed to lend to developing countries to support growth. The breakdown of the fixed exchange rate system in 1971 and the increase in the flow of finance around the world, meant the IMF lost the ability to fulfil its original function, leaving it in search of a role. ***** Oil crisis gives energy to new world order The dangers to the global economy concentrated minds in Washington Larry Elliott, economics editor Monday April 24, 2006 The Guardian It all went according to script for Rodrigo de Rato. At the start of last week, he warned that the healthy state of the global economy was at risk from high oil prices, rising protectionism and a disorderly unwinding of the global imbalances that have left the United States living off cheap exports from Asia. By the weekend, the cost of crude had hit $75 a barrel, hopes dwindled that the end of April deadline for a successful resolution of the global trade talks would be met and the dollar was coming under severe downward pressure. It was the perfect environment for Mr de Rato to forge a new role for the fund after years in which it has been suffering an existential crisis about what it is actually for. Last Friday was the 60th anniversary of the death of Maynard Keynes, one of the founding fathers of the IMF. There is now a chance that the fund can return to Keynes's original blueprint: an organisation that seeks to sort out the macro-economic problems of the global economy in a symmetrical fashion, with both debtor and creditor nations having responsibility to take policy measures to cure imbalances. Normally, it takes years for reforms to grind their way through the fund's decision-making process. This time was different. There was agreement among the member countries that Mr de Rato could set up his new process of multilateral surveillance of the global economy with immediate effect. That was a smart move, because as the fund itself has stressed, the good times won't last for ever. The overall picture looks healthy enough. Not since the early 1970s has the global economy been as strong for as long as it has been for the past four years. Inflation, the number one enemy for the fund, has been low despite the $50 a barrel increase in the oil price. Argentina and Brazil have paid off their colossal debts to the IMF and there have been signs that sub-Saharan Africa is at last starting to post the growth rates necessary to tackle extreme poverty. Nevertheless, the IMF sees plenty to be worried about. In real terms, the cost of crude is not back to where it was at the time of the Iran-Iraq war at the start of the 1980s, but that was the only time prices have been higher. The IMF has been surprised at the modest impact of dearer energy on the global economy, believing that the inflationary effects have been mitigated by the credibility of central banks and by the competitive pressures of globalisation. But, as the IMF correctly sees it, there is no iron law that says this state of affairs will persist. It argues that the full impact of higher oil prices has yet to be felt, that the geopolitical risks of a further rise in prices are high and that supply constraints mean that high prices are likely to persist for longer than they did in the 1970s. Impact At some point, the global economy will suffer from high oil prices; nobody is sure at what point but it's a fair bet that a year of prices at $75 a barrel would have a marked impact on growth. In Britain, where the level of taxation has resulted in some of the highest prices in the west, a litre of unleaded is threatening to breach the #1 mark nationwide. It's also a concern that higher oil prices are exacerbating the imbalances in the global economy. Clearly, the US current account was getting bigger even before the cost of crude started to rise in 2003, but dearer oil has not helped. The IMF estimates that the deficit has widened by over one percentage point of GDP as a result of more expensive energy. By contrast, oil exporters are awash with cash, which they can't spend all at once. They are saving a good chunk of the windfall, helping to drive down long-term interest rates. This in turn has made it easier for the Americans to carry on borrowing to finance their excessive spending. "Since it is neither feasible nor desirable for oil exporters to spend their newfound revenues immediately," the fund said in its World Economic Outlook, "global current account imbalances are likely to remain at elevated levels for longer than would otherwise have been the case, heightening the risk of a sudden, disorderly adjustment." It's this prospect that really concerns the fund. It has little time for the Panglossian view of the world that it doesn't really matter that the US is running a trade deficit of 7% of GDP, provided investors in Asia are prepared to finance it. The fall in the dollar on Friday following Sweden's announcement that it was diversifying its foreign reserves out of the US currency was a hint of what could happen if and when the mood changes. The IMF view is that prevention is better than cure, and that the solution is to have a format whereby the big players of the global economy talk through their global problems and act in concert. The IMF would hold the ring for this process, providing it with a reason to exist. When it was set up at Bretton Woods in 1944, the idea was that the fund would oversee a system of fixed exchange rates and help countries through short-term balance of payments difficulties. That role ended with the collapse of the Bretton Woods agreement in 1971, with the IMF then taking on a new function: lending large amounts of money to developing countries. That role, too, has now come to an end, with the IMF facing something of a financial squeeze itself because it is no longer receiving large dollops of interest from debtor nations. Expertise As a result, the fund's need to reinvent itself chimes neatly with the need for a multilateral mechanism for coping with difficulties that can't be resolved by one country alone. All this sounds marvellous. The fund's expertise is in macro-economic analysis, and it should specialise in what it is good at. It doesn't have the resources to be a lender of last resort, and development is better left to the World Bank. At the same time, there is clearly a vacuum in global macro-economic policy making. The G7, which excludes China and India, does not have a hope of dealing effectively with the global imbalances. The time is ripe for the fund to return to its original mission. There are certain preconditions for the new regime to work. The first is that the big shareholders of the fund agree to the move. Policymakers say growing concern over the threat posed by a violent unwinding of the imbalances has concentrated minds. We shall see about that. The second is that the fund has to adopt a different approach to the multilateral consultations than it does to its bilateral discussions. Nothing irritates policymakers more than the IMF seeking to micro-manage their economies, calling for changes in tax, spending and welfare policies, where it has no business to interfere. If the fund tries to do this at a macro-level, the new surveillance system will be smothered at birth. Finally, it is vital that the surveillance process is independent. Even if proposals are agreed at the fund's annual meeting in Singapore in September to give a greater voice to developing countries, the US will retain an effective veto. For multilateral surveillance to have any credibility, there must be no suggestion that the fund is doing the bidding of the US treasury, or any other country, for that matter.
