In the original conception of the 1944 Bretton Woods Conference, the International Monetary Fund (IMF) was created to deal with problems that had afflicted the interwar world, particularly the lopsided distribution of reserves and the deflationary consequences for the international economy – as well as with crisis management. Today the IMF has been almost completely sidelined from many of the major governance issues of the international financial system. In particular, it is much less active as a financial institution. The IMF’s diminished role seems at odds with the world’s need for global governance.
Today’s international financial system is characterised by numerous uncertainties. There are major debates about exchange rates; puzzlement about the large increases in reserves of many emerging market economies; worries about the strategic ambitions associated with the rapid rise to prominence of sovereign wealth funds; and concerns about the capacity of international financial institutions to respond to crises.
Some potential IMF reforms, such as those proposed ten years ago by Jose de Gregorio, Barry Eichengreen, Takatoshi Ito, and Charles Wyplosz1 , sought to make the IMF more relevant by making it less politically dependent. Such reforms, however, have usually been thought of as impractical.
There may be a case for a reform that harks back to the original Bretton Woods conception – although suitably updated for today’s world with its new lopsided distribution of reserves. The IMF could again become a powerful financial stabiliser if it took on a new role as the manager of a significant part of the reserve assets of the new surplus countries.
The reserve debate
Reserves are supposed to facilitate international transactions, in that they help countries deal with unanticipated falls in export revenues, increases in import prices, or sudden withdrawals of foreign credits. Since there are constant local shocks and ups and downs in the international economy, the size of reserves should also be expected to fluctuate (as the length of a cab rank grows and falls as new taxis arrive and lined up taxis are hired).
World reserves have not fluctuated much over the last decade. The negative consequences of not having reserves in the event of a financial shock or crisis are so great that countries (especially poorer countries) are tempted to build additional reserves. Since the millennium, the reserves of Japan, Taiwan, Korea, and Malaysia have all more than doubled, while that of China more than quintupled. Mature industrial countries needed reserves less, while emerging countries wanted them more. In the 1960s, the distinguished international economist Fritz Machlup formulated a different view of reserves, which he called the theory of “Mrs. Machlup’s wardrobe.” Mrs. Machlup apparently always liked to buy new dresses, while resisting giving away old ones: so the stock of dresses went on increasing. Asian reserves now look more like Imelda Marcos’s shoe collection than Mrs. Machlup’s wardrobe.
Because reserves are held mostly in short-dated and very low risk securities (traditionally treasury bills issued by a few industrial countries), the world pile up of assets has driven down short term interest rates and prompted a global expansion of liquidity that then powered asset price bubbles, especially in the housing markets of countries with current account deficits and higher interest rates such as the United States, Australia, and the United Kingdom.
When assets are managed in an alternative way, through sovereign wealth funds (SWFs), there are even greater difficulties. On the receiving end, industrial countries’ governments are increasingly anxious that SWFs will be used strategically rather than simply following the logic of the market. They might be used as a way of gaining control of key sectors of the economy, especially since the credit crunch has made the world’s largest banks look for new injections of capital. For the countries that own SWFs, there is continuous worry about the risk of losing capital (as in the case of China’s investment in Blackstone).
In the distant past, market expectations were stabilised during panics by the counter-cyclical behavior of very large private institutions. The multinational house of Rothschild made the first half of the nineteenth century stable, not only by lending in crises but also by combining its assistance with a policy conditionality intended to ensure that the credits were more likely to be repaid. In the great panics of 1895-6 and 1907, U.S. financial markets were calmed by J.P. Morgan. At the time of the Great Depression in the 1930s, there was no house of equivalent power.
In 1944 the IMF was envisaged as a public sector provider of the public good of stabilisation. IMF surveillance of individual countries had teeth because the IMF also had financial power and because countries taking its advice were borrowing from the Fund or might need to borrow in the future. Unlike the OECD, it could put its money where its mouth was.
At its most effective moments, the IMF had powerful leverage over countries whose behavior was vital to the health of the international monetary system. In the 1960s, the IMF went well beyond its own quota-based resources, and its financial power was enhanced by a new ability to raise additional resources through the General Arrangements to Borrow. Its ability to give powerful advice to the systemically important countries, such as the United Kingdom, was enhanced by the dependence of those countries on IMF resources.
The IMF as a Reserve Manager
The IMF could again become a very powerful financial stabiliser if it took on a new role as the manager of a significant part of the reserve assets of the new surplus countries. It would be in a powerful position to take bets against speculators. The stabilising action would ultimately benefit both the world economy and the interests of the owners of the reserve assets, who have (simply by the fact of the accumulation of the surpluses) a similar interest in world economic and financial stability. At the same time, the management of reserve assets by an internationally controlled asset manager would remove suspicions and doubts about the use of assets for strategic political purposes.
In the course of developing new functions, it would be important to distinguish between routine day-to-day transactions and crisis management (in the same way as central banks and national regulators do in their management of domestic affairs). The large stock of assets under the routine management of the IMF would in the first place represent a large masse de maneuver that would frighten off speculative attacks or irrational panics. The Fund would be in a situation to intervene preemptively, possibly but not necessarily at the request of the target of the speculative attack; so that the speculation would become impossibly costly.
The enhanced asset base of the IMF would also give it the possibility of switching into crisis mode without long discussions and formal negotiations. There could be very quick responses, and, as the shifting of assets by asset managers, they would also be noiseless. One of the problems of IMF functions in the past – whether it was in trying to define “scarce currencies” in the immediate postwar period or asking whether there was a sufficient world supply of liquidity – was that these determinations had to be made in such a formalised way that there could in practice never be an agreement on the issue. Operating as an asset manager, the IMF would be able to affect currency exchange rates without requiring authorisation through a formal decision.
The rise in reserves in many Asian countries was a deliberate response to the 1997 Asia crisis, in which there was a substantial disillusionment with the IMF. A precondition of the IMF acting as a global reserve manager would be a governance reform in which the new surplus countries were able to exercise a substantive influence through the IMF. They would need to feel absolutely secure that they were not being the subject of some politically motivated manipulation. In particular, if the IMF were to be in a position of an asset manager who could shift assets from one market to another, it would need to be at a longer distance from U.S. influence and attempts at control: otherwise, it would be seen as a device for propping up the dollar for political rather than economic reasons.
In a revised approach, votes in the IMF would be allocated or “bought” to a large extent through the assets held at the IMF. The proportion of votes determined in this way might be as high as 50 percent, while the rest would be allocated in the traditional way. There is an analogy to this double determination of voting power in the U.S. Constitution, according to which all states have an equal share of Senate votes, but very different numbers of seats in the House of Representatives, reflecting population differences.
Making a substantial part of Fund voting a reflection of the reserve positions held in the IMF would allow very quick adjustments to new international realities. It would make the IMF more of a market institution, in much the same way as the changing ownership of joint-stock companies can shift quickly and noiselessly. There would be no need for constant and cumbersome processes of quota renegotiation and revision. A revision of the voting system that meant an automatic reflection of reserve assets held in the Fund would at a stroke eliminate political complications and make the IMF appear much more like a market-oriented organisation: in short, the type of credit cooperative that Keynes and the other makers of the postwar monetary settlement envisaged at the 1944 Bretton Woods conference.
Jose de Gregorio, Barry Eichengreen, Takatoshi Ito and Charles Wyplosz, An Independent and Accountable IMF, Geneva: International Centre for Monetary and Banking Studies, Geneva, 1999.
1 De Gregorio, Eichengreen, Ito and Wyplosz (1999).