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gaurav200x September 9th, 2006 11:15 PM

Can the IMF Avert a Global Meltdown?
When world financial leaders meet in Singapore this month for the joint World Bank-IMF meetings, they must confront one important question: is there a way to coax the IMF’s larger members, especially the US and China, to help diffuse the risks posed by the world’s massive trade imbalances?

This year, the US will borrow roughly $800 billion to finance its trade deficit. Incredibly, it is now soaking up roughly two-thirds of global net saving. While this binge might end smoothly, as US Fed chairman Ben Bernanke has speculated, most world financial leaders are rightly worried about a precipitous realignment that might set off a massive dollar depreciation. If policymakers continue to sit on their hands, it is not hard to imagine a sharp global slowdown or even a devastating financial crisis.

Although Bernanke is right to view a soft landing as the likely outcome, common sense would suggest an agreement on some prophylactic measures, even if this means that contributors to the global imbalances have to swallow some bitter medicine. Unfortunately, getting politicians in the big countries to focus on anything but their domestic imperatives is tough.

Though the comparison is unfair, it is hard not to recall the old quip about the UN: “When there is a dispute between two small nations, the UN steps in and the dispute disappears. When there is a dispute between a small nation and a large nation, the UN steps in and the small nation disappears. When there is a dispute between two large nations, the UN disappears.”

Fortunately, the IMF is not yet in hiding and its head Rodrigo Rato rightly insists that China, the US, Japan, Europe and the major oil exporters (now the world’s biggest source of new capital) take concrete steps towards alleviating the risk of a crisis. Though the details are yet to be decided, such steps might include more exchange rate flexibility in China, and greater fiscal restraint from the US. Oil exporters could, in turn, promise to increase domestic consumption expenditure, which would boost imports.

Likewise, post-deflation Japan could promise never again to resort to massive intervention to stop its currency from appreciating. Europe could agree not to shoot its recovery in the foot with ill-timed new taxes like the ones Germany is currently contemplating.

Will the IMF succeed in brokering a deal? The recent collapse of global trade talks is not an encouraging harbinger. Fortunately for Rato, addressing the global imbalances can be a win-win situation. The same proposed policies for closing global trade imbalances also help address each country’s domestic economic concerns. China needs a stronger exchange rate to curb manic investment in its export sector, thus, reducing the odds of a 1990s-style collapse. As for the US, a hike in energy taxes would improve the government’s balance sheet and be a way to address global warming. What better way for new treasury secretary Hank Paulson, a card-carrying environmentalist, to make a dramatic entrance onto the world policy stage?

Similarly, technocrats at the Bank of Japan surely realise that they could manage the economy more effectively if they swore off anachronistic exchange-rate intervention techniques and switched to modern interest-rate targeting rules. With Europe in a cyclical upswing, tax revenues should start rising even without higher tax rates, so why risk strangling its nascent recovery? Saudi Arabia, with its oil revenues, could use a big deal to reinforce its image as a major anchor of global financial stability.

If today’s epic US borrowing does end in tears, and if world leaders fail to help the IMF get the job done, history will not treat them kindly. They will be blamed for not seeing an impending catastrophe. Let’s hope that in international diplomacy, the only thing that disappears are trade imbalances, and not the leaders and institutions that are supposed to deal with them.

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