I was invited by the International Monetary Fund (IMF) in 2001 to comment on the conditionality of its loans at that time. I had stressed that global financial stability was a global public good, falling under the auspices of the IMF, but the IMF has long since demanded the free flow of capital.
Alas, it resulted in a free flow of short-term capital, entailing a yo-yo movement of exchange rates, destabilizing the previous smooth development of global trade.
In the articles of agreement of the IMF, the first vital objective is to promote international monetary cooperation and some other aims to achieve are as follows: the expansion of the balanced growth of international trade, the promotion and maintenance of high levels of employment and real income and so on.
The stability objective is far from reality. Recently, the practice of currency wars through the competition of the interest rate cut was rampant. Isn’t this a beggar thy neighbor policy? Where is the cooperation?
After the recession of 2009, the US Federal Reserve (Fed) initiated an unconventional monetary policy — a zero interest rate policy (ZIRP). Following the 2008 global financial crisis, several economists expressed their concern about the possibility of the US economy following Japan’s negative economic path.
After the Fed’s ZIRP, some other central banks took a similar policy under the pretext of avoiding the threat of a deflationary process. The eurozone followed the American solution by issuing long-term refinancing operations (LTRO) to help banks hit by the crisis. The LTRO was implemented in the second quarter of 2009 with an interest rate of 1 percent, down from the previous range between 2.5 to 4 percent before 2009.
But in June 2014, the eurozone interest rate was lowered again to 0.15 percent, and in September 2014, it was further cut by only 0.05 percent. This has almost reached the lower bound of interest rates.
By considering real and potential inflation, the net real interest rate has been negative. A low interest rate, either nominal or real, will transform into the weakening of the currency exchange rate, namely the euro compared to the US dollar.
At a higher level, China has slashed interest rates three times in the last six months to 5.1 percent. Australia joined the race by cutting interest rates to a record low of 2.25 percent, entailing a fall in exchange rate to the lowest level in 5.5 years. Other countries in the race since January 2015 are Canada, Denmark, New Zealand, Singapore and Switzerland.
It is clear that the interest rate cuts will be followed by a currency exchange rate decline.
The lowering of the exchange rates of some countries will have the side effect of driving appreciation for other currencies. Certainly, it will have a negative impact on the export of goods and services of those countries experiencing currency appreciation.
The actions of the countries that join the race of interest rate cuts have pushed the world economy into instability.
Noting the disharmony of monetary policy in the world, the question that comes to the fore is about the implementation of the article of agreements of the IMF.
Where is the monetary cooperation? The IMF should urge the member countries to take consultative and collaborative action on monetary policy. This should be a constitutional task of the IMF to coordinate the world’s central banks to take cooperative action on monetary policy.
This should reduce the damage caused by the monetary stimulus to non-participating countries in the race of the interest rate cuts. Unfortunately, those countries are now the innocent bystanders.
But the main point is related to the unstable effects of that policy on the world economy. In the last two or three decades, the world economy has experienced more frequent balance of payments problems.
In global economic development in recent decades, the financial sector has been advancing independently of the real sector.
Initially, the financial sector had a role to facilitate the real sector, where money was either a unit of account, a means of exchange, or a store of value. But now, as the Bain consulting group’s report in 2012 showed, global financial wealth amounted to around US$600 trillion, almost 10 times the world’s gross domestic product (GDP) of around $65 trillion.
From the other side the world, trade value was $18 trillion in 2010, while the daily currency exchange market was around $4 trillion, equivalent to $1,000 trillion per year. World trade value was around one sixth of the yearly currency exchange market. This is different to what was originally conceived by the founders of the IMF.
One guess is that it seems that finance is not completely related to the real sector any more. Finance has its own independent world, and as such it could run without having a real relation to the economy. It is practically external to the world.
To be successful, these governments should pay serious attention to the development of this large wealth movement.
But who is in charge of this matter? The short answer is the IMF. But the IMF is in charge of sovereign financial flows and relations, while the large magnitude of financial private wealth rests outside its jurisdiction.
The IMF is a multilateral institution dealing with hundreds of member countries where one of them can run a surplus in international trade and the other can run a deficit. One of the peculiar things in this case is the amount of surplus is not equal to the deficit.
In order to achieve the purposes written in the articles of agreement, the IMF should forge an appropriate policy to attain and maintain an equilibrium balance of payments between countries in the world.
The appropriate magnitude of the international trade in goods and services is the end result of the economic relations between countries, while keeping in place a low level of inequality between countries in the world.
If trade imbalances arise, they will disturb the existing equilibrium of currency exchange-rates. It will have a further repercussion on the balance of trade between countries.
The new set of foreign exchange rates can reinforce the imbalances in trade and payments, which could end in crisis.
Clearly the global financial sector has a large magnitude of private financial wealth that dwarfs the flow of funds between sovereign institutions. It raises the question of the capability of the IMF to safeguard world financial stability.
This is especially due to the free flow of capital, which is the mantra of the IMF. Has the free flow of capital proposed by and supported by the IMF counteracted its function of safeguarding the world’s financial stability?
Seeing the actors of global finance, consisting of private and sovereign institutions, there is a need for change in the regime and scope of financial flows that fall under the surveillance of the IMF.
Alternatively, a new institution to survey private financial flows should be created. Without any change in the regime and scope of the operation of the IMF, there is a great doubt in the capacity of the IMF to safeguard global financial stability and then global economic stability.
The facts show that the IMF is also powerless in disciplining some countries that have been running balance of payments deficits or surpluses for several years.
This is another factor that leads to the same doubts over the inability of the IMF to maintain world economic stability in the coming years.
Finance has its own independent world, and as such it could run without having a real relation to the economy.