Dr. Mohamed A. Ramady
Publication Date: 
Mon, 2008-02-18 03:00

An intriguing question has arisen during the current global credit crunch and banking crises: Where is the International Monetary Fund (IMF) in this entire debacle? Apart from some soothing words during the annual IMF/World Bank meetings, that the global economy was in a comfortable shape, and that the US economy was, apart from the housing market, in rude good health, nothing has come out of the IMF in terms of crises management leadership. While the IMF Executives try to put on a brave face, the IMF's own reports, especially their respected publication "World Economic Outlook", clearly identifies the looming risks. The IMF's director general seemed to have caught a bit of the Davos Economic Forum cold when the IMF seemed to shift tracks and comment that things were not as good as they seemed.

The globalized financial system has ensured that the bundling of loans into complex financial instruments, and on-selling them to other financial institutions, is not a viable one for the world's financial system, especially, if such bundled loans have not much value. Even current high oil prices, hovering at the $ 90-$100 a barrel, does not seem to bother the IMF much, who argue that higher energy costs are less of a problem than they used to be when economic output was more energy intensive. That may be true in the long term, as consumers and industries try to be more energy efficient, but it is the short term that is a concern, with a looming US recession and its world wide consequences.

As with the changing world economic order, the IMF has not readjusted itself to the new fundamentals. Established after the World War II, the IMF's first quarter of a century saw it preside over the Bretton Woods system of fixed exchange rates against the dollar, which was itself fixed against gold. In the 1970s, a new system evolved due to higher inflation in the US, prompted by large government expenditure due to the Vietnam war. The US could no longer maintain the fixed gold peg and the Bretton Woods system was replaced by a flexible exchange rate for the developed countries. Most developing countries tended to keep their currencies fixed against the dollar. The system is still alive and well today, despite the emergence of the euro, with the developed world floating against the dollar, and most developing nations fixed against the dollar.

Some currencies, most notably China's, are fixed against the dollar at artificially low levels which seems to ensure that the USA runs a systematic current account deficit and China runs a current account surplus. The latest US November trade deficit showed a widening of the deficit to its highest level in 14 months, as imports, especially of oil, overshadowed a small rise in exports helped by a weaker US dollar. While the US trade deficit with China shrunk slightly to $24 billion in November 2007, the year to date deficit with China stood at a staggering $237.5 billion at end of November compared to a full year 2006 deficit of $232.6 billion.

The growing deficit could only weigh on US economic growth, which has finally announced that a full blown recession is now in the making.

And so where is the IMF to ease on such imbalances, as one of its principal charter objectives states that it must do? Nearly two years ago, the IMF launched a process known as the "multilateral surveillance" in which a handful of key global players - the US, China, Saudi Arabia and Europe - get together to discuss what to do about the global imbalances. This was a welcome sign that the IMF would focus on its principal role of smoothing out economic imbalances, rather than be accused of jumping hard on some of the poorer nations and lecture them on sorting out their (financial) houses. For the IMF to act decisively today, the fund's lending portfolio has to be large, and this is not the case, indicating some reluctance by key states to provide the IMF with more support. Part of this is the feeling that the post-World War II IMF dominated by Europe and the US, needs to become more representative of today's realities, so as to give it more legitimacy.

The anachronistic privilege of nominating the IMF's managing director from Europe (and the World Bank's president from the US) needs to be revisited at some stage. Right now, the IMF seems constrained in acting decisively to affect world economic imbalances and finds itself, under its new Managing Director Dominique Strauss-Kahn, looking for a new vision and a more democratic voting structure. For how long can the IMF resist appointing an Asian managing director, given the new world economic realities? If this is not done, then some of the stronger developing countries might go their own way. President de Silva of Brazil floated this idea in October that developing countries should set up their own alternative to the IMF and the World Bank, unless there is a change in the voting rights of the world's poorest nations.

(Dr. Mohamed Ramady is visiting associate professor, finance and economics at King Fahd University of Petroleum and Minerals, Dhahran.)

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