Off Balance

by Paul Blustein

  9 Michael Pettis (2013), The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy, Princeton: Princeton University Press.

  10 David Wessel (2013), “A Chinese Lesson for Germany,” The Wall Street Journal, March 7.

  As for currencies, the RMB may no longer be a prime target of criticism, but it is not difficult to imagine nasty outcomes for the “currency wars” that have been flaring since 2010, when Brazilian Finance Minister Guido Mantega popularized the term.

  “Currency wars” is an inapt metaphor, because some of the alleged acts of belligerence are neither warlike nor even intended to involve currency exchange rates. Mantega’s comments were aimed primarily at the Federal Reserve’s quantitative easing of the US money supply, which the Fed had good and proper reasons to think was necessary to keep the US economy from slipping back into recession. The problem, from Mantega’s perspective, was that by lowering interest rates in the United States to zero and using its powers of money creation to flood the economy with even more dollars, the Fed was indirectly giving investors the incentive to shift their money to countries where yields are higher — such as Brazil. As welcome as it might seem for a country like Brazil to receive inflows of dollars, the Brazilians are all too aware of how harmful the results can be when such inflows go into reverse, and because the inflow also caused the Brazilian currency to appreciate against the dollar, the impact bore more than a faint resemblance to the competitive devaluations of the 1930s. Other Latin American countries have echoed Brazil’s complaint, and Japan’s massive easing of monetary policy in 2013 has undergone harsh attack as a currency-cheapening ploy from, of all places, China.

  With global markets awash in dollars, euros and yen, and global rules shrouded in ambiguity, some governments have taken matters into their own hands, the most prominent and controversial example being Switzerland. In September 2011, the Swiss National Bank started intervening massively in currency markets to put a halt in the upward climb of the Swiss franc, which had become a favourite “safe haven” for investors. Considering that Switzerland had a sizable current account surplus (12 percent of GDP) and one of the lowest unemployment rates in Europe, this action struck many observers as unwarranted manipulation that would thwart healthy rebalancing.11 Switzerland’s approach is not unique; a number of other medium-to-large-sized countries that generally run trade surpluses have been trying, with varying degrees of success, to keep their foreign exchange rates from appreciating by buying foreign currencies with their own. Economist Joseph Gagnon of the Peterson Institute calls these countries “currency aggressors,” and his list, in addition to Switzerland, China and Japan, includes Singapore, Taiwan, Malaysia, Thailand, Israel, Saudi Arabia, Norway and Russia.12

  11 Daniel Gros (2012), “An Overlooked Currency War in Europe,” VoxEU.org, October 11, available at: www.voxeu.org/article/overlooked-currency-war-europe.

  12 Joseph E. Gagnon (2013), “Currency Wars,” The Milken Institute Review, First Quarter, available at: www.milkeninstitute.org/publications/review/2013_1/46-55MR57.pdf.

  Although not yet anywhere near on a par with the 1930s, “currency wars” warrant deep concern. However, the world still lacks any viable, enforceable system of preventing a country from pursuing a currency-cheapening policy to the point where it violates its IMF obligations. Indeed, once the Fund retreated from its 2007 decision, restraints on such policies may have become weaker than at any time since the breakdown of the Bretton Woods system in the 1970s.

  To its credit, the G20 has put rebalancing at the top of its agenda, in the “Framework for Strong, Sustainable and Balanced Growth,” and its approach marks a major departure from the efforts undertaken prior to the crisis. Instead of giving an external body like the IMF the primary role for overseeing the exercise and deciding which countries are fulfilling their obligations and which ones aren’t, the G20 has arrogated those responsibilities to itself, by promising that its members will subject each other to surveillance. In the MAP, peer pressure is the chosen method for inducing countries to adopt policies conducive to shrinking imbalances. “Ownership” of the process belongs to the members, not the IMF, which was relegated to a sort of secretariat function, providing technical analyses of countries’ policies and the compatibility of those policies with global interests.

  It is understandable that the G20 chose an approach that sidelined the IMF, given the results of the multilateral consultations and the 2007 decision. Esteem for the Fund’s capacity in such matters was at rock bottom; US officials were disgusted with its fecklessness, and their Chinese counterparts with its susceptibility to American pressure. But in adopting mutual surveillance, did the G20 draw the right lessons to be gleaned from the IMF’s pre-crisis experience? Careful consideration of the research presented in previous chapters yields other conclusions, which might offer better guidance for international policy making. The following, in my view, are two of the most instructive take aways:

  Accountability is essential — preferably delivered by an “umpire.” International meetings to discuss issues such as global imbalances will not get very far without some process for holding participating countries to account, and a process involving a neutral referee offers the best prospects for success. If the multilateral consultations taught a lesson, this is it. The failure of those talks is often attributed to the fact that they were run by the IMF, which allegedly led to a lack of ownership by the participating countries. But this interpretation, logical as it sounds, turns out to be at odds with facts that may be recalled from chapter 4. Although the exercise undeniably suffered from an ownership deficit, especially when Treasury Secretary Paulson’s indifference manifested itself, the IMF took a fairly passive stance, underscored by the statement by the Fund’s Lipsky to the deputies in their first meeting that he saw the Fund’s role purely as a “facilitator.” The problem was not an overassertive IMF; a much bigger weakness was the lack of any arbiter, along the lines suggested by Yusuke Horiguchi, to publicly identify the participants that were making the necessary contributions toward the jointly agreed goal and those that weren’t. Such a system would by no means guarantee the success of talks; however, national policy makers would be more likely to treat the process with a level of respect that stands a chance of producing meaningful results.

  The good news is that the G20 seems to be moving, albeit haltingly, toward making its MAP reflect this take away. During the first half of 2011, G20 finance ministers agreed on a set of indicators for identifying member nations with “persistently large imbalances,” plus a follow-up procedure that would subject countries to a special assessment by the IMF and their G20 peers. The knowledge that their countries’ economic performance will be scrutinized against those benchmarks, and they could be singled out for special attention at summits, will presumably help leaders and their senior policy makers maintain interest in, and respect for, this process. That should raise their consciousness, to some extent at least, about the effects of their policies on the rest of the world. Moreover, the process is intended to be ongoing for years, rather than for a finite period as was the case for the multilateral consultations.13

  13 See Barry Eichengreen (2011), “The G20 and Global Imbalances,” June 26, available at: www.voxeu.org/index.php?q=node/6694.

  The odds appear slim, however, that this process will impel major countries to change their policies in meaningful ways. Here is why.

  The umpire had better be neutral — and seen to be so — as well as unrestrained in expressing opinions. Any institution or body that assumes the role of arbiter in the international economic arena must be as free of political influence as possible, especially if it is going to render judgments on complex, consequential questions, such as whether a country is violating international rules. The IMF fell appallingly short of that standard during the implementation phase of the 2007 decision. The dismal legacy of that episode is that the Fund lost much of its credibility as guardian of the international monetary system
against rule violators. Although the Fund is, in many ways, a much stronger and more vibrant institution today than it was before the financial crisis, the perception that it became a tool of US policy in the controversy over China’s foreign exchange rate seriously undercut its capacity to serve as an effective whistle-blower when countries are flagrantly manipulating their currencies. In an ideal world, the attempt to apply the 2007 decision symmetrically would have prevailed, so the Fund would have emerged with an enhanced image for treating countries with neither fear nor favour. Instead, the ultimate result exposed the degree to which the institution is captive to the whims of its most powerful members. So the IMF — in its present form at least — can be ruled out as the kind of unimpeachably objective umpire capable of delivering a stinging rebuke at a summit meeting to a country whose economic or currency policies pose a threat to others.

  The problem is that the G20 is also poorly suited to such a task. It is the very epitome of a political body, with all sorts of considerations — including diplomatic ones — liable to affect the judgments its individual members are prepared to issue during summit meetings about the economic policies of other members. For example, mightn’t worries about North Korea or the Middle East, or tensions over territorial feuds, or historical ill will stemming from past conflict, make certain G20 leaders more reluctant — and others more eager — to speak critically about their counterparts? Considering the fact that the IMF board, a much more technocratic body, could not even muster the gumption to label the Maldives rufiyaa as fundamentally misaligned, it strains credulity to conceive that the leaders of G20 countries will render verdicts so stern, so credible and so concerted as to alter the policy-making calculus in the capital of a major country. The phenomenon of peer pressure morphing into peer protection is well known to anyone familiar with the basic literature on international institutions, and the G20’s insistence that it will prove an exception rings hollow. To repeat, the claim that members “own” the peer review process, and will therefore take it much more seriously than the participants in the multilateral consultations did under IMF direction, is based on a false notion of how the consultations worked.

  Just as before the crisis — and just as in the multilateral consultations — the leading participants in the G20 won’t adjust their macroeconomic and foreign exchange policies in ways that benefit the global good, unless they do for their own, self-interested reasons. The MAP will not give them much incentive.

  Another drawback of the G20 — the non-universality of its membership — is becoming more manifest as “currency wars” heat up. Switzerland is not represented, nor are several other countries that stand accused of foreign exchange manipulation. Whether or not those countries belong on a list of “currency aggressors,” as economist Joe Gagnon contends, chances are increasing that the G20 may, like the G7 before it, lack the presence of one or more key countries whose behaviour poses concerns for the global system. Notwithstanding the G20’s claim to the title of “global economic steering committee,” this deficiency could hamper its ability to influence policies on a worldwide scale.

  The problems afflicting initiatives to deal with macroeconomic imbalances are not confined to this subject alone. Efforts by international institutions to confront the other major post-crisis challenge — global financial regulation — are bedevilled for similar reasons. In a candidly critical assessment of internationally agreed reforms in the financial regulatory area, the IMF recently acknowledged:

  Although the intentions of policymakers are clear and positive, the reforms have yet to effect a safer set of financial structures…financial systems are still overly complex, banking assets are concentrated, with strong interbank linkages, and the too-important-to-fail issues are unresolved.14

  14 IMF (2012), Global Financial Stability Report, chapter 3, available at: www.imf.org/external/pubs/ft/gfsr/2012/02/pdf/text.pdf.

  A look at some of the key regulatory initiatives bolsters the grounds for such pessimism.

  Different, Better…But Transformative?

  Mark Carney’s tough-guy image stems, in part, from his days on the Harvard hockey team, where he pumped himself up before games by blasting AC/DC’s “Hell’s Bells” (“I’m comin’ on like a hurricane...won’t take no prisoners, won’t spare no lives”). And that is just one element in the combination of credentials and talents that made Carney a highly touted choice to succeed Mario Draghi as chairman of the FSB.15 He holds a doctorate in economics from Oxford, spent 13 years at Goldman Sachs and, perhaps most impressive of all, headed the central bank of a country — Canada — whose financial system sailed through the crisis relatively unscathed. A spat between Carney and J.P. Morgan CEO Jamie Dimon in 2011, which ended in Dimon’s humble apology, burnished Carney’s reputation for steeliness.

  15 See Jeremy Torobin (2012), “Mark Carney: A Common Touch, an Uncommon Task,” The Globe and Mail, January 14; Sinclair Stewart (2009), “The Governor Gets His Hands Dirty,” The Globe and Mail, August 28.

  Carney’s selection as FSB chairman in the fall of 2011 afforded fresh hope that the body would fulfill the ambitions envisioned by many close observers of international economic policy, both in the official sector and outside of it. Those ambitions were well articulated in a 2010 collection of essays in which the authors, including several of my colleagues from CIGI, admonished that the FSB would need a “loud whistle, and the authority, expertise and support of its members to blow the whistle, even if the offender is a powerful country.” They also exhorted the FSB to engage in “ruthless truth-telling,” “provide unpalatable messages,” show itself “capable of leaning against the wind,” and “voice concerns about unsustainable financial booms.”16

  16 See Eric Helleiner, Ngaire Woods and Stephany Griffith-Jones (eds.) (2010), The Financial Stability Board: An Effective Fourth Pillar of Global Economic Governance?, Waterloo, Canada: CIGI. To be clear, the essay authors were expressing their desires for what the FSB should do rather than making predictions about what it would do.

  To see how realistic it is that the FSB may succeed in those regards, it is necessary to consider whether its advances over the FSF suffice or whether, underneath it all, the FSB is, in essential respects, a similar body to the one depicted in chapters 6 and 8 of this book.

  With the FSB’s members hailing from countries that cover about 80 percent of global population, never again will it serve as a means for a small club of the rich to tell the nations of the developing world how to conduct their financial affairs. Although representatives from advanced countries still tend to be the most influential members in shaping initiatives and decisions, the developing country representatives effectively hold veto rights, given that the body operates by consensus as the FSF did. This level of inclusiveness affords the FSB a degree of authority that its predecessor could not claim. And whereas the FSF was hamstrung for years by the US desire to keep it largely as a talk shop, the FSB enjoys extensive power to act on its own; it also exercises much greater leadership in the standard-setting realm. Standard-setting bodies such as the Basel Committee remain independent, but they are supposed to “report to the FSB on their work,” with the FSB empowered under its charter “to ensure that their work is timely, coordinated, focused on priorities and addressing gaps.”17

  17 Financial Stability Board Charter, available at: www.financialstabilityboard.org/publications/r_090925d.pdf.

  Beyond that, the FSB employs a much more organized and systematic process for discerning weaknesses in the global financial system, determining appropriate responses and inducing countries to improve their regulatory practices. The process starts with a division of the body into committees, which enables participants to focus on specific responsibilities. One panel, the Committee on Assessment of Vulnerabilities, has the job of identifying risks in the financial system and prioritizing them. Once it has decided that a “material vulnerability” is in urgent need of attention, a second panel, the Committee on Supervisory and Regulatory Cooperation,
swings into action to determine whether a policy response is needed, possibly directing international standard-setting bodies to consider new standards. Underpinning these activities are clear orders from the G20 for the FSB to focus on macro-prudential issues.

  The work of the Committee on Standards Implementation is potentially most important. The committee’s chief responsibility is overseeing the two kinds of peer reviews the FSB conducts, namely, country reviews of individual members and “thematic” reviews that assess the compliance of all members with particular agreed policies, such as those on compensation or mortgage underwriting. When a member country comes up for review, which is supposed to take place every five years or so, a small team of experts, selected mainly from other FSB members’ government agencies, drafts a report on that country for submission to the committee.18 After the panel considers the report — with representatives present from the country under review — the report goes to the full FSB plenary, which has the power of approval over the report. Similarly, for thematic reviews, teams of experts prepare reports assessing whether member countries are successfully implementing certain regulatory or supervisory policies, and these reports also go to the plenary for approval after consideration by the committee.

  18 These reports are not supposed to be comprehensive reviews of countries’ financial systems, because that is what FSAPs are for. Rather, a country’s peer review is intended to focus largely on whether the country is implementing recommendations contained in its FSAP. The peer review can also focus on other matters, although only when the team of experts has “agreed in advance with the reviewed jurisdiction.” As a “general principle,” the team of experts isn’t supposed to visit the country, relying instead on responses to detailed questionnaires, and its report is supposed to be descriptive, without resorting to “grades.”