Is the IMF America's Lackey?

♠ Posted by Emmanuel in ,, at 6/22/2007 12:16:00 AM
One of the longstanding accusations leveled against the Bretton Woods institutions over their history is that they were created by the US to serve US interests. Joseph Stiglitz, for example, famously said that there was a Wall-Street-(US) Treasury-IMF complex that mishandled the Asian financial crisis for its interests lay in safeguarding American ones and not in alleviating the crisis. More recently, I hinted that the new Baucus-Grassley-Schumer-Graham bill targeted at perceived Chinese currency undervaluation was difficult to implement in practice as it involved so many parties--Treasury, Federal Reserve, other central banks, the IMF, World Bank, and the WTO--that it would be unwieldy in practice. However, it seems that the IMF is now falling in line with calls from many in the US to become more proactive on the matter of currency manipulation. Here is the IMF's new guidance on what constitutes currency manipulation. First, the IMF defines "external stability":

IMF surveillance aims at fostering stability in the international monetary system by encouraging national policies that do not disrupt or compromise external stability. Here, the interest is in both the balance of payments stability of the country and the effect of its balance of payments position on the balance of payment stability of other countries.

External stability has been achieved when the balance of payments position does not, and is not likely to, give rise to disruptive adjustments in exchange rates. This requires both (i) an underlying current account (that is, the current account stripped of temporary factors, such as cyclical fluctuations, temporary shocks, and adjustment lags) broadly in equilibrium-a situation in which the country's net external asset position is evolving consistently with the economy's structure and fundamentals; and (ii) a capital and financial account that does not create risks of abrupt shifts in capital flows, whether through the presence of financing constraints or the buildup or maintenance of vulnerable external balance sheet structures.

When the underlying current account is not in equilibrium (which may be due to exchange rate policies but also to unsustainable domestic policies or to market imperfections), the exchange rate is "fundamentally misaligned." In other words, fundamental exchange rate misalignment, an important indicator of external instability under the 2007 decision, is a deviation of the real effective exchange rate from its equilibrium level-that is, the level consistent with a current account (stripped of cyclical and other temporary factors) in line with economic fundamentals.

While the concept of misalignment is clear, it is subject to significant measurement uncertainties. Accordingly, the IMF will exercise appropriate caution in reaching conclusions about misalignments. Moreover, an exchange rate would only be judged to be fundamentally misaligned if the misalignment was significant.

Next, it states four principles for members' exchange rate policies. These are iffy to me on definitional grounds once again:

The 2007 Decision outlines the following four principles for members' exchange rate policies.

    A. A member shall avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.

    B. A member should intervene in the exchange market if necessary to counter disorderly conditions, which may be characterized inter alia by disruptive short-term movements in the exchange rate of its currency.

    C. Members should take into account in their intervention policies the interests of other members, including those of the countries in whose currencies they intervene.

    D. A member should avoid exchange rate policies that result in external instability.

Third, here's the heart of the matter. Currency manipulation is given a definition:
The IMF's Articles of Agreement provide that member countries shall "avoid manipulating exchange rates ... to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members." But the Fund had provided little guidance on what constitutes such exchange rate manipulation. The 2007 Decision on Bilateral Surveillance that the IMF's Executive Board approved on June 15 provides guidance to the IMF's 185 member countries on the type of behavior that is at issue.

The 2007 Decision provides that a member would be "acting inconsistently with Article IV, Section 1 (iii)," if the Fund determined it was both engaging in policies that are targeted at-and actually affect-the level of the exchange rate, which could mean either causing the exchange rate to move or preventing it from moving; and doing so "for the purpose of securing fundamental exchange rate misalignment in the form of an undervalued exchange rate" in order "to increase net exports."

Last, seven indicators are flagged as to whether a member country is in violation:

In its surveillance of the observance by members of the Principles in Box 1, the IMF shall consider the following developments in a country's economy as among those requiring thorough review and might indicate the need for discussion with a member:

    (i) protracted large-scale intervention in one direction in the exchange market;

    (ii) official or quasi-official borrowing that either is unsustainable or brings unduly high liquidity risks, or excessive and prolonged official or quasi-official accumulation of foreign assets, for balance of payments purposes;

    (iii) (a) the introduction, substantial intensification, or prolonged maintenance, for balance of payments purposes, of restrictions on, or incentives for, current transactions or payments, or

    (b) the introduction or substantial modification for balance of payments purposes of restrictions on, or incentives for, the inflow or outflow of capital;

    (iv) the pursuit, for balance of payments purposes, of monetary and other financial policies that provide abnormal encouragement or discouragement to capital flows;

    (v) fundamental exchange rate misalignment;

    (vi) large and prolonged current account deficits or surpluses; and

    (vii) large external sector vulnerabilities, including liquidity risks, arising from private capital flows.

What is significant to me is how the rhetoric here--from "fundamentally misaligned" currencies to "large-scale intervention in one direction in the exchange market"--seem straight out of the US senators' playbook. This decision of the IMF to make its Article IV surveillance tougher sounds like the step in the senators' playbook of asking the IMF to determine just how "undervalued" a currency is (such as the yuan) before approaching the WTO to apply commensurate sanctions for manipulation. Clearly, the playing field is being tilted in America's favor by the IMF.

Understandably, China is alarmed by these new IMF surveillance guidelines which supersede the previous ones dating back to 1977; it appears to be squarely in the IMF's crosshairs. The Financial Times notes that China has warned the IMF not to go too far with this matter:

China on Wednesday issued a pointed warning to the International Monetary Fund not to back US pressure for a faster appreciation of the renminbi in a planned review of global exchange rates.

The People's Bank of China, the central bank, said in a statement on its website that the IMF "should carry out its duties based on mutual understanding and respect", especially for the views of developing countries.

Without directly naming the US, the PBoC said the IMF should step up supervision of member states issuing "major reserve currencies that play a pivotal role on the global systemic stability" [tit-for-tat].

China is coming under increasing pressure from the US over its swelling trade surplus, which many of its critics claim is the result of an undervalued currency.

US senators recently introduced a bill that would see disputes over exchange rates sent to the World Trade Organisation by treating them as unfair export subsidies. The bill did not specifically name China, but the renminbi is the most immediate target of the legislation.

China has committed itself to making its currency more flexible, but insists it needs to be done gradually to ensure the stability of its economy…

"An unregulated and massive adjustment will not only worsen external instability, but also influence the sustainability of domestic economic growth, and therefore global growth and the stability of international financial markets," the PBoC said.

Although China is the world's fourth largest economy and is on track to become the biggest trading nation, the PBoC statement stressed its participation in the IMF as a "developing country". The statement expressed reservations about the IMF review because "it fails to reflect opinions of developing countries".

The IMF said the PBoC's call for equal treatment of all countries and due regard to countries' circumstances "is fully reflected in the decision that has been approved and the IMF and its staff are dedicated to implementing it in this spirit".

Meanwhile, Hank Paulson, US Treasury secretary, hailed the IMF surveillance reform in testimony to Congress on Wednesday, saying it will "permit firmer surveillance in areas such as insufficiently flexible exchange rate countries".

He said the US would keep up the pressure on the IMF over its surveillance work, warning "nothing is more important for the relevance of the IMF than rigorous execution of its most fundamental responsibility".

Mr Paulson - who has emphasised the bilateral channel of diplomacy with China through the special economic dialogue he set up - said "firm, multilateral based exchange rate surveillance has the potential to be a strong complement to bilateral diplomacy".

Meanwhile, Deputy PBoC Governor Wu Xiaoling urges patience (just a little patience) on the matter for China to gradually acclimate itself to a stronger yuan. This, of course, is the official PRC line:

China urged on Thursday other countries to be patient on yuan exchange rate reforms and said a stronger renminbi is no panacea.

The main problem China is facing is the economic imbalance caused by the high-flying surplus in both current and capital accounts, which cannot be solved by yuan appreciation alone, said deputy central bank governor Wu Xiaoling at a forum in Beijing.

China is taking measures to enlarge citizens' income, boost domestic consumption, and increase imports and reduce exports, Wu told the forum on the 10th anniversary of the Asian financial crisis.

"However, China is a big country in the process of economic transformation and needs more time," she said. "So we hope the other countries can be more patient with China."

She went on to cite the examples of Germany and Japan, saying a stronger exchange rate alone was not the solution. The two countries retained big trade surpluses despite powerful rises in their currencies.

Those countries balanced their external accounts by exporting capital, she noted, adding: "Therefore the Chinese government hopes its companies can go out under the capital account."

To that end, China is loosing controls on overseas investment by domestic companies and individuals. In the latest move, the China Securities Regulatory Commission Wednesday gave the go-ahead for Chinese securities and fund-management firms to invest overseas…

The major difference between the old and new rules is the new one discards the requirement that IMF should prove the country concerned intentionally uses its exchange rate to make its exports cheaper.

In response, China's central bank, the People's Bank of China (PBoc) called on the IMF to pay attention to each nation's circumstances.

"An unregulated and massive adjustment will not only worsen external instability, but also influence the sustainability of domestic economic growth, and therefore global growth and the stability of international financial market," the PBoC said in a statement.

Chinese analysts called the new IMF rules a product of heavy US pressure. American lawmakers, manufactures and businesses are accusing China of keeping the yuan artificially low, by as much as 40 percent, to give an unfair advantage to its exports [my emphasis; they’re right, you know.]

So far, China has not really made large countermoves to actions designed to make it move on the matter of yuan undervaluation, preferring a softer line such as calling for "patience." I suspect that, if concrete action is taken to brand China a currency manipulator, it will have little choice but to scare the US by selling Treasuries to show just who is boss in today's international political economy. Stay tuned for the exciting conclusion to this trade squabble which has now been joined by the IMF on America's side, it seems. Answer for yourselves the question I posed at the beginning: Is the IMF American's lackey?