Friday, May 21, 2004
Asian Monetary Fund
My favourite columnist with the Financial Times, Martin Wolf, moots the idea of an Asian Monetary Fund to stop the inordinate build up of foreign currency reserves in the region. Clearly, such an idea has some merit and if nothing else, will force the United States to sets its house in order rather than to continue borrowing.
In 2002 and 2003, the principal economies of the Asian region ran a combined current account surplus of Dollars 540bn (Pounds 305bn), of which Dollars 249bn was Japan's (see chart). This aggregate surplus covered more than half of the cumulative US current account deficit of Dollars 1,023bn. It would be natural to assume that these huge current account surpluses were the means through which the region exported its excess private savings. But most Asian economies have not been net exporters of private capital.
Why did Asian governments behave in this way? The answer is that they wished to avoid a collapse of the US dollar. They feared a collapse for several reasons: it would have generated additional deflationary pressure, particularly important to Japan and China; it would have undermined their export competitiveness; and it would have reduced their current account surpluses or even generated sizeable deficits, rendering them vulnerable, they feared, to another financial crisis.
This recycling of the foreign currency pouring into the region creates a certainty, a probability and a risk. The certainty is that these countries lose a great deal of money, since the cost of the capital entering the country substantially exceeds the return on the foreign currency reserves. The probability is that they will lose still more when the dollar falls: if it were to fall by 25 per cent, the aggregate losses on Asian foreign currency reserves would exceed Dollars 500bn. The risk is that this huge increase in the monetary base will generate - indeed, already is generating - destructive asset price bubbles and ultimately inflation.
It makes no sense for a region with huge current account surpluses and foreign currency reserves to be so desperate to avoid international financial crises. The US should feel vulnerable instead. A step towards reducing the region's perceived vulnerability would be to create a large Asian Monetary Fund. Armed with this insurance, Asian countries could allow their exchange rates to appreciate, generate greater internal demand and then run current account deficits. This would generate global balance of payments adjustment. Moreover, if Asians do wish to lend money generously, why not benefit their own people rather than Americans?
Preliminary steps have been taken, notably through the Chiang Mai initiative, agreed in May 2000, which created bilateral swap arrangements worth Dollars 40bn. But the aim should be to create a fund with at least 10 times as much money, which would still absorb only a fifth of the region's currency reserves. Such an institution would need to undertake forthright surveillance of the members' economies. Initially at least, this job could be subcontracted to the International Monetary Fund.
Wolf also refers to the absurd power equation within the IMF today.
With total resources of about Dollars 316bn, the IMF is too small to be relevant to the region's larger economies. Moreover, by their arrogant narrow-mindedness over the appointment of the managing director, the Europeans have (together with the Americans) demonstrated once again their determination to keep the IMF under their thumb. It is unlikely that they would accept a large expansion in Fund resources, since this would certainly require a sizeable reallocation of quotas and so of power inside the institution. Today, tiny Belgium, with no currency of its own, has a bigger quota than India. That makes no sense at all.
A de facto Asian secession from the IMF would also teach Europeans an invaluable lesson in humility. Asia should dare to take a big leap forward in trade, monetary and financial co-operation. Americans and Europeans may not like the results. They will have to live with them.
BTW, Wolf is in India right now. Those of you living in Bombay should go listen to him speak (he is doing the speaker rounds), if you can wangle an invite. Unlike Stephen Roach, Wolf actually thinks India could do well to expand its manufacturing base and not depend on the service sector alone.
In 2002 and 2003, the principal economies of the Asian region ran a combined current account surplus of Dollars 540bn (Pounds 305bn), of which Dollars 249bn was Japan's (see chart). This aggregate surplus covered more than half of the cumulative US current account deficit of Dollars 1,023bn. It would be natural to assume that these huge current account surpluses were the means through which the region exported its excess private savings. But most Asian economies have not been net exporters of private capital.
Why did Asian governments behave in this way? The answer is that they wished to avoid a collapse of the US dollar. They feared a collapse for several reasons: it would have generated additional deflationary pressure, particularly important to Japan and China; it would have undermined their export competitiveness; and it would have reduced their current account surpluses or even generated sizeable deficits, rendering them vulnerable, they feared, to another financial crisis.
This recycling of the foreign currency pouring into the region creates a certainty, a probability and a risk. The certainty is that these countries lose a great deal of money, since the cost of the capital entering the country substantially exceeds the return on the foreign currency reserves. The probability is that they will lose still more when the dollar falls: if it were to fall by 25 per cent, the aggregate losses on Asian foreign currency reserves would exceed Dollars 500bn. The risk is that this huge increase in the monetary base will generate - indeed, already is generating - destructive asset price bubbles and ultimately inflation.
It makes no sense for a region with huge current account surpluses and foreign currency reserves to be so desperate to avoid international financial crises. The US should feel vulnerable instead. A step towards reducing the region's perceived vulnerability would be to create a large Asian Monetary Fund. Armed with this insurance, Asian countries could allow their exchange rates to appreciate, generate greater internal demand and then run current account deficits. This would generate global balance of payments adjustment. Moreover, if Asians do wish to lend money generously, why not benefit their own people rather than Americans?
Preliminary steps have been taken, notably through the Chiang Mai initiative, agreed in May 2000, which created bilateral swap arrangements worth Dollars 40bn. But the aim should be to create a fund with at least 10 times as much money, which would still absorb only a fifth of the region's currency reserves. Such an institution would need to undertake forthright surveillance of the members' economies. Initially at least, this job could be subcontracted to the International Monetary Fund.
Wolf also refers to the absurd power equation within the IMF today.
With total resources of about Dollars 316bn, the IMF is too small to be relevant to the region's larger economies. Moreover, by their arrogant narrow-mindedness over the appointment of the managing director, the Europeans have (together with the Americans) demonstrated once again their determination to keep the IMF under their thumb. It is unlikely that they would accept a large expansion in Fund resources, since this would certainly require a sizeable reallocation of quotas and so of power inside the institution. Today, tiny Belgium, with no currency of its own, has a bigger quota than India. That makes no sense at all.
A de facto Asian secession from the IMF would also teach Europeans an invaluable lesson in humility. Asia should dare to take a big leap forward in trade, monetary and financial co-operation. Americans and Europeans may not like the results. They will have to live with them.
BTW, Wolf is in India right now. Those of you living in Bombay should go listen to him speak (he is doing the speaker rounds), if you can wangle an invite. Unlike Stephen Roach, Wolf actually thinks India could do well to expand its manufacturing base and not depend on the service sector alone.
