Not Even A Cat To Rescue
The Economist
Apr 20th 2006
The International Monetary Fund contemplates its future
WHAT is a firefighter to do when there aren't any fires? The IMF spent 1994-2002 dashing from one financial conflagration to the next. But the sirens have been silent for some time. As a result, the fund's budget is shrinking and the morale of its staff is sinking. Some of its best customers are now doing without it, leaving some of its biggest shareholders wondering what to do with it. In the run-up to the fund's spring meetings in Washington, DC, this weekend, its managing director, Rodrigo de Rato, has unveiled his proposals for a revamp. They range widely, from questions of power—of which emerging economies want more—to matters of paperwork—of which Mr de Rato wants much less.
Apart from generating reams of analysis, the fund's job is to furnish foreign exchange to countries that have temporarily run short. It can call on about $220 billion of hard currency in the first instance. That sounds like plenty. But some of its former customers now have big, shiny fire-engines of their own. South Korea, for example, has $217 billion in its vaults. Between them, eight East Asian countries (Japan, Singapore, Indonesia, China, Malaysia, the Philippines, Thailand and South Korea) command reserves worth about ten times the IMF total. These countries have even begun to pool a small fraction of their combined hoard, under what is called the Chiang Mai Initiative.
Lately no one has been calling on the fund's own supply. Brazil and Argentina have both repaid their debts. Only Turkey and Indonesia still owe it money on any scale. Quiet times are lean times for the IMF. Like any bank, it covers its running costs (which will amount to over $900m in the year to April 2007) from the interest it earns on its loans. But this financing model “is no longer tenable”, Mr de Rato's report says. By its own projections, the IMF will live beyond its means by almost $300m in 2009-10. The belt-tightening this implies has not gone down well with staff, who show little taste for the austerity they are notorious for prescribing to others.
There are lots of ways to plug this gap (the fund sits on 103m ounces of gold, for example). But is the fund worth the price? Friends and foes alike urge it to recover its standing by rediscovering its roots. It was set up in 1944 to police exchange rates and to oversee the orderly resolution of trade imbalances. America's Treasury thinks at least one currency, China's yuan, warrants a bit of policing today, and many others think that America's $800 billion current-account deficit needs work.
But the fund's authority does not match this ambition. John Maynard Keynes envisaged his brainchild as a “grandmotherly” institution, able to guide and chide national governments. But the fund now has little sway over family members who do not need its money.
With no way to punish offenders, the fund is left only with the power of “surveillance”: keeping an eye on the policies and frailties of its members and reporting on each in turn. But several critics, including Mervyn King, the governor of the Bank of England, and Edwin Truman, of the Institute for International Economics, a Washington think-tank, argue that the fund should take a more panoramic view, examining its members collectively, not just one by one. Otherwise, it will miss the spillovers from one country to the next.
If the IMF were to wither away—its money untapped, its advice unheeded—should anyone care? If emerging economies want to insure themselves against financial crises, rather than run to the fund, surely they should be applauded? Alas, their self-reliance is expensive and inefficient—as if every home had its own fire-engine. Emerging economies are, in effect, lending to foreigners (by piling up treasury bonds paying miserable rates of interest) in order to underwrite borrowing from them (at higher rates of interest). According to Dani Rodrik, of Harvard University, the developing world's reserves carry an opportunity cost of nearly 1% of GDP.
One way for a country to narrow these costs is to seek a fatter return on its reserves. Larry Summers, Harvard's departing president and a former treasury secretary, thinks the IMF could offer its serv
ices as an international fund manager, pooling official reserves in a more rewarding portfolio of assets. But this idea may mistake the origins of the problem. The build-up in reserves reflects a lasting anxiety about financial markets, but also a lingering distrust of the IMF. Mr Summers assumes that countries will be willing to entrust their dollars to the IMF. But if they had that much confidence in the fund, they might not feel the need to accumulate quite so many reserves in the first place.
How can the fund regain the confidence of its estranged members? The first step, as Mr de Rato recognises, is to give them a greater say in its affairs. The fund is close to being a shareholder democracy: the votes a country wields are proportional to the money it contributes. This “quota” is in turn meant to reflect a country's weight in the world economy. Even by the obscure formula that the fund uses, several emerging economies are now hugely underrepresented and many European countries overrepresented (see table).
Countries guard their quotas jealously. But Mr de Rato hopes they will agree to give a handful of the bigger emerging economies (China, Mexico, South Korea and Turkey) more votes, even if there is no appetite for a general increase in shares. Last year, Burhanuddin Abdullah, governor of Indonesia's central bank, warned that without changes, the “fund's credibility will continue to be undermined due to the monopolistic behaviour of large countries with veto power.” That power shows up in telling ways. Thomas Oatley and Jason Yackee, of the University of North Carolina, Chapel Hill, have shown that the fund's biggest rescue packages go to countries where the exposure of American banks is the greatest.
For all its mystique, the fund is at bottom just a financial middleman, as Michael Dooley, of the University of California, Santa Cruz, has pointed out. As such, it is always hemmed in by the threat of disintermediation. Countries such as Japan, China and South Korea can either lend to their neighbours through the fund, or they can bypass it and lend to their neighbours directly. Giving Asian countries a greater stake in the fund would encourage them to make use of it.
Mr de Rato also hopes to tempt them by changing the way the fund lends. Rather than mounting ad hoc rescue missions after the event, it would commit itself in advance to help favoured countries if the need ever arose. Which countries would qualify? Answer: those members pursuing sustainable policies that are nonetheless vulnerable to self-fulfilling reversals of sentiment on the part of their creditors. For such countries, a promise to lend might in itself avert the need ever to do so.
But could the fund ever revoke that promise? Disqualifying a strayed country might in itself precipitate a crisis, which is one reason why Barry Eichengreen, of the University of California at Berkeley, thinks the idea is a blind alley. On the other hand, if favoured countries can never fall from grace no matter what they do, the fund might find itself lending in support of unsustainable policies after all.
These objections need not be fatal. Moral hazard is part of all insurance arrangements. And as Michael Mussa, of the Institute for International Economics, has pointed out, the fund differs from an insurer in one important respect: the money it provides in a crisis has to be repaid. As long as governments care about the burden of repayment on future taxpayers, they will not seek loans capriciously.
By the time Mr de Rato's welcome proposals are enacted, if they ever are, the fund's identity crisis may well have resolved itself. If China slows, America starts saving again or interest rates spike, indebted or illiquid economies will struggle once again. Firemen with no blazes to put out are easily bored. Sadly, the fund's morale will not be this low for ever.
Copyright © 2006 The Economist Newspaper and The Economist Group. All rights reserved.
Apr 20th 2006
The International Monetary Fund contemplates its future
WHAT is a firefighter to do when there aren't any fires? The IMF spent 1994-2002 dashing from one financial conflagration to the next. But the sirens have been silent for some time. As a result, the fund's budget is shrinking and the morale of its staff is sinking. Some of its best customers are now doing without it, leaving some of its biggest shareholders wondering what to do with it. In the run-up to the fund's spring meetings in Washington, DC, this weekend, its managing director, Rodrigo de Rato, has unveiled his proposals for a revamp. They range widely, from questions of power—of which emerging economies want more—to matters of paperwork—of which Mr de Rato wants much less.
Apart from generating reams of analysis, the fund's job is to furnish foreign exchange to countries that have temporarily run short. It can call on about $220 billion of hard currency in the first instance. That sounds like plenty. But some of its former customers now have big, shiny fire-engines of their own. South Korea, for example, has $217 billion in its vaults. Between them, eight East Asian countries (Japan, Singapore, Indonesia, China, Malaysia, the Philippines, Thailand and South Korea) command reserves worth about ten times the IMF total. These countries have even begun to pool a small fraction of their combined hoard, under what is called the Chiang Mai Initiative.
Lately no one has been calling on the fund's own supply. Brazil and Argentina have both repaid their debts. Only Turkey and Indonesia still owe it money on any scale. Quiet times are lean times for the IMF. Like any bank, it covers its running costs (which will amount to over $900m in the year to April 2007) from the interest it earns on its loans. But this financing model “is no longer tenable”, Mr de Rato's report says. By its own projections, the IMF will live beyond its means by almost $300m in 2009-10. The belt-tightening this implies has not gone down well with staff, who show little taste for the austerity they are notorious for prescribing to others.
There are lots of ways to plug this gap (the fund sits on 103m ounces of gold, for example). But is the fund worth the price? Friends and foes alike urge it to recover its standing by rediscovering its roots. It was set up in 1944 to police exchange rates and to oversee the orderly resolution of trade imbalances. America's Treasury thinks at least one currency, China's yuan, warrants a bit of policing today, and many others think that America's $800 billion current-account deficit needs work.
But the fund's authority does not match this ambition. John Maynard Keynes envisaged his brainchild as a “grandmotherly” institution, able to guide and chide national governments. But the fund now has little sway over family members who do not need its money.
With no way to punish offenders, the fund is left only with the power of “surveillance”: keeping an eye on the policies and frailties of its members and reporting on each in turn. But several critics, including Mervyn King, the governor of the Bank of England, and Edwin Truman, of the Institute for International Economics, a Washington think-tank, argue that the fund should take a more panoramic view, examining its members collectively, not just one by one. Otherwise, it will miss the spillovers from one country to the next.
If the IMF were to wither away—its money untapped, its advice unheeded—should anyone care? If emerging economies want to insure themselves against financial crises, rather than run to the fund, surely they should be applauded? Alas, their self-reliance is expensive and inefficient—as if every home had its own fire-engine. Emerging economies are, in effect, lending to foreigners (by piling up treasury bonds paying miserable rates of interest) in order to underwrite borrowing from them (at higher rates of interest). According to Dani Rodrik, of Harvard University, the developing world's reserves carry an opportunity cost of nearly 1% of GDP.
One way for a country to narrow these costs is to seek a fatter return on its reserves. Larry Summers, Harvard's departing president and a former treasury secretary, thinks the IMF could offer its serv
ices as an international fund manager, pooling official reserves in a more rewarding portfolio of assets. But this idea may mistake the origins of the problem. The build-up in reserves reflects a lasting anxiety about financial markets, but also a lingering distrust of the IMF. Mr Summers assumes that countries will be willing to entrust their dollars to the IMF. But if they had that much confidence in the fund, they might not feel the need to accumulate quite so many reserves in the first place.How can the fund regain the confidence of its estranged members? The first step, as Mr de Rato recognises, is to give them a greater say in its affairs. The fund is close to being a shareholder democracy: the votes a country wields are proportional to the money it contributes. This “quota” is in turn meant to reflect a country's weight in the world economy. Even by the obscure formula that the fund uses, several emerging economies are now hugely underrepresented and many European countries overrepresented (see table).
Countries guard their quotas jealously. But Mr de Rato hopes they will agree to give a handful of the bigger emerging economies (China, Mexico, South Korea and Turkey) more votes, even if there is no appetite for a general increase in shares. Last year, Burhanuddin Abdullah, governor of Indonesia's central bank, warned that without changes, the “fund's credibility will continue to be undermined due to the monopolistic behaviour of large countries with veto power.” That power shows up in telling ways. Thomas Oatley and Jason Yackee, of the University of North Carolina, Chapel Hill, have shown that the fund's biggest rescue packages go to countries where the exposure of American banks is the greatest.
For all its mystique, the fund is at bottom just a financial middleman, as Michael Dooley, of the University of California, Santa Cruz, has pointed out. As such, it is always hemmed in by the threat of disintermediation. Countries such as Japan, China and South Korea can either lend to their neighbours through the fund, or they can bypass it and lend to their neighbours directly. Giving Asian countries a greater stake in the fund would encourage them to make use of it.
Mr de Rato also hopes to tempt them by changing the way the fund lends. Rather than mounting ad hoc rescue missions after the event, it would commit itself in advance to help favoured countries if the need ever arose. Which countries would qualify? Answer: those members pursuing sustainable policies that are nonetheless vulnerable to self-fulfilling reversals of sentiment on the part of their creditors. For such countries, a promise to lend might in itself avert the need ever to do so.
But could the fund ever revoke that promise? Disqualifying a strayed country might in itself precipitate a crisis, which is one reason why Barry Eichengreen, of the University of California at Berkeley, thinks the idea is a blind alley. On the other hand, if favoured countries can never fall from grace no matter what they do, the fund might find itself lending in support of unsustainable policies after all.
These objections need not be fatal. Moral hazard is part of all insurance arrangements. And as Michael Mussa, of the Institute for International Economics, has pointed out, the fund differs from an insurer in one important respect: the money it provides in a crisis has to be repaid. As long as governments care about the burden of repayment on future taxpayers, they will not seek loans capriciously.
By the time Mr de Rato's welcome proposals are enacted, if they ever are, the fund's identity crisis may well have resolved itself. If China slows, America starts saving again or interest rates spike, indebted or illiquid economies will struggle once again. Firemen with no blazes to put out are easily bored. Sadly, the fund's morale will not be this low for ever.
Copyright © 2006 The Economist Newspaper and The Economist Group. All rights reserved.
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