Leaders at the April 2 summit of the Group of 20 leading and major emerging economies agreed to a broad package of reforms, substantially increasing the war chest of the International Monetary Fund (IMF) and setting aside money for trade financing. Sebastian Mallaby, director of CFR’s Center for Geoeconomic Studies, says the summit "could be a turning point for the way that financial regulation is managed and the way the international monetary system is managed." He points to an apparent willingness by the United States and Britain to regulate aspects of the shadow banking system, including hedge funds, which they had resisted regulating prior to the economic crisis. With respect to additional funding promised to the IMF, however, Mallaby notes the group didn’t say which countries would actually pay for the new lending capacity. Looking forward, Mallaby says he hopes monitors keep a close eye on how countries implement domestic financial regulation and that the G-20 should use likely follow-up meetings in September to "name and shame" nations that don’t live up to internationally agreed standards.
Yesterday world leaders at the G-20 summit announced a $1.1 trillion plan to address the ongoing economic crisis. What are your initial reactions?
"[I]t might be the beginning of a rebalancing of the world economy so that we get away from this world in which some countries like Germany, China, and Japan have … enormous exports of capital which flood into the deficit countries, principally the United States, and inflate bubbles."
Potentially this could be a turning point for the way that financial regulation is managed, for the way that the international monetary system is managed. For a long time continental Europe and some of the East Asian economies have favored regulating hedge funds and other parts of the shadow banking system, but typically the United States and the UK have resisted that. And there has been a complete shift such that in the two weeks leading up to the summit, both Tim Geithner, the U.S. treasury secretary, and in London, the top financial regulator, Adair Turner, came out with a report saying that they want to regulate hedge funds and essentially adopting what had been the European view. Oddly, right before the summit, the Europeans tried to kind of change the game a bit, saying that wasn’t enough. But the way the communiqué ended up from the G-20 in London was essentially to come down on this consensus that the shadow banking system does need to be regulated.
A big part of this package was getting new funding to the IMF. It brings the IMF’s war chest now to $750 billion, or $1 trillion, if you count the new special drawing rights that they are essentially creating. I was hoping you could put those numbers in some kind of context for us. Is the size of the IMF now commensurate with the size of the global economy?
There’s some amount of smoke and mirrors in these numbers. They did announce a big expansion in the lending capacity of the IMF but they didn’t say which countries would actually cough up the dollars necessary to create that new lending capacity. We have had some pledges but I don’t think it gets to the full additional amount of $500 billion, which they say they are going to put in. Then on top of that $500 billion, there is talk of creating another $250 billion worth of cash for governments to use by allowing governments to have more of the special IMF currency called special drawing rights (SDRs), which can be converted into dollars if a country gets into trouble. The problem with the way that these are allocated, these special drawing rights, is that they get given to the biggest shareholders in the fund mainly. And these countries are the United States and Japan, which probably have enough reserves and don’t need to draw on special drawing rights from the IMF. So again, it’s going to help a few countries, but the ones that are really in a crunch--like the Central European countries, which face a serious balance of payments crisis--are not going to be given enough of these special drawing rights for it to really make a difference.
"They did announce a big expansion in the lending capacity of the IMF but they didn’t say which countries would actually cough up the dollars necessary to create that new lending capacity."
So there are some questions about whether this money will really be there. But if it can be mobilized, then we are into a new and interesting world. Partly because in the short term, the IMF will have more capacity to lend to distressed countries that can therefore do a fiscal stimulus, which they couldn’t do without an IMF loan. But also going forward, it might be the beginning of a rebalancing of the world economy so that we get away from this world in which some countries like Germany, China, and Japan have enormous export surpluses, enormous exports of capital which flood into the deficit countries, principally the United States, and inflate bubbles. And that is really the background to what went wrong in the subprime crisis. And to avoid that being repeated in the future, you have to persuade these surplus countries like China, like the other emerging market countries that have run export surpluses, that if they get into a currency crisis, the IMF will have enough money to lend and will lend at a rate that is not full of conditions that are perceived to violate sovereignty.
So we really need to undo the legacy of the 1997-98 emerging market crisis, when lending was coupled with so many conditions that countries really hated it. And there was a huge stigma, thereafter, attached to going to the IMF. And we have to get to a world in which the Brazils, and Thailands, and those middle-income countries feel like they don’t have to run surpluses over time because if they do get into a balance-of-payments crisis, there will be an IMF to turn to, which has the ammunition and has the lack of conditions that make it worth using.
One of the most urgent questions going into the crisis was about the banking system and credit markets. We didn’t really hear too much concrete about how to fix the current problems with the banking system. I am wondering what you make of that?
That’s right. In one sense it is not surprising that the G-20 summit failed to address the banking system, because banking bailouts and banking regulation are always going to be a fundamentally a national issue. So as long as the world’s tax base is organized on a national basis, banking regulation and financial regulation will also be organized on a national basis. So the G-20 is really not the place to resolve all that. There is one very important and complex challenge which was talked about by experts who were involved in the preparations of the summit but didn’t really surface at the high political level. And that has to do with what you would do if a seriously big bank with branches in multiple countries went bust. If it has got assets in let’s say fifty different countries, each government of the fifty countries would be tempted to seize the assets to protect its depositors in that bank. And you could get into a completely awful, cross-border argument that dragged on and on, and there was no way of resolving it, there was no international court you can go to which can figure out how to do that bankruptcy in multiple jurisdictions. That is something the world will have to grapple at some point but it wasn’t done at this summit.
And what do you make of the fact that there wasn’t a pronouncement on stimulus, which had been one of the main focuses of United States going into the summit?
"[T]here has to be a summit again that takes these reviews and tries to name and shame the summit participants that have not done their bit in the interim."
Yes, that is something that the United States wanted very much and there were definitely times when U.S. officials in the run-up to the summit were saying, "Look, ultimately, this is the only thing that matters, we are in really bad downturn and absolutely the first priority is to get out of this downturn. And we can talk about financial regulation in the medium term but the priority now is just stimulus." And that view was flatly rejected by most notably the continental Europeans, the Germans, the French and so on. They argued that too much stimulus just doesn’t work. That they have done plenty already because the way their budgets are designed there is a lot of spending that goes up automatically in a recession, so you don’t need to pass an extra stimulus to stimulate--it happens by itself. And further that some economies in Europe are showing quite widened credit spreads, meaning that when the government issues debt, it’s having to pay a high interest rate because the markets are worried that there could be a government default. And when you see those kinds of spreads widening, it means you can’t be too aggressive in issuing more national debt. So for all of these reasons the Europeans rejected the U.S. position and basically the United States just had to swallow that and back down.
There will presumably be G-20 follow-ups later this year. What are you looking for out of those meetings?
Yes, there is talk of a follow-up meeting in September in New York, attached to the UN General Assembly meeting. It is very important if the potential of this summit is to be realized, i.e. you do get an International Monetary Fund and other international organizations which try to keep score of countries’ behavior in terms of protectionism, in terms of whether they are doing enough stimulus, in terms of whether they are really grappling with the problem of toxic assets in their banks. The summit communiqué this time said that the IMF and various other organizations would watch all that stuff. But you can’t just have technocratic international organizations watching. For the watching to mean something, they need to publish their reviews of different countries and there has to be a summit again that takes these reviews and tries to name and shame the summit participants that have not done their bit in the interim. So what I am really looking for in September, which is five months from now, is to see whether the next summit has the guts to look back at this summit and say which country did and which country didn’t live up to the spirit of April.