Sometimes it's just no fun being the International Monetary Fund (IMF). Somewhere around 2009, contemplating the fiasco of the great crash of 2007-2008, IMF fund officials focused on what they politely called "the excessive accumulation of reserves" by some countries. The persistent accumulation of excessive reserves was a threat to the global monetary system, they argued. I took this at the time to be a diplomatic way of telling China that it was not blameless in the events leading up to the crash.
Excessive accumulation always looks odd, be the "accumulator" a country or a private individual. Who, after all, needs multi-billions or even multi-billionairs for that matter? And what, exactly, is the point of any country running a trillion dollar trade surplus? The excessive accumulation of wealth in the hands of a tiny, tiny minority of individuals provokes the rest of us, especially if circumstances force us in the direction of austerity. Rage at the base of the pyramid is not healthy for those who sit at the top of the pyramid. The same goes for countries.
Then there is the technical point that when you sit on huge surpluses something has to be done with them or their value seeps away through inflation. So the money gets recycled as cheap loans (cheap, because you have so much cash to recycle the laws of supply and demand work against you). This fosters easy credit and creates credit bubbles in the countries you recycle the loans to. In the case of the US in particular the world has had an object lesson in how vast flows into Treasuries encourages the growth of government spending to the point where the debt becomes crushing. Again, not exactly a healthy state of affairs.
So the fact that IMF officials began focusing on excessive reserves was natural enough. However, the whole thrust of that "policy", to call it that, though it probably never amounted to an actual IMF policy effort, was profoundly mistaken, according to a report from the IMF's own watchdog, the Independent Evaluation Office. Entitled “International Reserves: IMF Concerns and Country Perspectives (August 2012)”, the report examines the origin, rationale and robustness of the IMF’s concerns over excessive reserves and the impact on the stability of the international monetary system, and it assesses the conceptual underpinnings and quality of the advice on reserve adequacy.
The main problem that the IEO team has with the IMF’s focus on excessive reserves is straightforward, and flagged up right at the start of what is, after all, a pretty technical report. The problem, the IEO says, is that IMF officials have got themselves into a muddle and are mistaking a symptom of the problem for the cause. What the IMF should have been focusing on, the IEO says, is “the causes and consequences of fluctuations of global liquidity and international capital flows” – these are of more pressing concern that the accumulation of excessive reserves.
What should happen when a country acquires excessive reserves is that there is an adjustment in its exchange rate viz the dollar and other major currencies, but with Asia in general and China in particular, this adjustment has been slow to materialise as countries have indulged in a deliberate weaking of their currencies to protect their export capabilities. Another point the IEO makes in passing is that when it is investigating the potential for “systemic externalities” affecting a specific country, to destabilise global liquidity the IMF should be mindful of the scale of the country it is looking at. No matter how off the wall a tiny country gets, its impact is going to be limited. In accepting the IEO’s Report, IMF Managing Director Christine Lagarde was quick to say that the report simply mirrored current IMF thinking. Policies had changed to move in the direction indicated by the report, she said, so the belated slap on the wrist was a) not really necessary, but b) helpful as a restatement of current IMF policy.
Further reading on global currency flows
- Bernanke’s analysis of capital flows – does anyone actually know how to invest? By Anthony Harrington
- Gambia: a lesson in not messing with exchange rates via edicts, by Anthony Harrington
- A Silver Lining to the Credit Crisis, by Peter Zollinger and John Schaetzl
Tags: Asia , China , currency flows , emerging markets , excessive reserves , IMF