Can the IMF Avert a Global Meltdown?

Kenneth Rogoff
Kenneth Rogoff
Kenneth Rogoff Thomas D. Cabot Professor of Public Policy and Professor of Economics - Harvard University, Former Brookings Expert

September 10, 2006

CAMBRIDGE, Massachusetts — When world financial leaders meet in Singapore this month for the joint World Bank/International Monetary Fund meetings, they must confront one singularly important question: Is there any way to coax the IMF’s largest members, especially the United States and China, to help diffuse the risks posed by the world’s massive trade imbalances?

This year, the U.S. will borrow roughly $ 800 billion to finance its trade deficit. Incredibly, the U.S. is now soaking up roughly two-thirds of all global net saving, a situation without historical precedent.

While this borrowing binge might end smoothly, as U.S. Federal Reserve Chairman Ben Bernanke has speculated, most world financial leaders are rightly worried about a more precipitous realignment that would likely set off a massive dollar depreciation and possibly much worse. Indeed, if policymakers continue to sit on their hands, it is not hard to imagine a sharp global slowdown or even a devastating financial crisis.

Although Bernanke is right to view a soft landing as the most likely outcome, common sense would suggest agreeing on some prophylactic measures, even if this means that the U.S., China, and other large contributors to the global imbalances have to swallow some bitter medicine. Unfortunately, getting politicians in the big countries to focus on anything but their own domestic imperatives is far from easy.

Though the comparison is unfair, it is hard not to recall the old quip about the IMF’s relative, the United Nations: “When there is a dispute between two small nations, the U.N. steps in and the dispute disappears. When there is a dispute between a small nation and a large nation, the U.N. steps in and the small nation disappears. When there is a dispute between two large nations, the U.N. disappears.”

Fortunately, the IMF is not yet in hiding, even if some big players really don’t like what it has to say. The IMF’s head, the Spaniard Rodrigo Rato, rightly insists that China, the U.S., Japan, Europe and the major oil exporters (now the world’s biggest source of new capital) all take concrete steps toward alleviating the risk of a crisis.

Though the exact details remain to be decided, such steps might include more exchange-rate flexibility in China, and perhaps a promise from the U.S. to show greater commitment to fiscal restraint. Oil exporters could, in turn, promise to increase domestic consumption expenditure, which would boost imports.

Likewise, postdeflation Japan could promise never again to resort to massive intervention to stop its currency from appreciating. Europe, for its part, could agree not to shoot its recovery in the foot with ill-timed new taxes such as those that Germany is currently contemplating.

Will the IMF be successful in brokering a deal? The recent catastrophic collapse of global trade talks is not an encouraging harbinger. Europe, Japan, and (to a much lesser extent) the U.S. were simply unwilling to face down their small but influential farm lobbies. The tragic result is that some of the world’s poorest countries cannot export their agricultural goods, one of the few areas where they might realistically compete with the likes of China and India. Fortunately for Rato, addressing the global imbalances can be a win-win situation. The same proposed policies for closing global trade imbalances also, by and large, help address each country’s domestic economic concerns.

For example, China needs a stronger exchange rate to help curb manic investment in its export sector, and thereby reduce the odds of a 1990s style collapse. As for the U.S., a sharp hike in energy taxes on gasoline and other fossil fuels would not only help improve the government’s balance sheet, but it would also be a way to start addressing global warming. What better way for new U.S. Treasury Secretary Hank Paulson, a card-carrying environmentalist, to make a dramatic entrance onto the world policy stage?

Similarly, the technocrats at the Bank of Japan surely realize that they could manage the economy far more effectively if they swore off anachronistic exchange-rate intervention techniques and switched wholeheartedly to modern interest-rate targeting rules such as those used by the U.S. Federal Reserve and the European Central Bank.

With Europe in a cyclical upswing, tax revenues should start rising even without higher tax rates, so why risk strangling the continent’s nascent recovery in the cradle? Saudi Arabia, with its burgeoning oil revenues, could use a big deal to reinforce the country’s image as a major anchor of global financial stability. If today’s epic U.S. borrowing does end in tears, and if world leaders fail to help the IMF get the job done, history will not treat them kindly. Instead, they will be blamed for not seeing an impending catastrophe that was staring them in the face. Let’s hope that on this occasion in international diplomacy, the only thing that disappears are the massive global trade imbalances, and not the leaders and institutions that are supposed to deal with them.