The Disquieting View from the IMF Meetings, and the Need for U.S. Leadership

The International Monetary Fund held its annual Washington meeting last weekend, so I spent a balmy Sunday discussing the potential pitfalls for the U.S. and world economies.  I attended as one of two American representatives on the IMF’s advisory board for the Western Hemisphere; and in that group and beyond, almost no one could see a clear path to worldwide prosperity.  Yet, few delegates seemed open to their own countries accepting any costs to enhance the prospects of global growth or even to protect the world from another meltdown.  

The weekend’s favorite topic was the slow growth unfolding in the United States, Europe and Japan – too slow, that is, for the large developing countries that depend on us to buy their exports and so support their employment.  The upshot is new concerns about a “currency war” breaking out in the developing world, and perhaps beyond.  Already, many countries are intervening to keep their currencies relatively cheap and so make their exports more price-competitive than their neighbors.  Of course, the only certain way for a country to keep its exports competitive is to produce better goods and services than its rivals.  But that can involve reforms in investment, education and business-formation policies, all much harder to pull off politically than temporarily managing an exchange rate.  The catch is that when everyone tries to keep their currencies cheap at the same time, no one ends up better off – and the next step is protectionism.  If that sounds far-fetched, consider that one of the first orders of business in the new Congress will be legislation to punish Beijing for its cheap currency by slapping new tariffs on Chinese imports. 

Forgotten in all these machinations is the supporting role that artificially cheap currencies played in the financial crisis.  The strong dollar, compared to almost everyone else’s currencies, made Americans outsized consumers of everyone else’s exports – in 2007, U.S. imports totaled $2.2 trillion, or more than the entire GDP of all but five countries.  But most of the dollars we spent on imports came back here, since the United States is the only place where dollars are the legal currency to buy stocks or companies.  Those dollars helped swell the liquidity that financed the reckless leveraging by mortgage lenders and Wall Street, which all came crashing down in 2008.  And when economists today say we have to redress “global imbalances” to avoid another crisis, they’re talking about the same dynamics.  Yet, today’s competitive currency devaluations put us right back on the same path.

 The weekend’s next favorite topic was the current political fashion for tight budgets, especially in the advanced countries.  Since those are the same countries with slow growth, the talk turned to technical moves by the Federal Reserve and perhaps other major central banks – so-called “quantitative easing” -- to expand credit even as interest rates already are near zero. This cheap new credit, of course, could someday be the kindling for the next bubble.  

Moreover, it was hard to find anyone at the meetings who believes that the financial reforms taken thus far, here and around the world, are enough to avoid another meltdown.  The good news is that the Financial Stability Board – that’s a rule-setting body for the major central banks – is set to issue another set of requirements for big finance, which will go well beyond what anyone else has done so far.

Of course, it’s unlikely that the world’s big banks will accept significant restrictions from the FSB, following their success in watering down new limits everywhere else.  And even if they did, those rules won’t help contain the current flash point in the global capital system, the sovereign debt problems of Greece, Spain, Portugal and Ireland.  A default by Spain, for example, would leave major French and German banks insolvent.  They also would be unable to meet their obligations to U.S. and British banks, setting the stage for another financial meltdown.   Now, even if Greece goes down, as most financial experts privately expect, Spain and the rest may still avoid the worst.  But if the worst does happen, the EU-IMF contingency bailout program might well not stem the tide.  At least, that’s the current judgment of global investors, who have bid down the prices for Greek, Spanish, Portuguese and Irish bonds to levels near those before the EU and IMF announced their program months ago. 

Behind all of these problems, the core issue remains the persistent slow demand and growth across much of Europe, Japan and the United States.  The unavoidable fact is that the financial crisis has left countless tens of millions of households in the advanced countries poorer, and therefore reluctant to spend like they used to.  The only recourse is to help people rebuild their incomes and wealth through direct measures to stabilize housing prices (the source of most people’s wealth) and to induce employers to hire more people.   As usual, the world’s dominant economy and its President will have to take the lead.  And that, I suspect, was the main topic of discussion this past weekend at the White House, just a few blocks down the street from the IMF meetings.