TCS Daily


The IMF as Global Economic Cheerleader

By Desmond Lachman - April 26, 2007 12:00 AM

The International Monetary Fund's recent Spring Meetings confirmed yet again how far the IMF has strayed from its original mandate as guardian of the international financial system. For far from substantively addressing the present risks of a disorderly unwinding of global payment imbalances, the IMF chose to play the role of the world economy's cheerleader and to busy itself with IMF internal housekeeping matters. By so doing, the IMF not only risks further denting its already tarnished credibility, but it also risks raising anew fundamental questions about its continued relevance in today's global economy.

Set up in 1944 against the backdrop of the dismal international economic performance of the 1920s and 1930s, the IMF's original mandate was to promote exchange rate stability, to maintain orderly exchange rate arrangements among members, and to avoid competitive exchange rate depreciations. The basic idea in creating the IMF was to have a multilateral institution that would do everything in its power to prevent a repeat of the "beggar-my-neighbor" exchange rate policies that were so destructive to international prosperity during the inter-war years.

Sadly, today's global payment system displays many of the same dysfunctional symptoms that characterized the 1920s and 1930s. In particular, over the past sixty years, global payment imbalances have never been more pronounced than they are today. These imbalances are exemplified by the record US external current account deficit of around US$800 billion or over 6 percent of GDP, and the correspondingly large record Asian current account surpluses. At the same time, currency manipulation, especially in Asia, which thwarts orderly global payment adjustment, is all too prevalent, while protectionist pressures, especially against China, are on the rise in Europe and the United States.

Judging by today's Asian economies, it would seem as if each country is free to do as it likes with its exchange rate without raising real objections from the IMF. Indeed, China massively and persistently intervenes in its exchange market to the tune of US$250 billion a year to prevent any meaningful appreciation of its currency without incurring the IMF's wrath. For its part, Japan persists with a mix of tightening fiscal policy and extraordinarily low interest rates that ensures a continued weakening in the Japanese yen. By effectively keeping their currencies weak, the Asian economies shift the burden of adjustment of a weaker US dollar to Europe, even though Europe's balance of payments is presently not significantly in surplus.

Beyond today's global payment imbalances, a more immediate threat to the global economic outlook is the all too evident bursting of the US housing market bubble. In the period ahead, it is more than likely that US home prices will fall significantly following their spectacular 80 percent run-up between 2000 and 2006. They will do so not simply because of the present sub-prime mortgage lending crisis, but because of the generalized tightening of mortgage lending standards, the unwinding of speculative positions, and the resetting at higher interest rates of adjustable rate mortgages.

The unraveling of the US housing market could very well be the trigger that leads to a disorderly decline of the US dollar. Should the Federal Reserve be forced to cut interest rates to prop up a flagging US economy, the interest rate differential that presently favors the US dollar could be seriously eroded. More important still, should the US housing downturn diminish the attractiveness to foreign investors of both US mortgage and non-mortgage related financial assets, the US would have a major problem in financing its gaping current account deficit.

Seemingly oblivious to the mounting risks of a disorderly unwinding of global payment imbalances, the IMF had little to offer at its Spring Meetings by way of leadership towards a coordinated policy response to those risks. In its supposed exercise of multilateral exchange rate surveillance, the IMF cobbled together well-worn policy plans from its bilateral consultations over the past year with the United States, Europe, Japan, China and Saudi Arabia. Aside from being at the most general of levels, those policy plans offered virtually nothing new by the way of policy initiatives, especially in the vexing area of the greater flexibility needed in Asian exchange rate policy.

Unwilling or unable to exercise meaningful multilateral exchange rate surveillance, and bereft at least for now of its previous role as lender of last resort to the large emerging market economies, the IMF has taken upon itself the role of the world economy's cheerleader. In that role, the IMF counsels us not to be unduly concerned about the unusually large number of real risks presently confronting the global economy. It also assures us that, previous experience to the contrary, a significant downturn in the United States will not spread to the rest of the global economy.

This all has to leave one wondering what the IMF's founding fathers might have made of the spectacle of the IMF being reduced to the world economy's cheerleader. It also has to raise questions as to whether the IMF really needs quite as large a bureaucratic apparatus as it has today to exercise that limited role.

The author is Resident Fellow, American Enterprise Institute.



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20 Comments

cheerleading
At least cheerleaders look cute, but the dysfunctional IMF, like it's sister the World Bank only serve their own beauroctats and tin pot dictators and keep alive crappy third world states, like Indonesian, that don't even deserve to be countries, and wouldn't be if they weren't keep on arificial life-support. Nobody every mentions how many people work that the IMF, and what their budget is for their own wages; deep secret. It should be disbanded.

The Fed and the Economy
Once again we get the mantra that if the economy cools because of the bursting of the housing bubble, it's up to the Federal Reserve to come to the rescue. Apparently nobody remembers the US economy in the 1970's or the current Japanese economy. Having the Fed pump out money in a recessionary environmenht will likely result in the same thing it did then: stagflation. Low nominal interest rates have done nothing to boost the Japanese economy. If anything, current interest rates are still too low, not too high.

I agree, but another subject...
I appreciate the validity of Dietmar's statement. On a different subject, I have often wondered about the possibilities of establishing an outside authority to ensure the rule of law in underdeveloped countries.

Possible...
Charles,

This is actually possible in spite of a weak government's inability to enforce its own laws of property and contracts. Those are the issues that most directly cripple GDP expansion because traditional banks cannot underwrite industrial development. Without a source of working capital successful small entities are not able to leverage the things they do well up into the larger, global market. Therefore, the economy has no way to convert its cheap labor into dollars by exporting high margin goods with substantial labor content.

These cheap labor markets are trapped into exploitation at the hands of foreign interests. And such slavery into perpetuity.

However, banks themselves are able to impose adequate discipline on their own clients if those banks are downsized enough to be dealing only with parties known to them, with myriad interlocking transactions, and clients without the motivation to run away.

In the United States most contracts are fulfilled and most titles are secure without anyone turning to the judiciary system. Of course, the courts are standing by if needed and the legal profession is more than happy to take our money.

All this overhead costs tax dollars but only allows us to deal with strangers. If we might accomplish all of our business interactions (involving credit) with trusted parties and if some one of us owns the small bank itself then those "outside authorities" we are looking for could actually be ourselves.

re another
There used to be such a system of outside authority to ensure the rule of law, but it's not considered PC anymore; it's colonialism. The Sudan was better run when it belonged to Britain, then after they gave it up, we see what happened. Same with many places. But people nowadays(that is the western left-liberals)think it's better to have local dicatators bring countries to ruination instead of having any foreigner rule them, especially if they're white. But what if the Japs ran the Ivory Coast? What if HongKong ran, Kashmir? Would Liberia be such a backwater if Ireland ran it? The PC think to do instead is to have the IMF and world bank just continue to support these dysfunctional countries, on our dime.

Exploitation by foreigners...
Colonial rule is, indeed, a military occupation with a strong government presence. However, the point of such empire building is the exploitation of cheap resources and the extraction of any wealth created by putting the conquered people to work.

I am talking about downsizing the effective, self-governing social units as economic entities that have sufficient resource depth to own and operate their own businesses to convert cheap labor into dollars through exporting. (Rather than to allow foreigners to create this wealth, to repatriate their earnings and to then exit leaving behind the same poor people they came to exploit.)

Companies large enough to pull this off must have a source of working capital. If our manufacturing group included its own small bank then the standard issues of property laws and the laws of contracts not being enforced would be moot. We would naturally discipline our own behavior (among ourselves) without relying on the government or its judges.

This model simply implies large LLC partnerships that are operating businesses in the global marketplace and that are permitted, in many such countries, to hold title to their own, private banks.

Forex...
I have discussed many of my problems regarding Dr. Lachman's arguments concerning "the mounting risks of a disorderly unwinding of global payment imbalances" elsewhere.

Nevertheless, it seems astounding that Dr. Lachman makes no mention of the role the $2 trillion per day Foreign Exchange Market (Forex) plays in buffering any such risks.

There is specific and irresistible evidence that imbalanced piles of hard currency (whether dollars or anyone else's funds) are simply not building up anywhere.

In their daily transactions the banks themselves convert one hard currency into another on their books, according to their client requirements and at the (Forex established) prevailing rate of exchange. One currency balance simply ceases to exist and the other is created. This is possible because all of the new money in the world is actually created by those same banks when they write loans. That loan activity is much larger than the volume of international trade which is, in its turn, dwarfed by the daily volume at Forex.

Governments do not create money. Banks do. And hard currency designations are fundamentally unimportant. There is only one "amount" of such value at any snapshot in time. Whether this line item is designated as dollars, as euros or as yen...it simply does not matter.

Further, it is argued that China is using its holdings of dollars to artificially keep the yuan weak. Mechanically, however, the Chinese must actually buy dollars through their Forex account to accomplish that.

My own sense is, just as when the Fed draws a line in the sand, very little Open Market Transaction activity is required to set the target rate. Everyone already knows that the government of the United States or that of China should be able to back up its stated intention to move the market.

There is nothing going on out there. This issue is like global warming, the hole in the ozone, genetically modified foods and the impossibility of simply killing the malaria mosquitoes in Africa.

Such (let's all pretend there really are) problems, with very little underlying validity, keep academic types fully employed in study groups and think tanks. And strip huge chunks of working capital out of our GDP. The Carbon Credit market has now reached $100 billion? And there are no supporting documents? Then it is mostly a financial sham, isn't it?

Do you think that the Chinese waste their time and money with this sort of foolishness?

exploitation
When you said, "However, the point of such empire building is the exploitation of cheap resources and the extraction of any wealth created by putting the conquered people to work." Do you know of any examples that contradict that statement? If there are some, will you admit that it's not correct? BTW, what school of economics do you follow? It seems some people have asked you several times, but you never mention. Is it secret?

I am not a professional economist...
Dietmar,

I manage companies. In the past I was a consultant with a large firm you have heard of. But mostly I make business operations work. I studied economics, finance and accounting (three separate disciplines) in the days of my youth.

I am a general manager. I do not follow a school of economics. As far as I can tell, none of the economists actually have it figured out yet. So what's to follow?

However, I did work as a management consultant for Eli Goldratt for a number of years in the 1980's and his theories are as close to describing the reality of capitalism as anything I know about. The theories of OPT and TOC require a solid background in general management. Most economists need not apply.

Dietmar, talk to me about your examples of colonial rule that accidentally enabled the enslaved, indigenous populations to do anything more than to stay brown and die.

When we enslaved more advanced civilizations they needed to step back hundreds of years to restart their own cultures when we finally walked away.

Sometimes we do not like the way this process looks. But we watch anyway.

re: Eli Goldratt
Yes, he's just a management guru, TOC and all that, but the presumtion is capitalism with the freedom to actually manage companies, not state run companies who make decisions based of politics and social engineering. But in other places you mention very strange underlying economics, not just business management, it sounded like you were into something weird and discredited like the wacko 'social credit' school of economics.

re: colonies
You said, "Dietmar, talk to me about your examples of colonial rule that accidentally enabled the enslaved, indigenous populations to do anything more than to stay brown and die". Examples; Hong Kong, the brits just gave it up in 97, and even then it was one of the most prosperous places around. People risked their lives to get into it from red China that was free of such filthy colonialism. Then Singapore, ruled by the UK till 65, and because of their good foundation of rule of law and capitalism, one of the riches places in the world. Also Malyasia, far better off than its non colonial neighbour Thailand. In Africa, south africa much better ruled when it belonged to Britain, Zimbabwe, when Rhodesia was the breadbasket of africa, only ruined when no longer a colonngy. Then what about Bermuda, have the blacks there suffered from colonialsim. What about America, and Canada? But don't worry, I don't expect a retraction of your innacurate comments, or an apology; I know you're not too hot on history, nor economics.

TOC...
Eli Goldratt's concepts might be resolved into: "We know where we want to go and we know where we are right now. So what do we do next?" This is called "forward finite planning". And tomorrow we will see where we are again.

We want to accelerate operational processes toward the goal by focusing management attention on the finite processes that "limit" the production (throughput) of the entire system.

Twenty years ago we called these restrictions "bottlenecks" when it was OPT. Eli simply calls them "constraints" now that the philosophy has evolved into TOC.

Whichever term you use, the planning paradigm is pointed at identifying the actual, structural, rate limiting factors of production. We maximize the performance of each such resource or we "open the bottleneck" by adding capacity. The system will then produce at an increased rate until we encounter the next structural constraint.

All the other income producing resources have (by definition) excess capacity and they should not be doing anything other than to feed the bottleneck or to take the output of the bottleneck away into finished goods as quickly as possible. Otherwise, the non-bottlenecks should be idle. This reality drives many managers crazy. Especially when those idle resources are people. But if you lay off too many of those workers then people become the constrained resource. And that is stupid. People are the most flexible production resource and workers should always be in excess supply.

For example, if the maximum throughput of the system is $8,000 per hour but you lose an hour of production each day because you don't have one more $20 per hour worker to execute rapid changeovers at the bottlenecked machine...Well, you do the math.

In manufacturing, raw materials need to move across the factory floor as rapidly as possible into finished goods that are needed to serve actual (versus projected) market demand. You want to turn your investment in raw materials back into cash in the shortest possible time. You should build to "order" rather than to "stock".

The Japanese Kanban system gave them what we called Just-In-Time manufacturing. Without computers. Dr. Goldratt's systems employed mathematics (algorithms) and (heavy weight) computer software to give us decisions about what to do next. These solutions were superior to the margin of error in the input data in spite of the fact that the multi-variable algorithms themselves could not be solved to completion.

But by focusing on the constraints we could generate most of the benefits without modeling the process for the computer. It really did become more of a philosophy of operation than a computer tool.

The political system involved is not very important, Dietmar. Manufacturing in China should be no different even if the government does own the factory. If the management decides to do stupid things for political reasons then such operations would not be competitive. As far as I can tell Chinese operations are very competitive.

Well...you didn't say anything about my mother...so I'll keep playing...
My apology to you is that I have, so far, failed to explain myself well enough that you understand what I am talking about. I respect your intelligence. So this is entirely my fault.

Hong Kong was not a proper colony. Hong Kong was a free port possession of the UK enabling goods to flow out of an otherwise inaccessible China. The British bankers and trading companies made money there. But the fundamental wealth creation operations were owned by Chinese. Same with Singapore. Transition back to Chinese rule in both places was virtually seamless.

If Hong Kong and Singapore never existed then all that trade would have defaulted back to Manila as it had for centuries under Spanish rule. The Chinese in the Philippines were over there all that time for precisely this purpose and they are still there today.

India, the Middle East and many places in Africa did not do so well when the Brits walked away, did they? America became Super-England. And the indigenous brown people here were mostly killed or incorporated into our larger society.

South African did fine without the UK because the Dutch came to stay. But the blacks were hard put upon...or did I not understand that bit of history?

Bermuda is also not an example of a colony for the British any more than Guam is a colony of the US. No one much wanted them and we needed an outpost...so fine.

Malaysia probably has a way to go. Although you might prefer it to Thailand.

This is not a contest, here, Dietmar. We are just talking. If I am not smart enough for you then, again, I take it all back and I do apologize. Indeed, nothing about me is all that hot, if you must know.

TOC
Ok, these day by day management issues you maybe know about but then we're talking at cross purposes, since I mostly refer to either macro economic stuff, or else comment on specific items. For example, I'm not even sure what you meant about the just-in-time notion that the japs started, but I do know that in many instances that was also crap because, let's say the car plant doesn't want to stockpile a lot of inventory, but insists that the suppliers deliver every day , or every hour. Sounds good for the car plant, but often it has just meant that the inventory was just stocked at somebody els's yard, or waiting on the street for hours etc. That's for management guys like to to work on, it's not a matter of whether markets should be free or whatever.

re your mother....
Oh never mind. But my comments were in answer to yours about exploiting natives, stealing resources, keep the brown and dead, etc. Then when I gave concrete examples of where that was not the case, you just say that HK was not a proper colonly! It remeinds me of alice in wonderland where that one guy said that words mean whatever he wants them to mean. HK did well with the brits owning it 100% with power of life and death, but instead of expoiting the natives, built up as prosperous place where refugees from red china risked their lives to get to. The natives in Canton prefered the colony to independant red china. Also, you don't know history if u say that if there were no HK and Singpaore, trade would have reverted to Manila. Manila was not even on a strategic waterway, the malacca straights were most of the trade went thru, and still does, today. Singapore was a filthy swamp with a few kampongs(native villiages) and a few sea gypsies. The brits didnt expoilt them but built up a good little colony where people from all over asia could come, and make good livings. Also in all the places, the Brits voluntarily handed them over, and din't fight on like some did after the war. Also re malaysia, malasians also prefer it to thailand, it's much more prosperous.

bank money
You said, "Governments do not create money. Banks do." THis is false in that governments control the central banks, thus the fractional reserve system. They try to claim that the central banks are independant, but in reality are not. If there were only private banks, there could be no inflation, no printing of money.

Dietmar...
Bless your heart. You really don't know where money comes from, do you?

"If there were only private banks, there could be no inflation, no printing of money." How can you say stuff like that?

You do know where babies come from though, right?

banks
They can print money only in the same manner that i could from my house. If it's not recognized, or backed, the it's just monopoly money. Government fiat money is close to that too. You claim you're not a 'social credit' guy, but are Keynsian. I still think you have some hidden other wacky non main stream school of economics, but you're not telling us. But this does not preclude you maybe being a successful businessman. A shapr guy can succes under any system, and manipulate any system; I've seen that in the old country under nazzis, and then under the commies, and now in the new russia, China etc.

No one is a Keynesian any more...
Keynes described earlier phenomena in a useful way. The financial world, however, has evolved past his assumptions.

As we have said, the math itself cannot be solved with economic models (algorithms cannot be taken to completion) and the input data is never perfect.

You are right, though. I am working on something. And you are helping me quite a lot.

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