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The IMF did its job (more or less) last time around …

by Brad Setser
September 29, 2006

The IMF received its share of criticism over the past two weeks. 

The IMF governance structure is dated.  Europe is over-represented on the IMF board (and isn’t inclined to allow much change).  Asia is under-represented.    Countries guard their position on the board jealously.   The difficulty getting agreement on a modest ad hoc quota increase (Brazil and India objected because they were not among the winners) doesn’t necessarily bode well for the next set of more ambitious changes.

The IMF remains strangely (given its original mandate) unwilling to criticize countries with inappropriate exchange rate pegs (its silence on Saudi Arabia’s peg is a case in point; the IMF only delivers criticism in its regional outlook); hopefully the G-7’s call for the IMF to update its guidelines for exchange rate surveillance will spur a bit of change.

The IMF’s advice on how to reduce the surpluses of the world’s big surplus countries and the deficit of the big deficit countries is generally unheeded.    The US hasn’t shown any real commitment to balancing its budget over the economic cycle.  China has let its real exchange rate depreciate this year, even as its trade surplus exploded — not that you would know about China’s growing surplus if you just read the IMF’s public reports.   

For that matter, the markets — at least after June — don’t seem to share the IMF’s concern about imbalances.  Market players are bidding up the currencies of countries with large current account deficits (New Zealand, Iceland, the US – v. at least against the yen), and pushing the currencies of countries with surpluses down (Japan).

The IMF isn’t – despite what some argue – outgunned by the private markets.  At least not in the emerging world.  The $25b the IMF provided to Turkey is far more than the international sovereign bond market ever supplied Turkey (once you net out the bonds held by turkey’s own banks, which are effectively a foreign-currency denominated domestic loan).   But it is outgunned by the huge stockpiles of reserves held by many emerging markets.  $200b and change in loanable funds isn’t what it used to be. 

The IMF’s model for generating the income needed to pay its staff is in a bit of trouble.  The IMF used to pay its staff out of interest in got from lending to the big emerging economies ….  

That in some ways is a shame.   The IMF staff still do more comprehensive analysis than just about anyone- I challenge my friends in the markets to match the IMF’s analysis of petrodollars or its assessment of Lebanon’s balance sheet risks.  

Ironically, though, the IMF’s current absence of income is evidence of some real successes.    The IMF isn’t in the business of providing long-term financing.  It is in the business of providing short-term financing to supplement the reserves of cash-strapped emerging economies.   That is an important role – there is a reason why emerging economies concluded that they need to hold more reserves …

And lo and behold, if you look at the IMF’s balance sheet over the past ten years, it basically has performed its mission.   If you want to look at the supporting evidence (including some fancy charts), read on. 

Over the past ten years, the IMF has lent counter-cyclically, supplying emerging markets with reserves when private market financing dried up. And – as one would expect – those emerging economies have paid the IMF back as private flows resumed and as higher commodity prices provided many emerging economies with a windfall.   

That means IMF lending increased during periods of turbulence – Mexico in 95, Asia, Russia and Brazil in 97-98 and Argentina, Turkey, Uruguay and Brazil again in 2001-02.     Those surges of lending show up clearly in a chart of the IMF’s non-concessional loans outstanding.


Incidentally, if US bilateral lending was added to IMF lending in 1995, the peak would be a lot sharper – the US lent its funds out fast, and got repaid far faster than the IMF.

The following chart presents the same data in a slightly different way.  It shows the one year change in total IMF loans outstanding.  It is in dollars billion – not SDR – so it tends to slightly understate IMF lending when the dollar is strong and slightly overstate IMF lending when the dollar is weak.  But that source of error is small (and few folks think in terms of SDR).

In Bailouts and Bail-ins, Nouriel and I argued that the IMF’s lending subtly changed between 97-98 and 01-02, as the countries that the IMF lent to in 01-02 were more indebted than the countries the IMF lend to in 01 and 02.    This experiment lending to more indebted countries – countries that needed a sustained period of adjustment to bring their debt ratios down – looks to have worked out better than Nouriel and I expected.  

Argentina is obviosly the case that didn't work.  IMF financing was — mistakenly in my view — used to put off a necessary depreciation in the peso and a necessary debt restructuring.  But even Argentina ended up in a position where it could repay the Fund.   And Brazil, Turkey and Uruguay all avoided default.

Global conditions took a turn in emerging markets favor.  The dollar’s decline helped those emerging economies with lots of dollar debt (particularly if they exported a lot to Europe).  Turkey is a case in point.   Commodity prices rallied, big time.  Low rates in the “center” fueled a new wave of capital flows to the periphery.   Global growth was exceptionally strong. 

I think though the evidence does still suggest that lending to more indebted countries is more risky.  Even with very favorable conditions, the countries that took out big IMF loans in 01-02 have repaid the IMF a bit more slowly than the countries that received large amounts of IMF money in 97-98 (Russia actually didn’t get that much new money in 98, which no doubt helped … ).   

Consider the following graph, which plots the IMF lending surge in 01-02 against the 97-98 surge for comparison’s purpose.   >imf_lending_in_9798
The big loans stayed outstanding for longer in 01/02.  That may reflect the slower buildup of the crisis.  Brazil took out a loan in 2001 to guard against contagion from Argentina, got into real trouble in 2002 and ended up borrowing a lot of money in 2003 to rebuild it reserves.  Brazil consequently explains most of the surge in IMF lending in the q8-q12 period of the most recent wave of crises.   But I suspect it also reflects the fact that the IMF is lending to more indebted countries. 

Consider a graph showing both IMF and US loans outstanding to Mexico and to Turkey when both are plotted side to side.  Turkey had a lot more debt.  And it has taken a lot longer to repay.>img_and_esf_loans_outstandi
However, even Turkey now looks to be in a position where it will be able to repay the IMF when the time comes.  That is how it should be. 

The IMF shouldn’t have large loans outstanding when times are good.  Its job is to be ready to lend when times aren’t so good. 

Alas, that isn’t the only role the IMF should perform either.   Indeed, looking ahead — given all the changes in the world economy —  providing crisis financing to cash-strapped emerging economies may be the IMF's least important future role.


  • Posted by OC

    The main reason behind the negative votes by India, Brazil and many others (almost 10% of the votes) was the fact that the criteria suggested to be followed in the second stage of the reform would lead to an increase of shares by developed countries, exactly the opposite to what was the rationale for the reform in the first place. Combining (non-PPP) GDP and trade openness with no consolidation of intra-regional trade (such as in the case of the Euro zone) would aggravate the current distortions and misalignments in the IMF strcuture.

  • Posted by Guest

    “Since Argentina pulled off its controversial debt restructuring last year after the record default of 2001, the fate of those “hold-out” investors who refused to accept the government’s offer has remained unclear. There is still about $20bn of untendered debt out there, but attempts to recover funds via US courts have met with limited success, in spite of rulings in favour of bondholders…”

  • Posted by Guest

    The IMF should be cut in half. Too many taxpayers dollars subsidizing too many burocrats. Don’t shut it down, just reduce personnel, perks, costs, and fundamentally countries’ subsidy to benefit a few. Did you know that as an IMF employee you get home leave paid flights for you and family in business class, in addition to a tax-free salary and a 9-6 job? I’m not saying don’t pay for family to visit home country, but business class? and every year? what are vacations for? Use own money as most of us do! come on…I work in financial industry where salaries are high relative to the nat’l average, but i)my hours are from 7 to 6, ii)my work is stressfull, and iii)I pay taxes.

  • Posted by Butch

    Here are some thoughts for you big-brained guys:

    Imagine that instead of fiat currency, money was based on a finite resource such as gold or silver and that instead of fractional reserve lending (which is both institutionalized fraud AND leads to boom-bust cycles) there was “warehouse banking” for holding the hard-earned savings of depositors (for a small fee) and commercial banking that matched the liabilities of the bank (such as CDs to the loans outstanding)

    Imagine that that there would be no need for a “lender of last resort” in the form of a central bank since the above practices would obviate the need for one.

    Furthermore, imagine if you will that governemnt was taken out of the money-creation business (yes, including the use of their lackeys the central banks) and had to actually pay for their wars and welfare out of revenues confiscated via taxes from their citizenry.

    Imagine that there was BIS no IMF, or World Bank

    Imagine if you will that there was no currency speculation competitive devaluations, bond speculation, market manipulations by governments or $400 trillion in derivatives bets.

    Imagine a world without securitization whereby the original lenders were actually married to the borrowers they approved for the loans.

    How might that world differ from the one we are living in today?

    Furthermore, how might today’s world be impacted should anything go wrong with the “Bretton Woods II” arrangement?

    You may say I’m a dreamer. But I’m not the only one…

  • Posted by Guest

    For those of us who frequent this blog, but are not well informed on this issue, a bit more background in this May /05 article – if Brad may care to elaborate:

    ‘The successful restructuring of Argentina’s debts has set a painful new benchmark for creditors’

  • Posted by HZ

    What you imagined would have turned us back a hundred years or maybe more. Money’s primary use is for transactions – making sure goods and services can be exchanged efficiently. Use of money as value store is only a derivative of its primary function. Stability of value is needed more to enable long term planning than to give you a value store. Creating an artificial shortage (hard money) merely unfairly benefits hoarders. Hope this helps.

  • Posted by Gcs

    brad i read your bill of particulars
    and i wonder
    what in hell must the staff think

    we’re getting irrelevent
    there’s a very obvious forex problem
    that’s our metier
    why aren’t the top boys giving us the green light ”

    and why aren’t they ???

  • Posted by Butch

    HZ wrote:

    “What you imagined would have turned us back a hundred years or maybe more. Money’s primary use is for transactions – making sure goods and services can be exchanged efficiently. Use of money as value store is only a derivative of its primary function. Stability of value is needed more to enable long term planning than to give you a value store. Creating an artificial shortage (hard money) merely unfairly benefits hoarders. Hope this helps.”

    Let’s parse these statements out, shall we?

    “What you imagined would have turned us back a hundred years or maybe more.”
    (Reply) Do you mean to a time BEFORE rampant, runaway, ruinous specualtion, manipulation, by hedge funds, investment banks, governments and their lackeys–all facilitated by fiat currency, fractional reserve lending, central banking, securitization, derivatives, competitive currency devaluations, market manipulations and other skullduggery? Well, then color me nostalgic.

    “Money’s primary use is for transactions – making sure goods and services can be exchanged efficiently.”
    (Reply) ONE of money’s uses is for transactions. NOT the only one, though. In addition to the medium of exchange function, money MUST serve as a store of wealth. And what attributes give money a store of wealth value to people? Rarity and fungibility come right to mind. Somehow, infinitely-created electronic digits don’t qualify as rare in my book.

    “Stability of value is needed more to enable long term planning than to give you a value store.”
    (Reply)And what gives money its “stability of value”? Creating infinite amounts of fiat? Then creating even MORE fiat by fraudulent fractional reserve lending? Then compounding the problem by introducting the moral hazard of central banking’s “lenders of last resort” to bail out the system? By adding the “dicing and slicing” and further pyramiding of debt with securitization? Or the creation of $400 trillion notional of derivatives to attempt to offset the risk to the next greater fool (in addition to using said derivatives to obfuscate all manner of financial shenanigans)? Do you mean THAT kind of stability?

    “Creating an artificial shortage (hard money) merely unfairly benefits hoarders. Hope this helps.”
    (Reply) “Artificial”. Sorry, my friend, but using gold or even silver, which is real and rare is anything but “artificial”. What IS artificial is creating infinite amounts of fiat. Finally the statemnt regarding “hoarders”, is interesting. Why is it that people who save fiat credits are “savers”, but people who save gold are “hoarders”. Sounds strangely like the same cover Franklin D. Roosevelt used to confiscate the wealth of supposedly free Americans in 1933 by literally stealing their gold at gunpoint.

    Hope this helps.


  • Posted by Guest

    Here’s something to horrify the IMF. I have no way of knowing how representative this opinion piece is of the Chinese government’s view, but the People’s Daily Online (a party mouthpiece) has some fairly alarming comments. They use trade surplus per capita (!) as a measure:

    China has the greatest trade surplus in the world. The export summit in Japan and Germany after World War II enabled the per capita exports of those countries to exceed US$8000 and per capita trade surplus to reach over US$1500. If the population in China is 15 times that of Germany, the trade surplus may surpass US$2 trillion. Therefore, the 2005 trade surplus, more than US$100 billion, has not appreciated in real terms.

    It is very likely that the Chinese trade surplus will grow constantly, for the per capita trade surplus is very low, less than US$100.

    And here’s more fun stuff, “exchange rates won’t fix things anyway”:

    The traditional trade regulation mechanism of regulating the balance of trade through the exchange rate has become completely ineffective. Now the adjustment of the exchange rate can only change the relative price in a less-than-100-percent range, while the commercial price gap between developed countries and developing countries, which is determined by the price difference in production factors, is several thousand percent. If the adjustment of the exchange rate is less than 10 percent, its impact on the price difference of production factors will be less than 0.1 percent. Accordingly, adjustment of the exchange rate cannot effectively balance trade between developing countries and developed countries.

    Oy vey!

  • Posted by Emmanuel

    The last comment is mine, BTW. While entering the confirmation I thought it was “The l” and not “The I” so things got jumbled.

  • Posted by Enrique

    “Combining (non-PPP) GDP and trade openness with no consolidation of intra-regional trade (such as in the case of the Euro zone) would aggravate the current distortions and misalignments in the IMF strcuture.” OC

    Europe is clearly showing it is interested in maintaining its influence, not in creating a fair global institution. The concept of “trade openness” defined by their terms is selfserving.
    The EU is not so open as they pretend. Exclude all “protected trade”, that is, every trade who is not open in the same terms to all countries, and very little remains.
    It is not just intra-euro trade, a big part of extra-european trade takes place under special arrangements (Example: with former colonies)

  • Posted by Gcs


    great find
    that op ed
    shows how tough the party position
    can appear to be
    from the outside

    inside trust me
    they know its a bogus comparison

    what isn’t bogus is the future size of the chinese economy

    and if it retains a high degree of open -ness
    brad proly has the comp %’s between germany china and the usa
    the potential trade sector will be ….huge and as s consequence
    the potential surplus could be too

  • Posted by Gcs

    “The EU is not so open as they pretend”

    right on

    uncle sam however is just as flim flam ish

    stigiltz is relentless on this

    fair trade is a fond figment
    free trade a swindler’s lie

    we have “might makes right” one way open trade
    the one way is the trans nat way either way

  • Posted by bsetser

    GCS asked what do the staff think …

    I think that is more of a puzzle than it might seem. Partly for institutional reasons.

    Balance of payments analysis is handled by PDR, not the area departments. The area departments consequently tend to prefer to focus on fiscal policy/ structural changes — their balliwick, while arguing that exchange rate policies are some combination of:

    a)none of the IMF’s business (articles say every country can choose its own regime)
    b)not all that important, since with appropriate macro policies, any exchange rate choice can be made to work …

    hence the argument that Argentina’s currency board (pseudo currency board) wasn’t the problem in 00-01, at least it wouldn’t be with sufficiently tight fiscal policy (I thought the IMF’s BOP sustainability analysis here was sloppy tho — making fiscal consistent with the $ peg might using fiscal to engineer a deflationary contraction to generate a real depreciation — something the IMF didn’t point out firmly enough).

    Moreover, exchange rate policies tend to be decided above the staff’s pay grade — they aren’t typically a fruitful subject for “technical” discussions. If they are gonna be changed, it is a decision that is worked out at very, very high levels. Think US treasury secretary calling the finance minister and often being told “no, the president/ PM isn’t open to talking about this”.

    The IMF consequently has long had an institutional preference not to talk about exchange rate regimes bilaterally — Argnetina famously said everything was on the table in late 01, except for the peg.

    And I think that bias still shines through frequently in the area departments work. The Saudi article IV PIN is a good example — it parrots the official saudi line that there isn’t anything to discuss about the peg in advance of the GCC monetary union …

    The Asia-Pacific Division is also very cognizant of the IMF’s unpopularity in the region, and wary of being seen as the agent deputized to do the United States dirty work — they have opted to keep their input on the peg quiet.

    And frankly, after Eswar Prasad’s departure as the China mission chief, my sense is that the World Bank’s Beijing office has been putting out better work (at least better public work) than the IMF team. The work Louis Kuijs does is a great example — it really has shaped our understanding of China’s savings and investment balance. The IMF folks claim to have a great private dialogue with the Chinese, but I am not sure that excuses the IMF’s very lagged analysis of china’s BOP (which may reflect the long lead times associated with IMF publications). In my view, the China team should be saying very publicly what is clear from the data — namely, that China’s export machine geared up another notch, and china’s current acocunt surplus is getting bigger not smaller despite the authorities stated desire for rebalancing.

    One last point: the IMF staff are more experienced dealing with EMs with balance sheet fragilities linked to FX debt and exposure to a depreciation/ fiscal problems from fiscal profligacy than problems of too much — too many reserves/ too large a fiscal surplus. And that also sometimes shines through.

    Because of the institutional aversion to dealing with exchange rates/ a desire to be a privileged advisor and a sense that privileged advisors don’t talk about exchange rates, the overall result is that the IMF’s analysis of XRs tends to end up being done in so called multilateral products … whether the middle east regional outlook or the WEO, rather than in bilateral surveillance.

    the results are sometimes strange. the Article IV (04 I think, but maybe also in 05) with China says that it is 100% clear the RMB is undervalued, but the WEO says rebalancing requires emerging asia to appreciate v the US (I wonder who is the biggest economy in emerging asia … ). the US article IV says the $ needs to fall by another 15-35% in real terms, which presumably includes a big real depreciation against asia (since I don’t think the IMF thinks all the fall should come v the euro) … something that is hardly consistent with the China article IV. The Saudi Article IV endorses the Saudi peg in the run up to monetary union; press reports on the forthcoming middle east regional outlook suggest it criticizes the gulf’s real depreciation and calls for more flexibility …

    Multilateral surveillance is supposed to address some of these problems … and I hope it does.

    p.s. if I have parts of this off/ am being unfair, I apologize — I am no longer as in touch with currnet pulse of the IMF as I once was.

  • Posted by Guest

    re: “china’s current [account] surplus is getting bigger not smaller”

    Perhaps I’m not getting it, but wondering how quickly that might change, and if so, how the fallout and rescue may differ this time around:

    “…Mr. McCarthy, a former Goldman Sachs banker in Hong Kong, described the valuations some of these banks enjoy as “ridiculous,” and likened reading the prospectuses for their offerings to a “comedy show.” While he acknowledged public shareholders should accelerate the pace of banking reform, he predicts there will be two or three painful blowups in the sector before it gets its house in order. “It’s going to end badly,” he promised. “We’re in the ‘nuts’ stage — we’re not at ‘super-nuts.’ This could be one of those things where they shoot up another 20 per cent or 30 per cent first.”… “… these banks are essentially weaker than they were before. China is just piling up more and more non-performing loans, and eventually it’s going to come crashing down, because economically this doesn’t make any sense.”…”

  • Posted by HZ

    Any credit/debt/IOUs can be used as money, even without a central bank. There were bank notes long before central banks. It is just more efficient with a central bank. Stability means the amount of money in circulation should have some correlation with the amount of economic activity in aggregate, which property the supply of precious metals does not possess. If you prefer gold/silver or even postage stamps no one is stopping you from using those as your value store.

  • Posted by HZ


    Doesn’t IMF’s power only show during a crisis? Since nobody wants IMF meddling non-reserve currency issuing countries all build up large reserves (if they can afford to) which largely makes IMF irrelevant. No? World Bank seems to have more leverage because they do hand out development loans. Reserves are costly but many seem to value their independence more, which begs the question of why these countries want to stay in IMF in the first place.

  • Posted by Gcs

    god brad what a great answer

    unfortunately it depressed the hell out of me

    if as i belive the problem is systemic
    it needs multilateral action
    if as i believe its also highly technical and detailed
    it needs a big expert staffing function

    if i nominated the imf

    the nomination would be politely refused

    so now where are we

    summitry is not patient enough

    this requires a long process in my estimation
    and huge multi latreal co ordination


    how but we make you global forex czar

  • Posted by Gcs

    brad’s real ball kicker:

    using “appropriate macro policies..”

    ” any exchange rate choice can be made to work …”

    translation to reality on the ground:

    ” Argentina’s currency board ..wasn’t the problem… with sufficiently tight fiscal policy ..” one could make
    ” … fiscal consistent with the $ peg ..”
    “… engineer a deflationary contraction
    to generate a real depreciation..”

    the fiscal torture rack

    take the route of maximum pain and suffering
    to the littlest players

    one of the beautiful things about exchange rate policy is the possibility to avoid

    the extremely well understood horrors of deflation

  • Posted by bsetser

    gcs — agree on avoiding horrors of deflation.

    I was perhaps too negative on the IMF. The IMF has geared up its technical analysis of “imbalance” related subjects; just look at the recent WEOs. But this generally has been done in the “multilateral” context — whether as part of a global analysis (WEO) or a regional analysis (Middle East regional outlook).

    What I think has been lacking is translation of that global analysis into policy recommendations at the country level — i.e. there seems to be a consistent gap between the multilateral conclusions and the bilateral article IV process.

    other major problem is that — as HZ notes — the IMF’s leverage and capacity to act directly comes from its ability to lend out money. that means it has more leverage over debtors than creditors. and the US is a very unusual debtor, being the issuer of a reserve currency/ world’s biggest economy, so the IMF doesn’t really have direct leverage their. So I don’t quite see how the IMF can take “multilateral” action —

    it can prod and cajole — see the new multilateral surveillance exercise — but ultimately, the “Deal”, if there is gonna be one, will have to be between the big countries that can actually take action.

  • Posted by GCS

    i agree they can’t lever the peggers
    but maybe they could audition for the staff job
    while suggesting there’s a pending crisis that needs summit like

    if you look at keynes
    he throw his draft of a master plan on the table
    and got the ball rolling
    isn’t there some one at the IMF big enough
    to make that sort of splash ????
    even if they have to set up
    an ad hoc commision of global notables

  • Posted by Butch

    HZ Wrote: “Any credit/debt/IOUs can be used as money, even without a central bank. There were bank notes long before central banks.
    (Reply): I have no problem with bank notes being issued against AN EQUAL AMOUNT of specie. It’s when banks issue more notes (which are actually “IOUs”, you know) than something to back them. This is particular fraud is compounded by the illicit practice of fractional reserve lending.

    HZ Wrote: “It is just more efficient with a central bank.”
    (Reply) And ten times more dangerous, especially when those notes are forced upon the populace at gunpoint via “legal tender” laws.

    HZ Wrote: Stability means the amount of money in circulation should have some correlation with the amount of economic activity in aggregate,…
    (Reply)Whoa, please stop right there. Where did you get that premise? From Keynes? Friedman? Who decided the “correlation”? How much “correlation” should there be? Can you see a scenario where governments/central banks might incorrectly guess how much “correlation” is proper? Do you see any potential “moral hazard” problems with your “correlation” scenario?

    HZ Wrote:”…which property the supply of precious metals does not possess.”
    (Reply) Which is exactly why they should be used. To keep corrupt governments and banks from over issuing notes, starting the terminal process in motion.

    HZ Wrote: “If you prefer gold/silver or even postage stamps no one is stopping you from using those as your value store.”
    (Reply) For now. However, to paraphrase Alan Greenspan, history has not been kind to those who have attempted to preserve their wealth in ANY form when a corrupt desperate government wants to confiscate it. Even here in the supposedly “free” U.S., the SAVING (not “hoarding” as the propagandists would have you believe) of gold by citizens was confiscated at gunpoint–and at a profit to the U.S. treasury I might add. Other capital controls, restrictions on trade and punitive taxes have all been used by governments to exert their control over the populace.

    Now, a few questions for HZ: You seem to be well-versed in today’s monetary system. Would you please share your thoughts on the $400 trillion dollars (notional) of derivatives (according to latest figures from, including $25 trillion of CDS which themseleves are written against “only” $5 trillion or so of debt? Do you see any dangers in the murky, poorly-documented, unregulated, difficult-to-value OTC market for such unstruments? Do you see any potential problems with the concentration of risk in just a handful of banks for these instruments–in some cases exceeding capital by several hundered percent? Do you see any potential issues with the huge concentration of risk in MBS/loans in Fannie/Freddie (currently $4.5 trillion)? Do you forsee only smooth sailing as the U.S. runs up $900 billion per year in current account deficits? Do you believe that China (and OPEC) will forever finance our deficits? Do you see any issues with the fact that the U.S. is on track to create $5 trillion in NEW debt (over and above the already $43 trillion) each and every year from now to forever? Do you see any future problems with the forward liabilities of the U.S. Social Security/Medicare system totalling $50 trillion? (Speaiking of which, do you have any thoughts/knowledge regarding the $1 trillion “borrowed” from the Social Security “”trust fund”?)How might “Bretton Woods II” be impacted if our debt enablers actually demand a higher rate of interest on the treasuries/agencies that we need them to purchase at each and every auction? Or actually begin to sell off their current holdings of $2 trillion? Do you see any problem with the $10 trillion in real estate debt ($6 trillion of it “securitized”) as home prices are actually falling and may bottom out at less than HALF of today’s prices?

    I look forward to your responses.


  • Posted by HZ

    These are big topics that are hard for anyone to completely comprehend. I am more concerned with the flow of financial instrument than the accumulation of it. To me the financials are subserviant to ensuring a functioning economy that deliver goods and services to meet the population’s needs and wants. So to the end that one sees excesses in the physical economy (say housing bubble) one can say that inefficiency exists. Otherwise I am fine with the natural progression of things, even if we suspect that the other parties are manipulating their financials. If one day foreigners own a large percentage of our financial papers, would that truely make a difference to most Americans, who don’t own these assets anyway, so long as their needs and wants are met? Or if the foreigners see the light of the day and start reversing their policy, so long as it is orderly, things should work out. Now the keyword here is “orderly”. It is not just economics at play here, it is easy to get mixed up with politics and someone may be tempted to throw a monkey wrench into the system. With the large imbalances we currently have the danger is the large swing that may arise due to a confidence crisis. Now even if that happens what we have currently is preferred over the opposite scenario, where we have large surpluses while the developing economies accumulate debts. Since we are the reserve currency issuing country and our debts are denominated in USDs, we should be able to avoid a liquidity squeeze.
    As for fiscal deficits the concern is that government spending crowd out private investment. But because we also run a C/A deficit our investment needs are currently met through foreign capital. If these were to reverse we would have to make some likely painful adjustments or risk underinvestments in our future.
    Social security is an interesting subject. Generational accounting is often misunderstood. Saving for retirements is pretty much impossible at a national level since our needs are mostly in services these days, and labor (really time) can not be saved. As a nation we could try to save for retirement through owning foreign claims, but most large foreign economies have even worse demographic trends than we do (consider that another reason why we are running C/A deficits). Ideally we should decide through a political process to dedicate a certain portion of GDP to our retirees, proportional to the retiree population. If we were to fund it at the current SS level, that means a reduction in the current SS tax and a much steeper rise when the baby boomers retire, i.e. truely make it “pay as you go”. But that is the reality of our demographics. This way our politicians won’t be able to hide federal spending behind SS “surplus” and the taxation will have to be made more explicit and truthful, IMO.
    As a nation the only way to raise our standards of living is to raise productivity (assuming that we can’t do much about the working population, but maybe we can better incentivize people to work), and that means investment in people (education) and physical plants (capital investment). I would worry that we might start falling behind on these.

  • Posted by HZ

    And oh the derivatives, the recent Amaranth debacle is a good example. Yes Amaranth lost some billions, but that merely means someone else got the same billions. Unless you live in San Diego county, as I do, or are someone that invested in Amaranth, why would you care? But the nice thing about these futures contracts is that nobody (so far) needed to hoard the underlying physical assets to bet on price movements. That means no artificial shortage is created in the physical economy. So I agree with Greenspan that these instruments truely make our economy more efficient. Now it is unfortunate that my county pension board had seen it fit to invest in a hedge fund, but that is another story (see my previous comments on retirement funding).

  • Posted by Gcs

    hk some nice stuff in your last two comments

    in particular

    “As a nation the only way to raise our standards of living is to raise productivity ”

    i’d suggest the word potential b4 standard of living

    putting aside the limits of borrowing
    from “else where”
    even for uncle hegemonic those are sobering

    add the falling share in value added
    going into wages and salary

    (below those paid to the top 1%ers

    it surprises me how often folks
    forget globes are always on “pay as you go” (plus storage)
    that hasn’t changed since joseph’s time

  • Posted by HK

    Brad–I broadly agree with you on the assessment of the IMF and its staff. Let me make a few comments.

    1) The IMF has absolutely no leverage over the US (which has veto power on Charter change, quota increase, and gold sale), and weak leverage over creditors. Since the currenct global imbalances are between the US (debtor) on the one hand, and China and oil produces (creditors) on the other hand, it is impossible for the IMF to have any leverage over the countries concerned.

    2) However, if the IMF provides good policy advice based on the solid analysis by its staff, the authorities may listen and the markets may be influenced. Here, as many economists have argued, frank discussion and information disclosure are so crucial.

    3) The exchange rate issue is still difficult, because it is too market-sensitive. We have to recall that even the IMF Managing Director is asked to leave the meeting when G7 ministers discuss it. The long forgotten “Guidelines for Exchange Rate Management” can be revisited, but I am skeptical.

    4) The annual income of the IMF will soon show something like $300 million, unless there is another major currency crisis, which is unlikely for the time being. Fees to be imposed on its members in proportion to their quotas will never be supported by any important members. So, the only viable option would be the selling of its gold to invest in income-earning assets (subject to the US support).

    5) The number of the IMF’s staff can be reduced, but not so much as to make it financially viable. Because, to do so, it would have to reduce the number by more than one quater (800 or so), which is impossible without destroying staff morale.

  • Posted by Guest

    re: “that isn’t the only role the IMF should perform either”

    Given conflicting views as to the risks posed to the financial system’s resilience, along with changes to capacities and the leverage wielded by organizations like the IMF, any further speculation as to how the IMF should, or could be operating – or in the event of a real threat to the resilience of the financial system playing out.

    “…in benign times it was harder to identify the stresses which may develop in less favourable times, and as a result the industry needed to guard against the risk of sharp, and possibly coincident, corrections in a number of asset classes…”

    “…All parties were thus dependent upon one another: the banks deemed it essential that the debtor countries implement austerity programs; the debtor countries would not implement austerity programs unless the IMF extended loans; the IMF would not make loans unless the commercial banks extended bridge loans. The result of this triangular dependency was [that] action was either taken collectively or not at all…”

  • Posted by Guest

    part of the point being, looking at HZ’s comment above and using the example of the IMF workers – lay-offs or not, what is the definition of IMF worker productivity and how could a lack of it be corrected by better incentivizing IMF staff to ‘work’- longer, harder? And if productivity is achieved through lay-offs, what do the dislocated workers to do?

  • Posted by bsetser

    What do dislocated IMF economists do — glib answer. start a blog.

    serious answer. work in the markets. There woudl be an effective increase in the supply of applied economists .. which either would (or would not)have an impact on the real wages of existing workers — depending on how you read the literature on globalization’s impact on wages/ immigration’s impact on wages.

    Actually, that is already happening, but w/o the layoffs. there has a been some exodus for the markets as the imf’s role/ influence fades.

    HK — I think you are paining the imf’s income problem in somewhat dire terms. my understanding is that the imf put a fair amount of its profits from its peak lending years (03/04) into reserves, and consequently isn’t in dire straights. And it presumably could lower the rate of renumeration folks get on their contributions to the imf to generate a bit of spread income …

  • Posted by Joseph Wang

    Butch: I’m not alarmed. Mildly worried, but not alarmed. Notational derivative numbers are *completely meaningless*. All the other numbers are less alarming once you divide them by a comparison value (such as the US GDP which is $15 trillion).

    Just a bit more about notational values. Suppose I buy an interest rate swap. I agree to pay you 5% interest in exchange for a current reference interest rate (i.e. US treasuries). The payments are expressed in terms of notational values. i.e. if my fixed payment is US$5/year, the notational amount is US$100. The important part of this is that the notational value of the derivative is *merely a bookkeepping device*. No one actually pays, owes, or even has that US$100, the important number is the fixed US$5/year I pay in exchange for a variable amount that ranges from US$2 to US$15/year depending on the variable interest rate.

    That US$100 “notational value” is completely meaningless, and when people add together notational values for derivatives, the number is totally bogus.

  • Posted by HK

    Brad–I am not making any pessimistic forecast myself for the IMF’s net income in the medium-term. Rather, it is made by its Managing Director himself in his latest report that the IMF will become loss making in the FY2007 and record around $300 million negative income in FY2009, even though investment income from increased reserves is counted and the administrative budget in real terms is reduced by 1% per annum. So, this is an imminent and serious issue to be discussed by the international community sooner rather than later, although the current US administration is unlikely to address itself to it.

  • Posted by MrBill

    Joseph Wang: Correct me if I am wrong, but not only is the notional amount bogus, by adding together offsetting positions (A-B), which are likely hedged by still other offsetting positions (B-C & A-D), etc., but also when all those nominal positions are added up and expressed in dollar terms, it does not mean that all those nominal positions are in dollars either. Using your example of an IRS, they could be in dollars, euro, pounds or yen as well. They are just expressed in dollars at market exchange rates for ease of comparison, but misleading for the unintitiated just the same.

    Butch: A world with 6.5 or 9.0 billion people in it cannot return to the same living standards of one with less than 1.0 billion, and if there were no increases in productivity, including making capital work harder and more efficiently, then each additional person’s welfare would be at someone else’s expense. Something to contemplate while you’re raging against the machine that has so far delivered the goods despite its inperfections. Not only are living standards higher for *most* of the original 1 billion, but for billions more as well.

    You can argue about how sustainable that is? But perhaps that is the more important argument, not about derivatives and the efficiency of capital markets. The Chinese are perfectly free to invest their surpluses at home as is any other exporter.