Off Balance
Page 10
The plea failed, underscoring the IMF’s pitifully limited powers of persuasion. None of the participants would offer “down payments,” “upfront action” or “strengthening of commitments.” They would offer nothing more than assurances that they would fulfill previous pledges. The Chinese committed to making “further improvement in the exchange-rate regime,” for example, and the Americans vowed to achieve “fiscal consolidation over the medium term.”
Yet no hint of “serious disappointment” appeared in the IMF’s public statement at the conclusion of the multilateral consultations, which proclaimed it “a fruitful initiative.” Lipsky’s press conference on the matter was similarly upbeat. “This outcome represents something that is novel and innovative,” he told reporters on April 18, 2007.12 Emphasizing that the key to success was implementation, he touted a calculation by the IMF staff that if all of the participants proceeded with their policy plans as stated, global imbalances would shrink by about one to 1.75 percent of GDP over the following four years. “You can’t call this trivial or insubstantial,” he said. “Some people said there’s nothing new and I would say, show me where this has happened before that these participants have made this kind of public statement. I don’t find it anywhere else.”13
12 IMF (2007), “IMF’s International Monetary and Financial Committee Reviews Multilateral Consultation,” Press Release No. 07/72. April 14, available at: www.imf.org/external/np/sec/pr/2007/pr0772.htm.
13 Ibid.
Hard to answer, but well worth pondering, are questions that arise in looking back at the multilateral consultations. Might the exercise have ended differently if the format had been similar to Yusuke Horiguchi’s plan, with the IMF acting more like the “umpire” suggested by the British and Canadian central bank governors? Would Paulson have been less dismissive if he had known that the Fund was going to issue a scorecard to show how far each participant was going in taking the necessary steps to shrink imbalances, and that the next step would be additional consultations for participants that were falling short? Might the Chinese have been more willing to commit themselves on paper to alter their foreign exchange policy if they had known that by doing so, they would be able to avoid being cast as obstructionists and do-nothings like the others? Maybe not — the end result could well have been the same.
This much can be said for the consultations: the outcome may have been a flop, but compared with the IMF’s other initiative on global imbalances — the 2007 decision — it was not nearly so dismal.
5
Fundamental Misalignment and Its Discontents
The 2007 Decision
The phrase “fundamental misalignment” can be traced to the bill-drafting efforts of Stephen Schaefer, a Republican aide on the Senate Finance Committee, in early March 2006. Schaefer was searching for the right words to fit legislation that his boss, committee chairman Charles Grassley, planned to introduce with Senator Max Baucus, the panel’s ranking Democrat. The purpose of the bill was to put pressure on China regarding its currency in a more credible way than rival bills that used drastic (and largely empty) threats of punitive tariffs. This meant concocting a substitute for the language contained in US law, which was aimed at targeting countries engaging in exchange rate manipulation — “the scarlet M,” as Treasury Undersecretary Tim Adams called it, because the term was so loaded even the Treasury couldn’t bring itself to use it. So as he wrote and rewrote bill drafts, Schaefer sought to come up with a more practical standard for determining whether a country’s exchange rate policy was deserving of censure or possible sanctions. “Material disequilibrium” got into some drafts; “material misalignment” was another candidate. “Fundamental misalignment” struck him as best.
Schaefer had no idea that the IMF would adopt his term, much less that it would become a major bone of international contention within the institution. But his wordsmithing was a seminal moment in the story of the Fund’s 2007 decision on exchange rates. It helped set in motion a series of events that the IMF has long struggled to live down.
At that point, the IMF was in the midst of devising its response to the accusation of being “asleep at the wheel.” Irritating though the charge may have been, it rang true to a number of influential Fund policy makers. The problem, they reasoned, was not so much that they were guilty of dereliction of duty, it was that they were saddled with terribly outmoded and narrowly drafted rules — their own version of “the scarlet M.” The IMF’s guidelines on exchange-rate surveillance had last undergone a major overhaul in 1977, when the system of floating currencies was still in its early years, and before massive amounts of private capital had begun flowing across international borders. As noted in chapter 2, those rules focussed on preventing countries from “manipulating exchange rates...to gain a competitive advantage.” That language hamstrung the IMF from taking action because of the legal requirement to discern what motivated the manipulators — and therefore, these policy makers contended, new guidelines were in order.
Proponents of revising the 1977 decision offered additional compelling arguments. The Fund badly needed to clarify what surveillance was about, because Article IV reports often glossed over the issue of exchange rates. Mission chiefs were happy to fill their reports with advice on issues that interested them, such as labour markets, demographics and transportation regulation. But the IMF’s central purpose was supposed to be keeping countries from adopting policies that risked damaging the rest of the world or the international system in general — and exchange-rate policies that kept currencies under- or overvalued were among the most obvious examples of such policies.
But the dominant motivating factor for starting work on a new decision, of course, was the hope that it would pacify the United States by showing that the IMF was looking for better ways of dealing with the Chinese exchange-rate problem. And it wasn’t just American pressure that Managing Director de Rato had to worry about; the idea that the Fund ought to engage in more “ruthless truth-telling” of the sort Keynes had envisioned was coming from the governors of the Bank of England and Bank of Canada, as noted in the previous chapter. De Rato’s preference for “quiet diplomacy” made him chary of assuming such an aggressive role, but he could see the flaws in the 1977 decision, and by mid-March he was convinced that the revision should go forward, internal documents show. At the IMF-World Bank spring meetings the following month, the ministers who oversaw the Fund formally endorsed the idea as one of the key components of de Rato’s revised Medium-term Strategy.1
1 IMF (2006), “Communiqué of the International Monetary and Financial Committee of the Board of Governors of the International Monetary Fund,” April 22, available at: www.imf.org/external/np/cm/2006/042206.htm.
Taking charge of drafting proposals for the new decision was a small group of staffers. They included the general counsel, Sean Hagan, and legal specialists working for him, but the lead belonged to high-ranking economists in a department — Policy Development and Review, or PDR — sardonically dubbed the “thought police” by some in the Fund both because of its power and its role as enforcer of institutional orthodoxy. The drafters in the Legal and PDR departments had differing views of the undertaking; some felt strongly about the importance of making surveillance more focussed, while at least one cynic saw the primary purpose as the necessary evil of satisfying the US Treasury’s demands.
Nobody doubted the sincerity of their leader, Mark Allen, an avuncular Englishman who was the director of PDR. He believed that the international monetary system needed better rules for identifying problematic exchange-rate regimes such as China’s, and that the IMF had a duty to speak up when countries broke those rules — to that extent, he shared the US Treasury view. At the same time, Allen believed the guidelines needed updating to cover all kinds of situations in which one country’s policies might affect others adversely. He cared fervently about Keynes’s beloved principle of symmetry — that is, he believed the rules should apply both to countries with large surpluses and la
rge deficits, to both creditor and debtor nations, to currencies that were pegged as well as those that floated and to currencies that were overvalued as well as undervalued. Moreover, he saw a need for rules that would go beyond exchange rates and cover domestic policies too, because even though IMF member countries obviously had the sovereign right to make their own choices regarding, say, government spending, taxes and interest rates, sometimes those policies — big budget deficits, for example — might foment instability abroad.
Skeptics abounded within the IMF staff, to be sure, and unsurprisingly, they were mainly in the area departments, whose members staffed the country missions that wrote Article IV reports. Much of their criticism of the effort to revise the 1977 decision focussed on the impossibility of drafting rules that would reflect truly objective judgments about currency levels. As for the US Treasury, it was ambivalent at first. In a speech praising de Rato for seeking new methods of dealing with the currency issue, Undersecretary Adams said he recognized that the special consultations mechanism wasn’t working because of the “huge stigma” being called a manipulator implied. “Some of these phrases are used so infrequently, that when you do use them, they become headline news. So we need to...de-stigmatize, so we can use them for useful purposes,” he said.2 At the same time, Adams and his colleagues were less than fully convinced of the need for a new decision. The trouble with the IMF, they felt, was not so much antiquated rules as it was fecklessness. According to notes of a May 18, 2006 meeting between Treasury and Fund officials, Mark Sobel, a deputy assistant secretary known for his zealous and often blunt advocacy of the Treasury view, said, “The ’77 decision isn’t all that bad. The problem is in the practice.”
2 Timothy Adams (2006), “The IMF’s Role in Foreign Exchange Surveillance,” remarks at American Enterprise Institute (AEI) conference, February 2. I transcribed Adams’s quotes from a video that was on the AEI website, www.aei.org, but it no longer appears to be available.
Still, the United States soon warmed to the idea of rewriting the decision — with one proviso: the new decision had to incorporate the “fundamental misalignment” language in the Grassley-Baucus bill, which had been introduced on March 28. In the Treasury’s view, this would be an ideal way of multilateralizing the exchange-rate issue, thereby ensuring that responsibility for pressuring China would rest with the IMF, where it properly belonged, rather than increasing the risk that the bilateral US-China dispute would get out of hand.
High-minded as this approach may have seemed from the Treasury’s perspective, Mark Allen and his team accepted it with considerable reservation, because it created a huge image problem for them as they worked on drafts of the new decision. In a memo to top IMF management dated June 19, Allen fretted that “the focus on exchange rate misalignment [in the new decision]...may be seen by many as a concession to the US because this focus is also shared by the Grassley-Baucus bill.”
But the good news, Allen continued, was that the draft decision “also includes features that should please” many other member countries. Specifically, it “applies to all countries, not just [currency] peggers, and therefore applies to the United States and their domestic policies.” This was because the decision would aim to focus IMF surveillance above all on “external stability” — a term Allen and his colleagues coined, which referred to the effect a country’s policies might have on other economies and the global financial system in general. Although this concept aroused considerable criticism within the Fund, its ingenuity lay in its potential for promoting impartiality and symmetry. Exchange-rate policies were one of the important factors in determining whether a country met the standard of external stability, but the term also encompassed domestic policies that could lead to significant instability across borders. So the US budget deficit might just as readily run afoul of the new decision as might China’s currency manipulation.
Summing up, Allen told the managing director that “the new principle — which we consider to be the right way forward for the Fund — could ultimately be acceptable to various stakeholders. It may, however, elicit a great deal of controversy along the way.”
“A great deal of controversy along the way” — that, too, was perspicacious.
Peeling off the Opponents
It was entirely predictable that the Chinese government would “smell a rat” right from the start of the initiative to revise the 1977 decision. Its currency regime was obviously a target, in particular of a proposed new “Principle D,” which read as follows: “A member should avoid exchange rate policies that, while pursued for domestic reasons, lead to external instability, including fundamental exchange rate misalignment.”3 And Chinese officials had every reason to assume that they were chief among the candidates for participation in the “ad hoc consultations” with the managing director that were intended for countries with exchange rates judged to be fundamentally misaligned. The indicators for making such a judgment — which included “unsustainable” or “excessive” current account surpluses or deficits, and “protracted large-scale intervention in one direction in the exchange market” — applied to China in spades.
3 IMF (2007), “Review of the 1977 Decision on Surveillance over Exchange Rate Policies: Further Considerations, and Summing Up of the Board Meeting,” February 14, available at: www.imf.org/external/np/pp/2007/eng/fc.pdf.
More surprising was the wariness of officials in Latin America and other parts of the developing world. Although they had much less reason than the Chinese to worry that their currencies would run afoul of the fundamental misalignment standard, they were suspicious about what a revised decision would mean for them. Based on long and bitter experience, they had concluded that when it came to the IMF they were the rule-takers, while the rich rule-makers didn’t have to worry about becoming the targets of severe Fund surveillance. So in the summer of 2006, when the executive board began considering whether to revise the 1977 decision, the proposal drew support only from directors representing wealthy nations, internal IMF documents show. Their counterparts from developing countries were deeply concerned about the emphasis on domestic policy as a potential source of external instability. That, they feared, could entail new restrictions on their governments’ freedom to conduct domestic policy as they saw fit.
It didn’t help that the papers written by PDR and the Legal Department to explain and justify the new approach were not only lengthy (typically 20 to 30 pages) but also extremely dense, even by the IMF board’s standards. This was difficult to avoid; the papers had to spell out, in fairly rigorous terms, the meaning of concepts such as external stability and fundamental misalignment. The basic definition the staff came up with for fundamental misalignment was relatively easy for anyone with a modest background in economics to understand: it meant a country’s exchange rate was significantly above or below the level consistent with the country’s equilibrium current account. However, a host of questions naturally sprang from that: Which measure of the exchange rate was referred to? What time frame was implied by “equilibrium”? How large a divergence from the equilibrium level was required to be considered significant? At that point, the papers often resorted to jargon requiring Ph.D.-level expertise, for example this sentence: “In general, the equilibrium evolution of the NEAP [net external asset position] is expected to be consistent with the present and expected values of such fundamentals as productivity differentials, the terms of trade, permanent shifts in factor endowments, demographics, and world interest rates.”4
4 IMF (2007), “Review of the 1977 Decision — Proposal for a New Decision, Companion Paper, Supplement, and Public Information Notice, June 21, available at: www.imf.org/external/np/pp/2007/eng/nd.pdf.
Faced with the prospect that developing-country opposition might kill their initiative in its nascent stage, Allen and his lieutenants embarked in the fall of 2006 on an intense lobbying campaign, with high-level support from de Rato, “in the hope that we can peel off a few of these [directors] from what looks like an almost m
onolithic bloc,” as PDR’s Tessa van der Willigen, one of Allen’s deputies, put it in an email to her colleagues. The irony of the situation vexed them; the developing country directors were focussing their attacks on the very features of the proposed decision that were supposed to make surveillance more even-handed. One of the most contentious provisions, called “Principle E,” stated that IMF member countries “should seek to avoid monetary, fiscal and financial policies that lead to external instability.”5 That was precisely the kind of wording that Allen had thought could be used against the United States, and the PDR team hoped that by meeting the developing country directors to elucidate such points, at least some of the opposition would evaporate.
5 IMF (2007), “Review of the 1977 Decision on Surveillance over Exchange Rate Policies: Further Considerations, and Summing Up of the Board Meeting.”
But try as they might — and their lobbying efforts continued throughout the first half of 2007 — they kept finding themselves encumbered by the IMF’s legacy, as witnessed by an email that van der Willigen received from Hector Torres, an executive director from Argentina: “We cannot read the proposal without having in mind the democratic deficit that the governance of this institution has,” Torres wrote. On January 26, 2007, Allen and General Counsel Hagan reported to de Rato in a memo that, although all the directors from G7 countries were supportive of revising the 1977 decision, the developing country directors, who had banded together in a group called the G11, were solidly opposed. The G11’s concerns “center around asymmetries in surveillance,” Allen and Hagan explained. “They fear that a revised decision...would be used to threaten them with accusations of breach of obligation, while the advanced countries would escape.”