WHAT ARE WE TO DO
By TAN SRI LIN SEE-YAN
MAYBE I am getting old.
For 20 years since the early ‘60s, I was a regular at the annual meetings of the IMF (International Monetary Fund). Those days, the annual meetings were eagerly awaited and exciting – serious systemic international monetary issues were usually taken-up and resolved in corridors outside the main meeting.
While concrete action was definitely lacking, the just concluded mid-October meetings showcased the growing influence of emerging nations, who were on the verge of winning a greater share of IMF governance power. The flocking of a record number of private bankers and fund managers to gain insights from (and access to) policymakers from Asia, Africa and Latin America offered the main excitement – a further testament to the growing importance of emerging markets where generous returns have drawn (and continues to draw) an uncomfortably heavy flow of investment monies from the United States and Europe. The mood was absorbing.
I sense the common thread was countries pursuing a national agenda in a fruitless effort to resolve major global problems. It is clear no nation is really ready to act for the greater global good.
So what else is new. The main issue on the table was currencies, two to be precise – the US dollar and the yuan. The US dollar because it is deemed to be deliberately made too weak; and the yuan because it is deliberately managed too inflexibly (despite breaking away from its fixed parity with the US dollar on June 19).
Behind the squabbles, much is at stake – how to rebalance the global economy. The outcome was predictable – global economic co-operation was in tatters and the currency war is now destined to be picked up at the G-20 meetings in November in Seoul after the weekend meetings broke-up with no resolution.
Global economic adjustment
Let’s step back. This year has gone messy.
Policy-makers had thought having rescued the world from the brink of economic disaster, they would by now be plotting an exit from stimulation rather than planning again to boost demand. IMF data pointed to an anaemic global recovery after initially experiencing rather rapid growth albeit uneven.
As a result, GDP of the rich economies is still below pre-2008 levels. Stubbornly high unemployment is making lives uncomfortable and souring politics. Euro-zone narrowly avoided igniting a second worldwide crisis in May following the “bailout” of Greece and possibly other highly indebted euro-nations at risk of sovereign default.
Continuing massive monetary easing by the United States and until recently, euro-zone flooded global markets with US dollar in particular, forcing emerging economies like Brazil, India and Thailand to take steps to protect themselves from destabilising capital inflows, including exchange market interventions. The IMF now touts capital controls. Japan intervened in the currency markets for the first time in six years to halt its yen from being further appreciated but with little success.
Against this backdrop, the Oct 12 communiqué of the International Monetary & Financial Committee of the IMF stated firmly: “While the international monetary system has proved resilient, tensions and vulnerabilities remain as a result of widening global imbalances, continued volatile capital flows, exchange rate movements, and issues related to the supply and accumulation of official reserves. Given that these issues are critically important for the effective operation of the global economy and the stability of the international monetary system, we call on the Fund to deepen its work in these areas, including in-depth studies to help increase the effectiveness of policies to manage capital flows.”
What a cop-out.
IMF’s economic counsellor Blanchard is right in stating that “achieving a strong, balanced and sustainable world recovery was never going to be easy … It requires two fundamental and difficult economic rebalancing acts.”
First, internal balancing. Recession arose because private demand collapsed; fiscal stimulus helped alleviate the fall in GDP – which has to eventually give way to fiscal consolidation; this means sustained growth needs private demand to resume and be strong enough to take over and lead.
Second, external rebalancing. Most advanced nations (notably the United States) which relied excessively on domestic demand must now restructure to depend more on net exports to grow; similarly, most emerging economies (mainly China) which depended largely on net exports must now switch to rely increasingly on domestic demand. Adjustment problems arose because both rebalancing acts moved too slowly.
On paper, what needs to be done is straightforward. The private sector of high spending, high deficit rich nations need to deleverage quickly to reach the “new normal” referred to by this year’s Per Jacobsson lecturer Mohd El-Erian (Pimco, world’s largest bond fund). At the same time, economies with robust payments surpluses and strong investment opportunities need to let their exchange rates reflect the market and appreciate; while encouraging domestic demand to expand to offset consequential drag from fall in net exports. In practice, what happened was overdone and undercooked. Aggressive monetary easing by reserve issuing rich nations (again notably US) flooded the world with cheap US dollar, pushing exchange rates of strong emerging nations to revalue (since the US dollar as the world’s anchor can’t devalue on its own). Worse, capital recipients react stubbornly to accept the needed changes and acted to deflect the changes elsewhere. Hence, the currency “wars.”
Martin Wolf (Financial Times) sums it best: US wants to inflate the rest of the world, while the latter tries to deflate the US. Frankly, the US is getting desperate. The jobless recovery is not getting better fast. Debt deleveraging is moving too slowly. Monetary policy is up against Keynes’ liquidity trap (further falls in interest rates can’t stimulate demand). Inflation is low and falling. To avoid debt-deflation, the Fed has reintroduced QE2 (quantitative easing, Mark 2). The objective is to avoid deflation. The Fed is determined to do what it takes to meet this goal. Whatever impact this has on the rest of the world is collateral damage.
However, the World Bank has since warned that surging capital inflows threaten Asia’s economic stability, and fan fears of asset bubbles.
We can already see what’s going to happen. On Oct15, the Fed chairman sent a clear message, sledged-hammered home by four phrases in italics: The Fed takes its cues from two primary objectives: the “longer-run sustainable rate of unemployment” and the “mandate-consistent inflation rate,” adding what the Fed thinks of both right now: inflation is “too low” and unemployment “too high”. This means further QE2 is a given. The Fed will turn-up its electronic printing pieces, creates loads of US dollar and buys trillions of US Treasury debt, as it is poised to do to resuscitate the US economy.
As I see it, what’s unfolding are radically different views of the world. China does not accept that its under-valued exchange rate is a significant cause of global imbalances. Beijing goes on to suggest the US external deficits and fiscal deficits are self-inflicted. The common view in the United States is Asia’s excess savings created the US current account deficits.
So the solution lies in Asia. It has come to a stage of not who blinks first, but who moves if at all and in what direction. So there is no deal. Other emerging nations are mostly caught in-between: concerned about China’s currency misalignment which undercuts their exports; but worried at the same time that fund managers armed with lots of cheap US dollar, are driving their currencies higher in search of higher yields.
No doubt, QE2 is potentially very stimulative, with expansive ramifications for the global economy. This is particularly so if it compels other central banks to follow suit in retaliation to protect their currencies’ value and ward-off inflation. But does QE2 really work? It comes out loud and clear at the IMF meetings that European central banks and politicians need lots of convincing.
Despite almost identical problems-high unemployment and very low inflation, the Fed and the ECB (European Central Bank) walk vastly different paths in their policies. The Fed chairman attributed the unemployment “to the sharp contraction in economic activity that occurred in the wake of the financial crisis and the continuing shortfall in aggregate demand since then, rather than structural factors.” The Fed is wedded to using all tools at its disposal to lower long-term rates and goose growth to reduce the jobless. Hence, more QE2.
The Europeans regard their unemployment as more structural, reflecting labour rules. Axel Weber, Germany’s central bank chief, stresses: “my reading of what happened on the (euro-zone) labour markets is that what we’ve seen in the crisis is largely structural and we need structural policies.” Who’s right? In euro-zone, there is a wide gap – from 4.3% in Austria to 20.5% in Spain.
In the United States, there is growing concern that unemployment could become structural. The term “hysteresis” is now used to describe this dynamic in which the longer you remain jobless, the more your skills erode; as you get used to being out of work, you adjust your behaviour making re-entry to work tougher. The real challenge is whether more QE spurs real investment, badly needed to bring down the jobless rate.
In the United States, this gets more complicated because of viable attractive alternatives: including use as capital-protection against US dollar debasement and inflation; and greater growth prospects in emerging countries. Nobel Laureate Stigliz thinks QE is “ineffective in reviving the US economy … won’t do much to stimulate business directly.” For the ECB: “monetary policy cannot, by itself transform a jobless recovery into a job generating recovery.”
What’s to happen?
The world appears on the brink of a nasty confrontation over exchange rates. China’s central bank chief realises the yuan value will rise but its strength must depend on gauging fundamentals like inflation, growth and employment: “China likes to use more gradual ways to realise a balance between domestic and external demands … we have a package to enhance internal demand including consumption, social security system reform, new investment in the rural areas.” But the US is seeking to impose its will via the printing press: frankly, there is no limit to the amount of US dollar the Fed can create.
At its heart, the currency war appears more like a skirmish. The big problem lies in there being no political will to really reform the international monetary system. The core of the system is unstable. Reckless risk taking can once again lead to widespread collateral damage. The communiqué after the IMF meeting spoke of countries working “co-operatively,” but says nothing on how to find agreement on the issues that divide them.
● Former banker, Dr Lin is a Harvard educated economist and a British Chartered Scientist who now spends time writing, teaching & promoting the public interest.
