WASHINGTON/FRANKFURT, 16 September 2005 — The International Monetary Fund said yesterday that the world’s financial system has strengthened further and the short-term economic picture is largely positive, but repeated longstanding concerns about the long-term status of the dollar. “With global growth most likely to continue, inflation under control, and financial markets generally benign, we expect the resilience of the global financial system to improve even further,” the IMF said in its Global Financial Stability Report.
But while the short-term outlook is fairly rosy, the IMF pointed out that risks remain in the medium and long runs. “In short, recent economic and market developments have reduced risks in the near term, but they are storing up potential vulnerabilities for the future,” the report said.
Among the concerns are soaring oil prices, which could slow economic growth. The IMF also predicts that the growth of corporate earnings will likely begin to slow. The US current account deficit is another potential area for concern, but the IMF noted that this is not likely to be a short-term problem because other countries are still buying US dollars. However, this issue could affect the global economy in the medium or long runs. “(Investors’) willingness to smoothly finance global imbalances today reduces the sense of urgency for policymakers to take corrective actions and increases the potential for a ‘snap back’ — a sharp reallocation of assets away from dollar assets — some time in the future,” the IMF said.
The report stated that such a “snap-back” would “entail large costs in terms of sharply falling dollar exchange rates and rising dollar interest rates, thus causing disorderly financial markets and depressing global economic growth.”
Commenting on the report, Gerd Haeusler, counselor and director of the IMF’s international capital markets division, warned that a strong and sustained upswing in the German and Japanese economies could hit capital flow into the US economy leading to a negative effect on global economic growth.
“If Germany and Japan really got their act together this could in the long term undermine the advantage the US is enjoying right now,” Haeusler told a press conference in Frankfurt. Another area of concern is that private households in the US have build up a record level of debt. This could become a problem if prices for homes in the US fall sharply. This could hurt consumer confidence and could lead to an economic slowdown.
“All in all, while the near-term outlook is favorable, the increasing potential for a sharp correction in financial markets in the medium term makes it all the more important to address global imbalances and contain other risk factors, such as protectionist trends and or ‘event risks’ in emerging markets,” the IMF concluded. The report also lauded the US Federal Reserve for increasing interest rates at a measured pace and urged the central bank to stay the course.