COMMENTARY

Autumn 2009

by Charles Dumas

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Lorenzo Bini Smaghi’s paper is frustrating, because he identifies the chief problem that gave rise to the recent global financial crisis, but then diverts into a discussion of how to make the IMF fit to solve it. Closer examination of the problem of global payments imbalances would immediately rule out any likelihood that the IMF could have affected the course of events, or could in a comparable future crisis be empowered to do so.

The imbalances that Bini Smaghi refers to can be divided into two: the primary trans-Pacific story and the European sub-plot. The Eurasian surpluses, which unlike oil exporters’ in a boom, are structural not cyclical, were by 2007 $1,250bn, or about 2.5% of world GDP, and 6-7% of GDP in the relevant Eurasian countries. Of this, $750bn was the surplus of China, Japan and the Asian “Tigers”, and the deficit of the U.S. The remaining $500bn was the surplus of Germany and the Benelux and Nordic countries, Switzerland and Austria, largely offset by deficits in Britain, Spain, central and eastern Europe and various other European countries.

Did the borrowing and deficits of the U.S. induce surpluses in the Eurasian “savings-glut” countries? Or did their excess savings “crowd out” savings in the U.S. and other deficit countries? If the former, interest rates and credit spreads would have soared. If the latter, lower rates and spreads would have been a major aspect of the mechanism by which the “borrow-and-spend” boom was induced in the U.S. While the excess savings and borrowings were clearly interactive, the continued low rates and compressed spreads indicate that the savings glut was the chief driving force – and the leveraged boom more the reaction. World saving and investment went up as a percentage of GDP in the five years to 2007, so it was a conventional cycle in global terms, not particularly, as Bini Smaghi claims, based on consumption. While commodity price inflation was evident, overall inflation was not a major problem.

But we do not have to decide which was the cause and which the effect to see the weakness of Bini Smaghi’s IMF-based approach. The reality is that the U.S. and Britain had no difficulty funding their deficits and their domestic borrowing sprees. Where else could the excess savers put their money other than with those prepared to borrow? Is it realistic to suggest that the IMF should have powers to require the U.S. to give up its debt capacity and also the privilege of the dollar’s reserve currency status?

And what about the IMF’s advice to China to stop its currency from being “undervalued” and to stop running a large net export surplus of what by 2007 was nearly 10% of GDP? Might not China remind the IMF that it was IMF policies in 1997-98 towards South Korea and others – policies clearly orientated toward the interests of first-world bankers, rather than the health of the Korean economy – that mandated mercantilist, export-led growth in China and the Asian Tigers? Besides which, as students of the Bretton Woods conference know, the problem raised by Keynes of putting pressure on structural surplus countries, was ducked – not least because outsiders have little leverage on surplus countries. (Only John Connally in 1971 – “It’s our dollar, and your problem” – had the power to drive up the exchange rates of Germany and Japan.)

Then we should consider the European sub-plot. The country becoming more and more undervalued under cover of its eurozone membership was Germany. On the other side of the equation was Spain, where euro membership aggravated the extravagance of the boom. It might be a good idea for the IMF to suggest Spain leaves the eurozone – or maybe Germany – but that is not practical politics. And the private-surplus, public-balance behaviour pattern in Germany is not going to be changed to suit the IMF.

The IMF does a useful job taking care of the Icelands and Latvias of this world, but the big boys are not going to change their ways until the pain of their current behaviour and policies exceeds the motives behind them. The imbalances may well re-assert themselves in recovery, so it is therefore likely to be relatively weak and short. When the next crisis comes, perhaps in three or four years, we will find out whether China and America are prepared to moderate their national policies and cooperate.