IMF plays dirty economics

CALLING THE BLUFF

The G-7 finance ministers meet this weekend to discuss the world economy and what ails it, and what particularly ails the rich world.

After a rather vibrant 2003, and a more than vibrant stock market worldwide, one conclusion could be that the world is coasting and so nothing needs to be done. This would be wrong, and thought so by most economists. The major reasons cited for future instability in the world economy are the twin US deficits "" current account and fiscal.

In a recent report, the world's economic umpire, the IMF, states that there could be dire consequences of irresponsible US policies; "unless corrective action is taken, (US policy) raises a number of longer term and multilateral concerns" (press briefing on IMF occasional paper, "US Fiscal Policies and priorities for Long-Run Sustainability", emphasis added).

The sheer courage of the IMF needs to be applauded "" it is taking on, and strongly criticising, the number one economic power in the world, and from a vantage point just 100 yards away from the seat of imperial power at 1600 Pennsylvania Avenue.

Does the IMF not realise the risks it is taking in criticising the Americans; what will happen if the US got pissed off and stopped paying its dues, as it did with the UN some years back? Given the runaway imperialness of the US these days, this bold IMF report is what courage is all about. Or is it?

Let us look at the facts first. The US is barely managing to emerge out of a recession, and from extremely slow, and jobless growth. The situation was a lot worse just a few months ago. To the best of non-IMF knowledge, a highly recommended strategy for counteracting recessions is to use counter-cyclical fiscal policy.

Interest rates had been reduced in the US to near Japanese levels and people (and presumably also those at the IMF) were beginning to be apprehensive about the efficacy of monetary policy.

There was only one bullet left "" fiscal expansion, and whether coincident or not, it brought some life into the economy. And as the US economy expanded, so did the western world. But now the "authoritative" men on IMF white horses tell us that this fiscal expansion was all wrong.

IMF would be on a firmer footing if it were to highlight the consequences of the persistence of that other US deficit, currently hovering close to 5 per cent of GDP.

This deficit is an imbalance on the current account; simply put, the US is importing a lot more than it is exporting. Why is it able to do that? Mostly because until recently, the dollar was a strong currency, whose strength allowed the US to consume "cheap" imports.

How can some of this imbalance be corrected? By allowing the price of imports to go up. How does that happen? By increasing the price of imports, which automatically happens when the dollar depreciates. Simple Econ 101 actually.

The US dollar has depreciated by more than 30 per cent since its peak in February 2002 and is within kissing distance of its low reached in 1992 and 1995. This decline is the result of depreciation against the majors "" the yen, euro, pound etc.

There has been some effect on the imbalance in the current account, which after overshooting, has "stabilised" at around a $500 billion dollar level. So prices do matter "" yes, the demand curve is downward sloping.

One major reason the deficit is not lower is because the dollar has not been allowed to depreciate against the currency with the largest imbalance "" Chinese yuan. Almost a third "" yes, around $150 billion or so "" of the US trade deficit in 2003 was accounted for by China.

Not surprisingly, since the price (China's exchange rate) has not changed, the trade deficit with China has not declined; indeed, it has risen exponentially, in major part because the US dollar has depreciated versus practically every other currency.

The major imbalance in the world is likely not the US fiscal deficit, nor even the US current account deficit, but rather the imbalanced $/yuan rate. And several have correctly identified this as the number one problem.

The list is large and respectable "" government/central bank officials of the US, Euroland, Japan, Mexico; worker representatives from most countries; some academics (notably at the Fred Bergsten-led Institute for International Economics in Washington, DC).

Conspicuous by their absence are economists at the investment banks/major US corporations. Same difference, actually, since the latter believe (and are paid to do so) in selling their souls and the kitchen sink in pursuit of maximisation of profit.

But what does the bold white horse man from the IMF have to say on the subject of Chinese current account imbalances? Recall that he hurtled into Thailand in 1997 and (correctly) held its fixed exchange rate responsible for its current account deficits.

Why does the same logic not apply to China's surpluses? If depreciation was the factory ordered remedy then, why isn't appreciation of the yuan the no-brainer recommendation today? It is not, because the IMF instead believes something radically different. Some pronouncements from the oracle(s).

Head priest (IMF chief) Horst Kohler admonished everyone to respectfully bow (Chinese style) to China and "remember the contribution that China's exchange rate policy made to the regional and world economy during the Asian financial crisis".

He did not remind the audience of the 82 per cent depreciation of the yuan in just five years, 1989-1994 (3.77 yuan/$ in 1989 to 8.62 in 1994); a depreciation that was most likely responsible for the loss of East Asian competitiveness, a loss that likely caused the East Asian crisis.

Commending China for staying put with their highly undervalued exchange rate in 1997 is like being grateful to a thief for not committing highway robbery again.

IMF economics gets even more bizarre. The old IMF chief economist, Kenneth Rogoff, felt India, despite trade deficits, should allow its currency to appreciate, but cautioned against suggesting that China should do the same. (Oh, they have an unemployment problem, bad loans etc; BJP take note "" even the IMF approves of India shining and shining brighter than China which is still plagued by "poor" country problems, no matter that their trade surplus with the US is three times the level of aggregate Indian exports).

And the new IMF chief economist, Raghu Rajan, (co-author of a brilliant book about the nefarious activities of capitalists and elites in preserving their fiefdoms), upon entering the high priest halls of the IMF, claims to have discovered that the demand curve is flat as a Chinese pancake and therefore "it is complete red herring to hold the yuan responsible for the US bilateral deficit with China".

Senior IMF economists Eswar Prasad and Thomas Rumbaugh have no qualms about going further in stretching the limits; they do not mention the large renminbi devaluation of 1990-1993 in their explanation of rapid growth of Chinese exports in the 1990s; an annual growth of over 18 per cent per annum between 1994 and 2003!

All that the factory allows them to state is that "the recent depreciation of the US dollar, to which the renminbi is linked, has no doubt added temporarily to China's competitiveness"(emphasis added, Beyond the Great Wall, Finance and Development, December, 2003).

Umpires lose credibility when they start shading the truth; the decline is faster when their bluff can easily be called.

ssbhalla@oxusresearch.com