It all went according to script for Rodrigo de Rato, managing director of the IMF. 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 US living off cheap exports from Asia.
By the weekend, the cost of crude had hit US$75 a barrel, hopes dwindled that the deadline at the end of this month for a successful resolution of the global trade talks would be met and the US dollar was coming under severe downward pressure.
It was the perfect environment for 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 organization 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 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 US$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 out there to be worried about. In real terms, the cost of crude is not yet 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 fund 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 globalization.
But, as the fund 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. At some point, the global economy will suffer deleterious effects from high oil prices; nobody is quite sure what that tipping point is, but it's a fair bet that a year of oil prices at US$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 liter of unleaded is threatening to breach the ?1 (US$1.78) mark.
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 fund 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 US to carry on borrowing to finance its 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 percent of GDP, provided investors in Asia are prepared to finance it. The sharp fall in the US 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 fund's 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 fund 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.
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 marvelous. The fund's expertise is in macro-economic analysis, and it should specialize 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 that of any other country, for that matter.
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