The London summit’s real achievement

Put simply, the agreement at the London summit -- if key countries actually carry through on their commitment to expand the IMF’s resources -- allows the IMF to be able to both:

a) lend large sums, conditionally, to a host of countries in Eastern Europe that ran large current account deficit and are now having trouble rolling over their debts; and

b) lend large sums to a set of emerging economies that didn’t run large current account deficits and don’t have large stocks of external debt outstanding but still are facing a bit of pressure right now -- whether from falling capital flows, falling commodity prices or falling demand for the goods -- and wouldn’t mind a few more reserves.

A $250 billion IMF would have been stretched to just meet Eastern Europe’s need for emergency financing. It was too small, in some sense, to even be Europe’s monetary fund. A $750 billion IMF is big enough to be able to offer meaningful sums to the larger emerging economies -- think of the $50 billion Mexico wants to be able to borrow if it needs it -- and still cover a large share of Eastern Europe’s need for emergency financing.

Here is one way of thinking about the IMF’s need for resources:

At the end of 1997 -- at the height of Asia’s crisis -- the IMF had about $150 billion to lend, a sum that rose to around $250 billion after the IMF’s quotas were increased and the New Arrangement to Borrow provided the IMF with a bigger supplemental credit line.

At the end of 1997, emerging economies at the time had borrowed -- according to the BIS -- $1.045 trillion from the international banks. They also had something like $300 billion in external sovereign bonds outstanding. And they only had about $600 billion in reserves (from the IMF’s COFER data)

If the fall in bank lending to the emerging world in the years that followed Asia’s crisis had been financed entirely out of existing reserves, the roughly $200 billion fall in gross cross-border bank lending from 1997 to 2000 would have left the emerging world dangerously under-reserved. In practice, that "deleveraging" process was largely financed by a big swing in the emerging world’s current account balance. Deficits turned to surpluses, and the surpluses were used to repay debt.

Absent IMF lending, and agreements like the one that Korea reached with its bank creditors in 1997 to rollover maturing debts, that process would have been even more disruptive. Even so, the emerging world subtracted from global demand growth for a few years. A booming US, though, picked up much of the slack.

A comparable US boom obviously isn’t in the cards right now. And many emerging markets are facing similar pressures.

At the end of the third quarter, emerging economies had -- according to the BIS borrowed about $2.75 trillion from the world’s banks. Gross borrowing soared over the past few years. Emerging economies also had about $4.5 trillion in reserves.

Alas, China alone accounted for a little less half of all reserves ($2 trillion) even though it accounts for a fairly small share of cross-border bank borrowing. The distribution of reserves globally doesn’t match the distribution of debt. Some countries have a lot of reserves and little external debt (China, Saudi Arabia), some have a lot of reserves and a lot of external debt (Russia, Korea) and some have a lot of external debt and not-nearly-enough reserves.

The IMF’s $250 billion simply wasn’t enough to provide much insurance against a big fall in cross border bank lending. It is small relative to the $2.75 trillion in cross-border bank debt outstanding, and bank debt isn’t the only source of pressure on countries’ balance of payments.

Capital flows had grown more rapidly than the IMF’s lending capacity. If capital flows were stable that wouldn’t have been a problem. But they weren’t, and the IMF’s small size really was crimping the world’s ability to respond to one aspect of the current crisis. As my colleagues at the Council’s Center for Geoeconomic Studies have documented, the expansion of the IMF’s lending capacity puts it back in the game. Do check out Paul Swartz’s graph.

Give Secretary Geithner - and Ted Truman -- credit for recognizing that the IMF’s limited resources were a growing problem and then building global consensus on the need to expand the IMF’s lending capacity.*

The US though can only do its part if Congress authorizes a bigger US contribution to the IMF’s backstop credit line. It should. A world where many emerging economies cannot borrow is also a world where many emerging economies cannot buy US goods. And a world where Eastern Europe falls into a deep, deep crisis less than twenty years after the end of the cold war wouldn’t exactly be a victory for US foreign policy either ...

* Full disclosure: I worked for Mr. Geithner and Mr. Truman from 1998 to 2000.