September 12, 2006
Why bad news for the Fund is excellent news for its clients
The International Monetary Fund is in financial crisis. That will give its critics reason to cheer. But its supporters should cheer as well, for the reason the IMF is facing financial disaster is that its clients are not. The Fund needs crises, just as doctors need illnesses. But this particular doctor has been too successful. As a result, Fund credit outstanding has fallen to its lowest level in 25 years.
Bad news for the Fund is excellent news for its borrowers. Financial markets herald the reduction in the perceived riskiness of emerging market finance. Spreads have, as a result, collapsed. Investors are also pouring money in: last year, according to the March 2006 report from the Washington-based Institute for International Finance, the foreign private sector poured $400bn into the group of emerging market countries on which the IIF focuses attention.
“We do not need this money, thank you,” said the recipients. So, they pushed the money right back out again. Remarkably, a paper by three senior Fund researchers suggests they may have been right to do so: Developing countries that have relied more on foreign finance have not grown faster in the long run, and have typically grown more slowly. Does this mean that foreign finance plays no role in development? Not at all. What this does mean, however, is that there seems to be no benefit to being a net importer of capital. Emerging countries should smoke in the capital markets, but not inhale.
The remainder of Martin Wolf’s column can be read here (FT.com subscribers only). Discussion from our guest economists is free - click ‘Comments’ below.
Akio Mikuni: Surplus countries recycle the inflow of capital into US liabilities in order to resist pressure for currency appreciation. Therefore, the US does not lose currency by incurring deficits but gains currency instead. This creates excessive liquidity which has been funding and fueling housing loans and the price appreciation of any assets not only in the US but in the rest of the world. It is rising deficits that help US to grow rapidly. I suppose the global imbalances could continue as long as the US household sector is able to expand borrowing and spending swiftly.
Also, surplus countries export goods and receive dollars which are reinvested in the United States. This recycling reduces their currency. Central banks of surplus countries have to create currency to fund both capital export and regular economic activities. In case of Japan, Bank of Japan’s capacity appears to be strained as Japan has accumulated huge capital export already. Consequently, it has become clear that even rapidly rising exports in the past five years have not been able to be translated into meaningful increases in wages and consumer spending. The global imbalances could continue as long as Japanese consumers remain happily frugal.
Posted by: Akio Mikuni | September 14th, 2006 at 8:30 am | Report this commentJuergen von Hagen: Martin Wolf argues that the IMF has recently been a doctor too successful with the result that Fund credit has fallen dramatically. Maybe. Another explanation is that the doctor’s patients are eager to make sure they will never have to go to him again. There are certainly good reasons to avoid this doctor’s cures if a country is hit by financial crises: The experience of the crises of the past 10 years, from Asia to Argentina, suggests that the Fund’s recipes are too often biased in the direction of orthodox fiscal and monetary policies and carry high economic and political costs for the countries suffering crises.
Given that experience, the current, dramatic accumulation of foreign currency reserves by emerging market countries may be the result of a conscious effort to self-insure against the future need to borrow again from the fund.
This chart illustrates the point using data from 35 developing and emerging market economies from 1996-2005. The x-axis shows a country’s largest annual loss of foreign reserves (in % of the preceding year’s stock). The y-axis shows the country’s accumulation of foreign reserves between 2002 and 2005 (in % of the stock of 2002.) If the annual loss of reserves is a measure for the depth of a country’s currency crisis, the negative relation says that the deeper the crisis by which a country was hit, the stronger its efforts to build a new stock of reserves in 2002-2005. Regressing the reserve accumulation on the largest annual losses, including a dummy for countries that had no severe crisis, i.e., that did not have receive losses exceeding 10%, yields a coefficient of (-2.68), which is highly statistically significant.
The persistent current account surpluses may thus be the result of attempts to become more independent from the IMF because, from the perspective of countries hit by financial crises, IMF programs have not been all that successful. This is bad news for the IMF, but good news for the international financial system, since it shows that unsuccessful doctors lose patients, as they should in an efficient financial system.
Posted by: FT Economist Forum | September 15th, 2006 at 4:01 pm | Report this commentMartin Wolf: I agree entirely with Juergen von Hagen and have argued just this in other contexts. But, in a sense, it doesn’t matter.
Imagine you have a frightening doctor. This makes you decide to become so healthy that you don’t need to go near him again. So you exercise and eat healthily. This is even better than a temporary cure: it is a permanent one. Maybe, it is what the doctor had in mind all along. In any case, it is what happens. But, in the case of the global balance of payments, there is one small difficulty: with most emerging market economies determined to be prudent and fit (that is, run current account surpluses and accumulate reserves), someone else falls prey to their “disease”. That someone is the US. The implications of this are not yet clear. Maybe, it will all be fine. But maybe it will make the dollar seriously ill at some point.
Posted by: FT Forum - Martin Wolf | September 15th, 2006 at 6:21 pm | Report this comment