I downplayed the most recent gathering of the great and good in Washington, arguing that those gathered in DC didn't really commit to the policy changes needed to avoid an another year of widening imbalances so much as reassure each other that they wouldn't make any real changes.
The market seems to have a different view. The dollar fell against most currencies after — take your pick — the G-7 released its communique/ the IMF unveiled its new focus on imbalances/ the FT headline writers decided that something really had changed over the weekend/ the IMF stated the obvious. The dollar would be down even more if Japan hadn't intervened verbally and if Korea hadn't intervened with cold hard cash (see the FT). And no doubt China continued to spend big bucks to avoid joining in the general trend – though China spends big bucks to keep its currency from appreciating against the dollar even when the dollar isn't depreciating against everyone else.
One interesting point: those who think the world should take steps to reduce imbalances generally have downplayed the impact of the IMF's new mandate, and the G-7's communiqué, while those who don't think the world should do much are disappointed that the G-7 and IMF are signalling that they are not totally happy with the world as it is.
Those skeptical that the G-7 communique — and the IMF's new process of multilateral surveillance - signal real change note:
- The US has made it clear it doesn't intend to address is structural revenue shortage, guaranteeing large deficits. Rather, the US Treasury Secretary argued – contrary to much evidence – that fiscal deficits have little to no impact on the current account deficit.
- The Chinese have made it clear that they don't intend to let their currency rise, even though a stronger currency and higher interest rates would be a natural way to help cool what looks to be an overheated economy. 30% investment growth and close to 30% export growth are hard to square with the image of a fragile Chinese economy that cannot manage even a modest change …
- The GCC isn't willing to change its dollar peg (GCC = Gulf Cooperative Council), even though its dollar peg makes even less sense than China's peg. Oil is way up this year, if you haven't noticed. But the purchasing power of the GCC currencies is down, since they all peg to the dollar. If anyone wants to explain why that makes economic sense, be my guest. The argument that countries that sell oil for dollars should peg to the dollar doesn't cut it. The dollar price of oil isn't constant.
- The yen is about as weak as it ever has been in real terms, yet Japan still tries to talk the yen down. Or at least keep it from rising. Incidentally, Korea is by far the most responsible of the big economies in north Asia. It has let the won appreciate in real as well as nominal terms. Korea now has a small current account deficit. It imports oil. And last I checked, Korea's economy was managing just fine.
As Jens Nystedt, Deutsche Bank's new G-10 currency strategists (full disclosure: I worked with Jens at the IMF), observed, the G-7 statement was a lot stronger than the IMFC statement. Yet, setting Japan aside, the countries of the world with big current account surpluses are not members of the G-7. The G-7 remains a lot better at telling others what to do than figuring out what its own members should do.
Yet those betting on an ever more imbalanced world – or perhaps betting on a financially stable world in the face of ongoing imbalances – seem a bit more worried. Not because they think imbalances are anything to worry about – Stephen Jen calls imbalances a natural byproduct of globalization. No matter that globalization started well before the US current account deficit started to get big in 1998, and well before Chinese export growth and investment metasized in 2002-2003. Rather they are worried that efforts to reduce imbalances will trip up the markets.
My sense is that there are some — not a lot, but some — nervous folks out there, folks who are starting wondering if they should take trades that assume an imbalanced world will be a stable world off. Even if betting that the US deficit could rise from 6% to 7% in the course of 2005 paid off big timel, it is risky to bet that nothing will happen that will prevent the US current account deficit – 7% of US GDP in q4 – from rising to 8% of US GDP in q4 2006. It is also risky to bet on continuity when the American electorate is unhappy.
Yet there should be little doubt that the US is on trajectory that will take the deficit toward 8% barring a major slowdown in demand for non-oil imports. Check out the March port data. Or forecast the oil balance with oil at $75. Or calculate the income balance as the interest rate on US external debt rises from 3.75% to 5%. And so on.
Plus, there is small chance that the IMF's new multilateral surveillance process could have an impact.
I would emphasize a small chance. Hu didn't let the RMB breach 8 in the face of pressure from the US president. And if China can tell the US no (in the face of the risk of being branded a manipulator), it can tell the IMF no as well. The same argument applies in reverse as well: if Bush can tell China no will the US ever adjust its fiscal policy (in face of the risk of less Chinese financing), Bush can tell the IMF no as well.
OK, no one says no directly. Bush talks (with no credibility) of reducing the fiscal deficit by 2009. China talks (with decreasing credibility) of its commitment to exchange rate flexibility. But no one does much either. And, as they saying goes, the IMF doesn't have an army. Its influence over countries that don't need its funds is limited, yet the policy changes the IMF (and others) think are needed are not limited. Morris Goldstein is right:
"Process is process. What is the IMF really prepared to say? What pressure is it prepared to put on countries that are not delivering? We don't know."
That said, in some ways it may be easier for China to move in a multilateral context than in a bilateral context – particularly if it can note that the multilateral process is putting pressure on the US as well, and take some pride in the fact that China is treated like the major player in the global economy it so obviously is. So I wouldn't entirely rule out the prospect that the IMF's multilateral surveillance – which presumably involves getting the key players in a room for a lecture – might prompt a some evolution in policy.
Or at least prompt some in the market to worry that there might be some changes, and thus decide to try to get out of the kind of bets that pay off only if imbalances continue to widen before the major countries of the world decide to do something …