“Successful states have become self-righteous and immobile”

IMF chief Rato wants an institutionalized working group to work out an agreement to reduce global economic imbalances – the time is favorable because the world economy continues to grow

While the Bank for International Settlements (BIS) recently ied urgent warnings against an overvaluation of the emerging markets and a "systematic underestimation of risks" by the financial markets, the International Monetary Fund (IMF) paints a much rosier picture in its latest publications ahead of the start of the spring meeting of the IMF and World Bank in Washington. In its World Economic Outlook published on Wednesday, the IMF predicts another two years of very strong growth for the global economy, of 4.9 percent (2005: 4.8 percent) and 4.7 percent next year, raising its forecasts from the fall by 0.6 and 0.3 points respectively.

There was also much less danger for the emerging markets, which were on the whole much more stable today than during comparable phases in the past, as Gerd Hausler, the outgoing director of the International Capital Markets Department coming from the Bundesbank, pointed out on 11 September. April at the presentation of the latest Global Financial Stability Report for which he was responsible. Moreover, there was little systematic mispricing of risks by financial markets (as observed by the BIS). Countries with high foreign debt and weak budgets were still prone to crises, but the risk of "contagious" crises (as in the Asian or Russian crises of 1997/88) was currently rather low.

The imbalances in the balance sheets and rising household debt in the Anglo-American region (which had continued to build up, as feared), which had been deplored by the Fund for years, were mentioned only in passing in the World Economic Outlook and the World Financial Stability Report. Among the risks, the broadest is that of a possible pandemic, such as a worldwide outbreak of contagious, deadly avian flu that could prevent emboldened key workers from showing up at their jobs en masse. Otherwise, in the short term, the high price of oil could slow down the booming global economy. Es gehe der Welt so gut wie noch nie, fasste IWF-Chefokonom Rhaguram Rajan die Lage zusammen.

However, during the presentation of the current publications, the responsible authors and, most recently, the Managing Director of the IMF, Rodrigo de Rato, made it clear that the calmly optimistic tone of the two reports was probably motivated more by tactics – and was apparently intended above all to encourage the United States to finally tackle the problems at hand (budget, savings and trade deficits). In any case, the IMF representatives never miss an opportunity to point out the need for action. Rato now wants to establish a multinational working group at the upcoming spring conference of the IMF and its members to reach an agreement on the coordinated reduction of the increasingly gross and dangerous imbalances.

He said this, incidentally, in the halls of the Institute for International Economics in Washington, where William R. Cline had proposed a new Plaza agreement a few months ago, similar to the one reached on 22 December. September 1985, when, at the Plaza Hotel in NewYork, the G5 finance ministers and central bank chiefs had agreed to devalue the dollar in order to contain the then "twin deficit. This was successful, but with double-digit interest rates worldwide and particularly drastic effects on the populations of many highly indebted developing countries. But the "Anpang" also made itself felt unpleasantly in the first world.

The economic situation is favorable for any changes that may be necessary

According to Rato, there is consensus among experts on what needs to be done, and he cites Cline’s demands: Making exchange rates more flexible, which are currently pegged to the dollar; increasing both public and private savings in the U.S.; boosting consumption in China; and making structural changes to boost productivity and consumption in Japan and Europe. Dafur werde es eine bessere wirtschaftliche Situation als heute jedenfalls nicht mehr geben, betonte Rato am Mittwoch bei der Prasentation des „Economic Outlook“.

Geschehen sei hingegen bislang viel zu wenig. So seien die Sparplane der US-Regierung gleichzeitig uberoptimistisch und unambitioniert.

However, its consolidation plans somehow succeed in being both overoptimistic and unambitious at the same time.

Und auberdem seien einige grobe Lander angesichts hoher Wachstumsraten selbstgerecht und unbeweglich geworden:

But that consensus has, in most cases, not been translated into action. The question is, Why? Well, the answer is that things are looking good so there is a complacency situation in governments. To maybe back that complacent attitude, there is some use of arguments often coming from policymaking institutions in the countries concerned. The arguments are in the sense that global imbalances will either persist forever with no consequences or that it will dissipate gradually of their own accord. I have to say very clearly that those arguments, in our opinion, are not only unrealistic, but could bring the world to a not very good situation. The global economy remains vulnerable to an abrupt and disorderly adjustment of global imbalances and we all have to realize that. Even if times are good right now.

Rodrigo de Rato

The U.S. Treasury immediately responded to the accusations with its well-known position that the current account deficit is mainly due to the currency manipulations of Asian exporting countries and that the IMF should rather advocate free exchange rate regimes.

According to Rato, the risks have also naturally increased further, with Hausler listing among the existing risks the consumer and corporate credit cycles turning into negative territory (d.h. a rising insolvency rate) is considered almost inevitable. Only – since corporate profits are again expected to be very high – this could be delayed a bit, Hausler says. Das viel grobere Problem sei aber eine mogliche Erosion des Vertrauens in den Dollar:

Let me be very clear, the macro-economic imbalances are something that we all have concerns about and I have no exception to that and we all know that if there was ever any erosion in the confidence on the dollar, if there was any erosion in the asset allocation for the dollar, it would have very nasty consequences and so there is no disagreement on that. Rato: As far as the risk of an abrupt adjustment of global imbalances go, I think that risk is there and I think the longer the imbalances continue, the higher the probability of their risk. It is, nevertheless, a fairly low probability still, but we should do everything to reduce it because it can be a very costly adjustment process if it happens very quickly, and this is what we need to do.

Gerd Hausler

The financial system as a whole, however, has had to endure a lot at the moment. Also, due to the strong performance of the U.S. economy and the fact that nowhere else do investors have such extensive investment opportunities, the investment required in the U.S. remains attractive and the U.S. deficits can thus be financed, say Rato and Hausler. Of course, they had to reckon with a borse crash should they claim the opposite.

So it’s a long way of saying that "Yes it is a problem, it needs to be dealt with" and the Fund is trying to persuade its membership to deal with the ie. But, on the other hand, it would not be serious for us in a stability report, which comes out twice a year, to cry wolf and pretend as if there were signs that the dollar would collapse in the next six months.

Gerd Hausler

"Faustian pact" between private households and the financial markets

In the real economy, a successful balance would mainly lead to a price increase, experts say. Production that is no longer competitive at the new exchange rates should then be exposed to the forces of the markets, and those that are not viable should be allowed to fail. Hausler also suggests that the next risks to emerge could be related to the dramatic increase in leveraged buyouts. For, unusually, companies had recently saved rather than borrowed, but this trend was just turning around and isolated bankruptcies were foreseeable. In any case, central banks and governments should then refrain from any bailouts, although at present the demise of a coarser company has even had the advantage of helping the financial markets to make more realistic assessments of risk, according to Hausler.

Hausler seems to think that it is quite likely that the governments concerned will actually be deterred from bailing out stumbling national champions. However, he contrasts this with the new challenge of rescuing entire markets rather than just individual companies. Responsible for this is a "Faustian Pact" between private households and the financial markets, which offers far more potential for "moral hazard" (whereby opportunistic behavior of individual "free riders" is highly rewarded at the expense of the system as a whole).

Private investors are now able to participate in the profitable financial markets with all the opportunities, but they also bear the risk ("shock absorber of last resort")"). From a systemic point of view, they thus form an insurance for the financial markets – and because the risks are spread much more widely, the system as a whole is stabilized. But most private investors hardly had the opportunity to assess the risks correctly and to demand an adequate premium – which would become a problem if the negative side of the pact came to bear and asset losses occurred. But if investors’ hopes were dashed, the governments concerned could be obliged to support entire markets. Just as in the past "financial institutions too big to fail" were susceptible to "moral hazard" situations, now "markets which are too important to fall" took on this role, Hausler explains. And arguably, this is not quite in line with Rajan’s call to help not jobs or businesses, but individuals.

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