Time is running out for the deal makers. There appear to be no grounds for the US and Europe coming together in a meaningful way on fiscal policy: the US want everyone to commit to some (universal?) target; the Europeans either really don’t want that (Germany) or rightly feel they can’t afford it (most of the rest of the EU). Regulatory agendas intersect but only at the general level of, “we should do better” and ” it was your banks that got us here” – the AIG counterparties list make it clear that already-regulated large institutions in both the US and Europe are the problem. And the US Administration is waiting for Congress on regulation – this will take 6 months or more to sort out.
All of which leaves one main item around which there can be convergence: the IMF. And for this, China’s exchange rate is the issue.
The US has taken the initiative with Secretary Geithner’s proposal that IMF resources be increased by $500bn (i.e., from $250bn to $750bn) through a large loan from member countries. A loan of this scale has the advantage of providing sufficient support for the Fund over the next 12 months (unless the eurozone takes a major nosedive), while it doesn’t require the long drawn-out negotiation needed to change the Fund’s underlying quotas – the equity/voting structure of the organization is contentious because emerging markets demand more voice, while smaller European countries strongly resist reductions in their (overrepresented) voices.
Last weekend the Europeans rebuffed the Americans on the scale of this loan – preferring to stick with the IMF’s idea of “just” doubling its resources, i.e., an increase of $250bn. Of this, the Japanese already offered $100bn (in fact, this loan to the Fund is already in place). But in communique pledge math you can count contributions multiple times – come up with another $150bn from around the world and you can claim the $250bn headline.
In principle, this should not be difficult. In a world of trillion dollar problems, providing some tens of billions of dollars to prevent chaotic domino effects in emerging markets seems like a reasonable investment. And – here’s a key point – you are only providing the IMF with a line of credit, typically from your central bank, so the budgetary cost is basically zero and the opportunity cost is (a) minimal if you are holding a large amount of foreign exchange reserves, (b) definitely zero if you are a reserve currency country, so your loan is in your own money (which you get to issue.)
So why not just put the US down for $40bn, the EU for $40bn, and China for $40bn – presuming you can put the Saudis down for $30bn? Not so fast says Capitol Hill – the Administration needs to request an authorization, and this requires a serious conversation. Still, that’s not too difficult in the current context, particularly if the world is waiting for a formal US answer after the summit and the current level of world trade hangs by a pretty thin thread.
Not so fast or not at all is also the gut reaction of the Germans, who like to think of the IMF as being even more austere than themselves. Of course, their attitude of “responsibility” looks increasingly irresponsible – what was the point of pushing hard for massive cuts in scarce experienced IMF staff right during the worst economic collapse in living memory? At this point, other Europeans can probably bring the Germans along, particularly as East-Central Europe stumbles towards further devaluations (tending, other things equal, to move jobs eastwards) and as Europeans all realize – stunning though this may seem – that the only idea they have for weak eurozone countries is to send them to the IMF for loans.
But can you get $40bn from China? Yes, if you are willing to do a deal. What do the Chinese want? Some commitment to further “reform” at the IMF (code for: more votes for China). The US can do this – because they will keep their veto at the IMF, which is all they really want. The small (in every sense) Europeans may choke on this, but they increasingly feel the need for China’s commitment to the Fund. So, the Chinese suggest, if you can’t promise immediate change at the Fund, here is another proposal: stop talking about China’s exchange rate.
China’s exchange rate has, since 2003, been substantially undervalued and China has – unambiguously – intervened to keep it that way. This has contributed to a massive current account surplus (over 10% of GDP) and a capital outflow (hence China’s currently reserve level of around $2trn) that has contravened the spirit of what large countries are supposed to do and – since a rules change at the IMF in summer 2007 – the letter of its international agreements. The IMF has, for moderately inexplicable reasons, not yet been able to call China to account; this increasingly grates on Congress, as it should.
So now China proposes: hush money. Take complaints about the renminbi off the table, and you can have a big loan. And shut up already about how global imbalances (code for: China’s surplus) contributed to the easy funding environment that fed the latter phases of the global debt boom. It’s awkward, given the frequency with which policymakers like to blame the “global savings glut” (code for: China’s high savings/current account surplus, mostly), but this is mostly about deleting a paragraph or two from standard speeches.
Is it worth it? Would this lead to more or less pressure for protectionism in the US and Europe? If China devalues further, to take the edge off its recession, would that also be OK?
They’ll work hard to do this deal, or some version of it, in the run up to April 2nd. Whether it turns out to be a good idea remains to be seen.
Originally published at the Baseline Scenario and reproduced here with the author’s permission.