From 1980s through the early 2000s developing countries faced repeated demands to get their financial houses in order as a condition of financial assistance from the international financial institutions (IFIs) and the world’s leading economies. The Washington Consensus codified the standard conditionality. It tied financial rescue on all manner of draconian policies that were designed to ensure that developing country governments could meet obligations to their international creditors. In pursuit of solvency, few public sector expenditures were exempt from the neoliberal axe. Social welfare spending was slashed, taxes on all but the wealthy and large firms were raised, markets were liberalized, enterprises were sold off to the presumably more efficient private sector (though often the “private sector” were domestic elites with privileged access to the assets at bargain prices), and barriers to international trade and financial flows were rescinded. All of this was done with the expressed goal (among others) of demonstrating worthiness for continued lending by IFIs.

Of course, it seemed to many of us at the time that “solvency” was a euphemism for the protection of the interests of the immensely powerful international financial sector and home-grown neoliberals. Though the rhetoric of economic transition emphasized the need for all to share the pain of economic restructuring, there never was any serious chance that those interests that were best situated so as to be able to bear the costs of restructuring would face the greatest burdens. No progressivity of distribution was ever countenanced, let alone pursued, in these cases. No—the formula was to impose pain strictly in inverse relationship to political and economic power. Those without voice in the political sphere or veto authority in the economic sphere were to face the brunt of the adjustment costs. In contrast, those with influence were to be protected to some degree or other from the disruptions that attended neoliberal reforms. And at the top of the pyramid, finance capital was to be insulated virtually entirely from the hardships so liberally distributed to others. Indeed, to the degree possible, finance capital was to be assisted in its mission of profiting from the economic implosions affecting the indebted societies.

But oh how the worm turns. Today many developing countries have escaped the vice grip in which indebtedness had placed them in the past. Not just Brazil and China, about which we hear so much, but also Turkey, South Korea, Argentina, South Africa, Russia and several other rapidly-growing developing countries have amassed sufficient reserves so that they are no longer the target of IFI conditionality. And in a most remarkable twist of fate, some of these countries now find themselves being courted for a second time by the very same IFIs that squeezed them in the past to assist with crisis alleviation in Europe.

In the early days of the financial crisis, several developing countries committed to purchase the IMF’s first-ever issuance of its own bonds. In April 2009, China committed to purchase $50 billion of IMF bonds, while Brazil, Russia, South Korea and India each committed to purchase $10 billion.  This was a landmark event in the institution’s history as developing countries emerged as lenders to the institution. At the same time it became clear that any chance of a global recovery hinged on the performance of a larger group of economically-vibrant developing countries.  And now, in the face of the excruciatingly slow pace of the Eurozone’s march off of a cliff, the IMF has again gone hat in hand to the developing countries (after developing countries rejected requests to provide bilateral assistance to Europe a few months ago). As of this writing, Eurozone governments are still trying to figure out how and which country’s central banks will provide €150 of the €200 billion in bilateral loans to the IMF to which they committed at a Brussels summit on December 9.  Needless to say, the politics of contributing are complicated, not just by Britain’s refusal, but also by the political backlash against such moves in the Czech Republic and by Germany’s continued brinksmanship.  And let’s not even get into the question of where €500b for the European Stability Mechanism is going to come from when it will supposedly be launched in July 2012.

This brings us back to the developing world and the IMF.  Against this backdrop, new Managing Director Lagarde has gone on a charm offensive in the global south in the strange new world wherein policymakers there trust the Fund more than they do Europe.  Among developing countries Brazil’s government has been most receptive to Lagarde’s bid, though to be clear President Rousseff has wisely not announced the precise nature and dollar amount of the country’s new contribution to the Fund.  She is waiting (quite sensibly) to hear something concrete on the matter of IMF governance reform and a something credible and consistent from Eurozone leaders.  She has also made clear that decisions on new funding to the IMF will come out of the BRICS (Brazil, Russia, India, China and South Africa) meeting in February 2012.  Never one to miss a chance to note ironies, Brazil’s Finance Minister Mantega quipped during Lagarde’s visit to the country: “[i]t’s a great satisfaction to us that this time the IMF did not come to Brazil to bring money like in the past but to ask us to lend money to developed nations.”

The Russian, Chinese, Korean, and Mexican governments have also indicated that they would likely offer new support to Europe through the IMF, though they, too, are conditioning new support on a real plan and firm financial commitments from Europe.   Indeed, a few days ago Russian president, Dmitri A. Medvedev said Russia might pledge up to $20 billion to the IMF (to be used in Europe), half of which would come from Russia’s decision to let the Fund postpone repaying it the $10B it owes the country (as a consequence of its 2009 commitment to the Fund). That promise should help to quell criticisms of the recent elections in Russia!

The IMF needs the cash for its European reclamation project, and traditional funders like the US are a bit preoccupied these days with cleaning up their own little messes. Suddenly, the BRICS are the only available potential lenders.

So once again we’re about to witness the flow of funds from the global South to the global North—only this time, the funds are flowing from a position of strength, not weakness—and the ultimate net economic and political benefits from this resource transfer will likely flow from the North to the South.

But there is one constant in this otherwise shifting landscape of economic and political power.  Once again assistance to countries in trouble is predicated on meeting conditions (whether manufactured in Washington, Brussels, Berlin, or Frankfurt) that will impose the greatest costs on those least able to bear them; all social welfare programs, entitlements and public amenities will be slashed so as to preserve national solvency. And once again, solvency should be understood as the protection of the one interest in the global economy that is best able to bear the costs—finance capital. All manner of hardships are and will be imposed on the most vulnerable of the Greeks, Italians, Spaniard and Portuguese—in order to do what? To ensure that the banks shed not one Euro while the rest of society sheds tears and blood.

The BRICS have become central players in what is looking like an increasingly desperate effort to save the Eurozone. In this sense, so much has changed in the global economy since the heady days of the Washington Consensus. Unfortunately, so much also remains the same…

Remember the WTO– the institution that we loved to hate? We haven’t been hearing much from or about the institution since its 2003 meeting in Cancun Mexico. That meeting marked the emergence of open conflict between wealthy and developing nations on a number of issues (such as agricultural protection). The conflict left the institution frozen and irrelevant. It now stands on the sidelines as policymakers crisscross the globe signing bi- and multi-lateral agreements.

The G20 seems to be outpacing the WTO in the march toward irrelevance.  When it was organized in the early days of the financial meltdown, many progressives (including me) viewed the G20 as an embryo from which new and at least somewhat more inclusive discussions of global economic policy could emerge. In its early days the shock of the global crisis seemed to have engendered a genuine “Keynesian moment.” G20 leaders collectively declared the death of the Washington Consensus, indicted the financial sector for its misdeeds, acknowledged the economic firepower of the rapidly growing developing countries that became new lenders to the IMF, and took tentative steps toward amplification of the voice of developing countries at the IMF and World Bank.

But those heady moments passed quickly.  Key players in the G20 soon got hold of themselves and repudiated their brief flirtation with Keynes by calling for “fiscal consolidation” around the world.  At the same time, serious efforts to deal with global financial reform stalled. Lost was the opportunity to deal effectively with the shadow banking system, derivatives, and commodity market speculation. (For a thorough account of the G20’s accomplishments, failures and missed opportunities, see Eric Helleiner’s excellent op-ed on the subject.)

Today, the G20 is approaching irrelevance.  It is beset with conflict among members on key issues.  And much like its parent body, the G8, it is quickly becoming known for the platitudes in its communiqués and its timidity and sluggishness in the face of crisis.  The G20 Finance Ministers concluded their meeting in Paris on Saturday, and the G20 Leaders’ Summit is to take place in Cannes on 3-4 November. It is wise, of course, not to expect too much from any particular meeting.  But it is nevertheless notable that as the world economy slides further into crisis, the body appears to have less and less to say. The new cleavages amongst its members have stopped the G20 from taking meaningful stands on problems that threaten the possibility for global recovery.

Here are some of the fissures that are playing out within the G20 right now:

Europe

Germany’s Chancellor Merkel and France’s President Sarkozy have developed a plan to stabilize the Eurozone by recapitalizing the region’s banks, offering further debt relief for Greece via larger lender haircuts, and buttressing the resources of the newly-created European Financial Stability Fund (EFSF). However, in a curious game of “we’re not telling” Merkel and Sarkozy will not be announcing details of that plan until either a European Summit meeting on October 23 or at the G20 Leaders’ Summit next month.  Policymakers in G20 countries (especially the USA and the UK) have pressed quite publicly and with unusual directness for specifics to be unveiled at next week’s EU Summit. In the words of the Japanese Finance Minister, “Europe needs to get its act together.”

At the same time, the EU and the IMF continue their efforts to squeeze blood out of the stone that is Greece. Tensions over the situation in Greece are taking place against the backdrop of worries that countries like Italy and Spain could overwhelm the EFSF’s resources. Globally there is no consensus regarding whether further austerity is an appropriate response to crisis.  The close call in Slovokia last week and the continued mania to cut deficits in the US represent one pole in this debate; the growing protests against austerity in Greece and the globalization of the Occupy Wall Street movement represent the other pole.

Another fissure on Europe within the G20 concerns the question of which body should save the region from itself.  Many European governments have pushed for a new infusion of funds to the IMF so that it can play a larger role in regional rescues. China and Brazil endorse this position as well, though only in return for more representation at the IMF and World Bank.  (Brazil’s position on the matter is an interesting one: the country’s policymakers have quite publicly urged the other rapidly growing countries in the G20 to find ways to support the Eurozone. However, this position has largely been ignored.) But Germany and the US have rejected calls for the IMF to play a larger role in Europe. In particular, US and German officials have argued that the IMF already has sufficient funds, and that in any case, resolutions must be made in and paid for by an expanded EFSF.  And in a curious case of the pot calling the kettle black, US Treasury Secretary Geithner continues to chastise European leaders for moving too slowly and thereby threatening the health of the world economy.

China:  A currency war makes for strange bedfellows

The recent move by the US Senate to take steps against China’s currency manipulation has obviously done nothing to improve the already chilly relations between the two countries.  But it is bringing the US and Brazil closer together at least on this one issue. Brazil is pursuing the idea of pressing China on currency manipulation through the WTO.  Indeed, the country’s policymakers have suggested that they will retaliate against imports priced in weak currencies in the same manner as it could against goods that are unfairly dumped on its markets. Brazil has also requested that the WTO conduct a study of the interaction of trade and currencies as a weapon of trade. The request has at least given the WTO’s Chief Pascal Lamy something to do. He has been able to use this issue to press the case that the G20’s failure to take on global macroeconomic and currency tensions risks igniting a global trade war.

G20 critics of China’s currency policy did score one rhetorical victory at this weekend’s meeting of Finance Ministers.  Their communiqué reaffirms “support for more market-determined exchange rates.” In response, China’s representative was firm in his refusal to cede to pressure on its currency. President Wen Jiabao made clear at an exporters’ fair in Gaungzhou on Saturday that the government will not be pressed into liberalizing its currency. The government did agree to deploy expansionary fiscal policy to fuel domestic demand.

Controlling capital controls through the IMF

The French continue to raise the issue of developing a code of conduct that will govern the use of capital controls by national governments. There is a vague sentence to this effect in the G20 Finance Ministers’ communiqué.  But there is little momentum behind this issue in the face of more pressing matters.  Advocates of policy space can continue to hope that the fissures among the G20 that have already emerged on this front will continue to be asserted if the issue receives more energetic attention in Cannes or far more likely in 2012 when Mexico takes over leadership of the G20.

Taxing the financial sector

The G20 continues to discuss the possibility of introducing a tax on financial transactions. (See Edward Barbier’s treatment of this issue.)  The EU Commission has put forth a proposal to place an EU-wide tax of 0.1% on trades of bonds and stocks and a tax of 0.01% on derivatives beginning in 2014.  The French and German governments are pushing this initiative as a way to recoup some of the revenues that have and will be spent bailing out the financial sector. (This proposal will resonate for advocates of a currency transactions tax, also known as a Tobin tax.  Earlier campaigns around a currency transaction tax aimed to use the revenues collected from this tax to provide assistance to developing countries.)  But it is unlikely that the measure will be endorsed at the G20 Leaders’ Summit next month insofar as Britain, the US and China have gone on record opposing it.  Britain has taken the familiar line used by opponents of any tax scheme—namely, that such taxes will be evaded, and will place any nation(s) imposing it at a competitive disadvantage since a global agreement on the measure is not on the table.

These are but some of the fissures that have emerged within the G20. They are unlikely to be resolved in few meetings of Finance Ministers or national leaders. Indeed, the challenges that threaten our globally integrated, highly liberalized, volatile and increasingly broken global economy are deep, enduring and structural. It may be that G20 paralysis reflects the fact that the there are no easy fixes; that the adjustment to a new, non-neoliberal regime is going to be slow, uneven, politically fraught and potentially dangerous as countries continue to look for ways to offload their economic difficulties onto their neighbors. What is missing at the G20 so far is any sense of a common purpose in pursuit of more just, stable and sustainable international economic policy regimes. And that’s something to worry about.

I’ve written on a few occasions about the “currency wars” and the divergent responses to its macroeconomic fallout by policymakers across the developing world. (For a primer on the issue, see my earlier posts.) Until recently, the currency war garnered little global attention—likely because of its geography.  The pressures generated by appreciating currencies were largely a problem for rapidly growing developing countries. The currency war was therefore not seen as a “universal” problem that threatened global financial markets, the world economy, or relations among powerful nations. This misguided view obviously failed to acknowledge that any hope for global recovery rests with the continued growth of the larger developing economies. The other factor that kept the currency war off the global agenda was the dismal state of the US and European economies.  Economic stagnation in these countries precluded much attention there to problems abroad that policymakers in the US and Europe could only dream about—too much growth and capital inflows.

But things are changing in ways that make it impossible to ignore the issue for much longer.  While investors remain pessimistic about the prospects of the US and European economies, they are nonetheless moving funds not just to the rapidly growing developing countries but also to wealthy countries, most notably Canada, Switzerland, Australia, New Zealand, and Singapore.  The currencies of these countries are now appreciating dramatically against the euro and the dollar. The Swiss franc reached all-time highs against the US dollar and the euro this year, the Australian dollar has hit three-decade highs against the US dollar, and the Canadian dollar is approaching record levels as well. Among the 16 major currencies in the world, the Swiss franc, New Zealand dollar, Japanese yen, Brazil’s real and Singaporean dollar have gained the most against the US dollar in the past three months.  A Swiss banker put it well last week: “The franc is like the new gold.” As in the developing world, asset bubbles, currency appreciation, inflationary pressures, and risk of a sudden reversal of capital inflows are weighing heavily on policymakers, manufacturers and exporters in a growing number of safe haven countries.

What are policymakers now facing an embarrassment of riches to do? Do they intervene to slow the appreciation of their currencies? If so, through what measures? Do they risk expansionary monetary policy in the face of inflation and asset bubbles? Should they attempt to offset pressures on their currencies by purchasing dollars or euros; place restrictions on foreign investment inflows; provide support to domestic firms; and/or attempt to place restrictions on imports? All of these strategies are now in evidence (in an array of combinations), and yet all involve costs and risks of unintended consequences.

This is not to say that rich and developing country parties to the currency war now face identical challenges. After all, Switzerland’s industrial base remains vibrant and its current account performance enviable, even as the franc appreciates, while Brazil’s manufacturing and trade performance have suffered as a consequence of its high interest rates (now the second highest in the world) and the real’s dramatic appreciation.  And so we should expect divergent strategies within and across the global north and south, as policymakers confront different combinations of economic challenges.

Central banks in wealthy countries are responding to the challenges of the currency war in ways that reflect their own political economies, current economic realities, and attitudes toward currency market intervention. The Swiss Central Bank, itself not generally keen to intervene, has nevertheless been prompted into action by what an official termed the “massive overvaluation” of the franc relative to the euro and the US dollar.  It has responded by cutting interest rates, while the country’s central bankers and government officials are reportedly considering additional measures.  Shortly after the Swiss central bank’s move, the Japanese central bank injected liquidity into its monetary system and sold yen to counter the appreciation of the yen.  The strength of the Turkish lira has prompted the Turkish central bank to lower interest rates, and it also announced that it would sell dollars to banks as needed.

By contrast, the central bank of New Zealand has lived up to its reputation as a true believer in market forces.  To this point, the country’s central bank has done nothing to counter the appreciation of the currency. The Canadian central bank, too, has maintained a hands off attitude vis-à-vis its appreciating currency (thereby continuing a 13 year pattern of not intervening in the Canadian dollar). But even these central banks may be pushed away from this stance as their counterparts continue to intervene and as the political and economic costs of currency appreciations make themselves more strongly felt. Moreover, if (as seems likely) the US Federal Reserve embarks on a third round of quantitative easing, then even the most passive central banks may find it impossible not to intervene.

In taking these actions, central banks in rich safe haven countries are following a path by now well-trodden by their counterparts in the global south. Developing country central banks have been taking steps for some time now to address the US dollar’s weakness, as I’ve discussed here previously.  Recently, South Korea’s government announced that it is reviewing “all possibilities” on curbing capital inflows; officials in the Philippines say they are prepared to impose new controls (in the form of prudential limits on certain kinds of transactions by banks) to reduce the volatility in the peso after it rose to a three-year high this week; and policymakers in Brazil added to its existing array of controls a 1% tax on bets against the US dollar in the futures market, after the real reached a twelve year high. Brazilian officials are also set to provide $16 billion in tax breaks and to tighten trade barriers to protect manufacturers hurt by imports from China (which have been stimulated by the strength of the real). In response, Canadian Prime Minister Stephen Harper this week inexplicably lectured the Brazilian government on the need to dismantle its capital controls (good luck with that!). Finally, and as I’ve noted previously, in those developing countries where a commitment to the ideology of capital mobility precludes the use of capital controls (e.g., Chile and Mexico), we find central banks responding to the costs of an appreciating domestic currency through regular, large dollar purchases.

In the context of this unevenness, it is not surprising that a recent meeting in Lima of economic ministers of the twelve South American nations that are members of Unasur (the Union of South American nations) failed to produce a coordinated response to the currency war. UNASUR members continued discussions of coordination at a second meeting in Buenos Aires a few days ago.  But coordinated responses may yet be coming, as new alliances form among the diverse countries now facing the hardships attending currency appreciation.  The current crisis is exposing clearly the dangers associated with a policy free-for-all in monetary matters, and the need for a new regime of coordinated monetary and exchange rate policy. The currency war itself is in fact symptomatic of the severe institutional inadequacy of the global financial and economic architecture. The emerging currency war threatens to undermine global economic stability, economic integration, peaceable economic relations, and the possibilities of a global recovery. It is looking more likely by the day that Brazilian Finance Minister Mantega was right all along when he drew a parallel between the current period and the economic nationalism and conflict of the 1930s. The road ahead promises to be a rocky one.  Stay tuned.

The credit rating industry is firing from both barrels.  The industry has launched a public relations effort that aims to delegitimize proposed regulations announced for public comment last month by the US Securities and Exchange Commission (SEC). The proposed regulations stem from the Dodd-Frank Act of 2010. At the same time the industry is taking its hubris to new levels by inserting itself aggressively and directly into public policy debates in the US and Europe.

This is a rather stunning reversal of fortunes for the rating agencies.  In the early days of the financial crisis, it looked as if the industry was in for a fundamental overhaul. At that time, it seemed that there was momentum in the US around the creation of a new rating industry model—in the new model they would operate as public utilities. Elsewhere in the world, discussion of the failings of this industry was part of broader conversations about the need to move away from a US-centered financial architecture. In Europe and Asia, in particular, the misdeeds of the rating industry led to calls to create new regional and/or national entities that would credibly and ethically perform this work.

An overhaul of the rating industry was long overdue. The current crisis made it simply impossible to paper over the industry’s multiple failings.  These include, but are not limited to, the conflict of interest that is an intrinsic feature of a business model wherein those whose securities are being rated pay for their ratings. Moreover, the industry’s analysts and the models they use have consistently failed to assess sovereign and private risk accurately. There is a revolving door between analysts and the entities that they rate. The structure of the industry means that rating firms have incentives to build business by offering more lenient ratings than their competitors. And the monopoly power of the industry is maintained by the fact that some entities (such as insurance companies) can only invest in assets that are rated, and these ratings must be performed only by firms that the SEC designates as nationally recognized statistical rating organizations.  And though the report by the US Financial Crisis Inquiry Commission (a Congressional panel) was disappointing in so many respects, it did correctly indict the credit rating industry, calling its three biggest firms “essential cogs in the wheels of financial destruction.” 

With all of this, there was reason to assume that the industry would face serious restructuring.  But its officials and supporters managed to lobby their way out of serious change under Dodd-Frank. Having won the major battle, industry spokespeople are now pushing back hard against all of the proposed new regulations that the SEC proposed last month. The SEC’s proposals do not get at the heart of many of the key problems that characterize the industry. But they are at a step in the right direction, and so should be imposed on an industry that has escaped all responsibility for a crisis to which it contributed so mightily. The regulations would mandate that rating firms periodically test the competence of their employees, strip references to credit ratings in securities offerings, prohibit rating firm analysts from issuing a rating if they also marketed their firm’s products or services, and would require that firms examine whether a former analyst awarded overly generous ratings to a firm that later hired that person. The SEC is also studying the issue of whether it should create an independent body that will assign performance ratings to raters, another initiative that is being opposed aggressively by the industry and Republicans.

At the same time as the industry is pushing against these rather modest regulations, it is working hard to elevate its role in the global economy.  The industry has long exploited its falsely claimed role as neutral judge and oracle on matters of economic and social policy across the globe. These roles are reinforced whenever the firms announce downgrades, threats of downgrades or changes in what they call “the outlook.”  Such decisions can and have helped to empower politicians and the business lobby since they are treated as serious evaluations of whether a country’s economic policies render a sovereign default more or less likely.  All of this matters because a threatened or actual downgrade means that a government has to pay more to borrow money. This is because when investors become convinced that there is a greater risk of sovereign default they will lend money to the government (i.e., buy its bonds) only if they are compensated for this perceived higher risk via a higher interest rate. Other interest rates in the economy generally rise accordingly. 

The credit rating agencies have been quite busy lately downgrading countries and also threatening to do so. For example, despite the humanitarian and economic challenges of the Japanese nuclear disaster at Fukushima in March, Moody’s announced earlier this month that it might downgrade its debt rating for Japan, joining S&P and Fitch in taking a more pessimistic view of the country’s economy. In the end, Moody’s kept its rating for Japanese bonds constant, but said its review of the rating for a possible downgrade had been prompted by  “heightened concern, that faltering economic growth prospects and a weak policy response would make more challenging the government’s ability to fashion and achieve a credible deficit reduction target.” Without an effective strategy, the rating agency said, government debt “will rise inexorably from a level which already is well above that of other advanced economies.” The Japanese government noted that it was disappointed, but that it was nevertheless forced to take the threat seriously. 

The raters have been notably effective in injecting themselves into the debate over the US debt ceiling.  Moody’s warned last week that it might downgrade the US government’s perfect credit rating if Congress did not increase the nation’s debt limit in the “coming weeks,” a message that seemed to appeal to both Democrats and Republicans looking to reinforce their position that their opponents are forcing the country into a financial Armageddon. Moody’s said pointedly that whether the US keeps its AAA rating “will depend on the outcome of negotiations on deficit reduction.” Fitch Ratings has since made a similar announcement. These warnings followed a similar one from S&P in April, when it lowered its outlook for the US credit rating (but did not lower the rating itself).

As the European crisis has contaminated the southern part of the continent, the region’s economies have been buffeted by a repeated chorus of pronouncements by the raters. For example, the rating firms seem to be in a new competition with one another that involves regular downgrades and threats of future downgrades for Greece and Portugal (and formerly for Ireland).  Indeed, earlier this month Moody’s lowered Greece’s sovereign rating so that it sits even deeper within the category that the rating firms label as “junk.”  These downgrades arrive when Southern Europe faces unprecedented political turmoil and social conflict over reductions in public spending and rising taxes, all against the backdrop of devastatingly high unemployment. 

The industry has gone even further than it has in the past by positioning itself above elected governments, between political movements and against civil society groups. The positions taken by the industry in these national contexts not only undermine democratic debate over fiscal policies, but also threaten economic recovery by empowering those forces that see economic and other crises as the ideal time to roll back social spending and dismantle welfare states.

It boggles the mind that the credit rating firms are not taking a standstill on pronouncements in Europe, Japan and the US while conditions are so fragile. It also strains the imagination that the firms are still claiming that they are being unfairly targeted for regulation.  The industry’s recent efforts can only be read as a campaign to protect the industry’s global influence and profits.  Let’s hope that civil society actors intensify their campaigns to expose the failings, corruption and undue influence of this delegitimized industry. 

For more on rating agencies, see Triple Crisis Blogger Kevin P Gallagher’s post in The Guardian, The Tyranny of bond markets.

Today’s “currency wars” stand at the intersection of many critical issues. These include the ability of developing countries to deploy capital controls, the role of the US as global financial hegemon, the inadequacy of the global financial architecture, the power of the IMF, and the role of the BRICs (and other rapidly growing developing countries).  All of these issues are at center stage both at today’s meeting of G20 Finance Ministers in Washington DC and at yesterday’s BRIC Summit in Sanya, China (which South Africa attended for the first time).

Let’s begin with a bit of context. In September 2010, Brazil’s Finance Minister, Guido Mantega, warned that policy makers in rapidly growing developing countries (such as his own) were being compelled to take steps against the triple threat of currency appreciation, inflation, and asset bubbles that were induced by high levels of international private capital inflows. These inflows were and still are being stimulated by the multi-track recovery and the low interest rates on offer in wealthy countries, such as the USA. Mantega invoked the term currency war here because he was attempting to draw a parallel between the currency interventions of the 1930s and those of today. In the former case, policymakers responded to the collapse of the world economy and political tensions by pursuing mercantilist “beggar thy neighbor” strategies that involved competitive currency devaluations and discriminatory trade policies. At present, central banks in many developing countries are responding to different challenges by deploying diverse types of controls on capital inflows and other measures, such as sterilization.

Will these national salvos solve the problem they aim to address? No, and indeed, in the absence of viable, representative mechanisms of global economic management, we may, in fact, descend again into a period of nationalist, beggar-thy-neighbor policies.  But in the short run at least the sterilization and the new capital controls that are being layered over existing controls are helping to mitigate (though in some cases, only modestly) some of the appreciation pressures and asset bubbles induced by the flood of foreign investment into rapidly growing developing countries.  Even so, currencies in some rapidly growing countries remain far too strong from the perspective of exports, and inflationary pressures are a very serious problem. In this context, some analysts have suggested that the inflation problem has solved the currency war.  This is because the rising costs of imported food and energy mean that central banks will ultimately have to welcome currency appreciations. However, this optimism is nothing more than wishful thinking by those who fantasize that intractable economic problems are corrected by market adjustments. Brazil’s Finance Minister Mantega, not one given to such fantasies, recently responded to the daily question “is the currency war over?” with a resounding “no.”

How the currency war issue will ultimately be resolved is very much an open question at this point. Two types of responses are being pursued simultaneously.

Response #1:  Nationally divergent responses

Within the developing world, not surprisingly, we do not find consensus on structural solutions to the currency war.  As I’ve written here previously, some central bankers have taken great pains to make clear that they will not draw weapons in the war.  Among such countries, Mexico’s policymakers are highlighting their opposition to capital controls, even though the peso has been appreciating significantly against the US dollar since 2010.  Turkish, Chilean and Colombian policymakers have also publicly rejected capital controls as a means of dealing with the appreciation of their currencies. This is not to suggest that policymakers in these countries are sitting on the sidelines while their currencies appreciate and asset values balloon. With the exception of Mexico, these central banks have been buying dollars.  And even in Colombia, policymakers implemented measures that they do not define as capital controls, but which are nevertheless of a piece with the prudential goals of controls elsewhere.   For instance, Colombian policy wisely prevents domestic banks from borrowing in foreign currency to lend in pesos, restricts the use of short-term finance for long-term projects, and limits bets in foreign exchange derivatives.

By contrast, we can expect other countries to continue to respond to the currency war with unilateral measures, namely capital controls and sterilization. Countries like Brazil continue to put in place new measures to curb the appreciation of the real. For instance, recently the government put in place a 6 percent tax on repatriated funds that are raised abroad through loans or bonds with a maturity of up to 720 days (the previous limit was up to 360 days). South Korea also added to existing controls by introducing a levy of up to .2% on holdings of short-term foreign debt by domestic banks (with a lower tax levied against longer term debts).

This national divergence on responses to the currency war reflects many factors, not least of which are differing internal political economies, the continued sway of neo-liberal ideas in some countries, and perhaps also pride associated with dealing with the problem of an excessively strong currency in countries that have so long faced the opposite problem. There may also be skepticism about the efficacy of these measures, especially since Brazil’s real has appeared almost unstoppable in its appreciation.

One other interesting fissure among the BRIC countries has emerged.  The Brazilian government has sided (to an extent) with the US against China on the matter of currency manipulation. However to be clear, Brazil’s Finance Minister has placed far more emphasis on the problems that are being caused by loose monetary policies in wealthy countries and the speculative flows of money unleashed by hedge funds and derivative markets.

Response #2: Incoherent multilateralism

In addition to these divergent national responses, we also find that the G20 and the IMF are struggling to articulate what can only be described as an incoherent response to the currency war.

Early in 2011 it appeared that France was going to use its new leadership of the G20 and G8 to press the IMF to take on the role of coordinating capital controls via some type of code or mandate on the subject. French President Sarkozy and his Finance Minister Lagarde have discussed the need for IMF coordination on capital controls, suggesting that this might be among the country’s signature issues. Some ECB officials and representatives of the German government seemed interested in this issue as well.  But more recently the G20 has largely dropped the issue, no doubt because the French President himself is involved with events in North Africa and the Middle East, and European officials are caught up in continued fallout from the financial crisis (particularly the bailout of Portugal and the messy politics of Iceland’s referendum on repaying British and Dutch depositors). In this context, the drive to coordinate capital controls and address the currency war has taken a back seat to issues that are much more immediate.

The IMF seems to be picking around the edges of the currency war issue.  A November 2010 report and two recent IMF reports suggest that the IMF might develop standards for the appropriateness of different types of capital controls, as Gallagher and Ocampo have discussed recently. If the IMF does take further steps to try to claim this power, then it will mean that we are back to 1997, and the very significant ground gained over the last two years on policy space for capital controls could be lost.  It will be important for Fund watchers to stay on this issue and continue to make sure that such coordination—if it is to occur–does not presume a norm of liberalization.

It is encouraging that some developing countries, such as Brazil, have already weighed in strongly against any efforts by the Fund to take control over when and how countries can control capital. (They’ve also weighed in, quite rightly, on the Fund’s lack of enthusiasm for tackling the contribution of wealthy countries’ monetary policies to the carry trade activity that plays such a key role in the currency war.

A better direction?

The only real, enduring solution to the problems of currency pressures, trade dislocation, speculative bubbles and other global imbalances lies in the urgent but politically difficult challenge of constructing a new financial architectures that promote mutually beneficial coordination across countries on financial regulation, capital controls, and currency policies.  Until this emerges, we cannot expect national policymakers to refrain from mercantilist currency interventions and we cannot expect multilateral bodies like the IMF and the G-20 to take serious, coherent, or even-handed action.   But I am hopeful that developing country representatives have put the matter of recasting the global financial architecture back on the table, not least due to the global attention garnered by their unilateral actions on capital controls, their criticisms of US monetary policy and of the capture of financial regulation by the country’s financial community, and their push back against the IMF’s apparent interest in taking control of the conversation on capital controls.

It may also be the case that the evolution of the global financial architecture will change the terrain on which the currency war is being fought. Right now, the global financial architecture is being recast slowly (as I argue in a recent paper), not because of a specific plan or conference that aims to do so, but because the financial crisis itself has stimulated the expansion of existing and the creation of new bilateral, regional and sub-regional institutions and arrangements. The crisis has also been the mid-wife to the G20 and has fueled conversations among the BRICs, particularly its most powerful members, China and Brazil. That the BRIC Summit was held just before today’s G20 Finance Ministers meeting is notable. China’s government already let it be known that it is not interested in the US’ finger pointing at its exchange rate policies.  Collectively, all of these developments and tensions are having the effect of rendering the IMF, the US, and the dollar less dominant in the global financial architecture. At the same time, the two-track recovery and the assertiveness of rapidly growing developing countries are helping to widen fissures in the old financial order.  Looking back we may find that the salvos in today’s currency war are nothing more than the last gasps of a financial order that no longer is suitable to the challenges and realities of our time.

In what follows, I flag a number of new developments that relate to developing country and international financial institutions responses to the ongoing economic crisis.

1. Central banks to investors: “Don’t worry–no capital controls here!”

As Triple Crisis readers know, a great many developing countries have deployed controls on capital outflows and especially on inflows in response to the myriad challenges they face in the current environment. For some countries, controls on outflows have been implemented to mitigate financial instability and currency depreciation following capital flight. Rapidly growing developing countries, on the other hand, are using inflow controls to reduce inflationary pressures, cool asset bubbles, staunch currency appreciation, and protect economies from the financial instability induced by significant future reversal of inflows. Indeed, capital controls have emerged as a key weapon of choice in the modern day “currency war.”

But recently leaders of some central banks have taken great pains to make clear that they will not draw this weapon. Among such countries, Mexico’s policymakers are highlighting their opposition to capital controls, even though the peso has been appreciating significantly against the US dollar since 2010.  Turkish, Chilean and Colombian policymakers have also publicly rejected capital controls despite the appreciation of their currencies. This is not to suggest that policymakers in these countries are sitting on the sidelines while their currencies appreciate and asset values balloon. With the exception of Mexico, these central banks have been buying dollars and implementing expansionary monetary policies to stem the appreciation of their currencies.

Certainly we would neither want nor expect policymakers to fall in line around capital controls (or any other measures for that matter). But it is nonetheless notable to see some policymakers taking pains to communicate their opposition to capital controls.  This divergence on capital controls likely reflects many factors, not least differing internal political economies (such that capital controls are politically viable in some countries, but not in others, owing to the power of the financial and/or export-oriented community), the continued sway of neo-liberal ideas in some countries, and perhaps also pride associated with dealing with the problem of an excessively strong currency in countries that have so long faced the opposite problem. (We might recall in this context that US policymakers also saw the US dollar’s appreciation during the first half of the 1980s as a reflection of the country’s might and prestige.)

2) Who will control capital controls?

Since January, we’ve been hearing in the most general terms that the IMF needs to take on the role of coordinating capital controls via some type of code or mandate on the subject. This issue has arisen in the context of concerns about the ad hoc nature of country-level responses to the currency war.  French President Sarkozy and his Finance Minister Lagarde have mentioned the need for IMF coordination on capital controls, suggesting that this might be among the signature issues of the country’s new leadership of the G20 and the G8. There is some discussion of this issue in a November 201O IMF report “The Fund’s role regarding cross-border capital flows” (see e.g., p. 35, paragraphs 49-50).

Whether the IMF seizes this opportunity and how it comes to interpret this possible new charge is of critical importance to advocates of national policy space for capital controls.  As Peter Chowla notes (and as the IMF itself notes on p. 35 of this report), the recent advances in policy space for capital controls could be lost if the Fund presses for capital flow liberalization (as it was poised to do in 1997). It will be important for Fund watchers to stay on this issue and continue to advocate coordination that does not presume a norm of liberalization. We can also hope that those developing countries that have used capital controls so successfully will resist any effort to expand the IMF’s authority around such a norm.  Certainly there is much in the IMF’s own actions and official statements by the institution’s key figures during the current crisis to call upon should we find that momentum builds around rewriting the institution’s new position on capital controls.

3.  IMF self-critique: A welcome development

The release of the latest report of the IMF’s internal watchdog, the Independent Evaluation Office (IEO), makes for interesting reading. The new report examines the IMF’s work in 2004-07 to determine whether it did enough to identify circumstances that led to the global crisis. The report’s authors conclude that the institution failed on many levels–a conclusion that is unequivocally correct.  The report identifies numerous failures—among them, ideological blinders that reified liberalized financial markets, a tendency toward “group think” in the institution, weak internal governance, a lack of coordination and follow up across its units, political constraints that came from powerful countries, unevenness in the institution’s surveillance across countries and in the quality of staff recommendations, and the use of economic models that were not up to the task at hand.

The numerous failings in the IEO report accord with those identified by long-time IMF critics since at least the late 1970s (not that this is acknowledged by the report’s writers). (Aside: it is a pity that the report of the US’ Financial Crisis Inquiry Commission isn’t half as good or readable as this one. See Matias Vernengo’s critique of that report.) However, the reform recommendations that conclude the report stand in sharp contrast to its hard-hitting documentation of IMF failures. The recommendations are unimaginative and timid.  For example, having indicted the IMF for its tendency toward dangerous group think, the report does not call for a fundamental rethink of the Fund’s own hiring practices.  One remedy for group think would involve hiring qualified economists who possess diverse theoretical commitments and training. And while we’re at it, why not hire from other disciplines as well (as has more often happened at the World Bank)? Why not call for bolder changes in voting rights so as to expand the voice of developing countries in a significant way (beyond the ever so modest changes that will come on line in 2012)? Why not address the issue of how the Managing Director gets selected? And why not adopt the proposals by CEPR’s Mark Weisbrot and Dean Baker for institutional reform that makes public which economists at the IMF are responsible for which of its predictions and recommendations, and then holds them accountable when they get it so wrong?

Think back to the good old days just before the world financial system exploded.  Remember all the talk then of “decoupling”?  What advocates of the decoupling thesis had in mind was very simple:  the world economy had changed in such a way that the growth trajectory (and business cycles) of developing countries had separated from the economic fortunes of the U.S. The strong performance of rapidly growing developing countries, not least the BRICs (Brazil, Russia, India and China), was seen as evidence that substantial parts of the global economy had broken free of the U.S. iceberg and were now floating in distinct economic currents.  Decoupling advocates cited much evidence to support their claims—most importantly, they focused on the fact that export and GDP growth in large developing countries was smartly outpacing that of the U.S.

Then came the global economic crisis of 2008-?, which did serious damage to the decoupling thesis, as Chandrasekhar and others have pointed out. The contraction of remittances, exports and global credit hit developing countries hard.  On the European periphery the continued unfolding of crises and the contraction of output were also damaging to the thesis.  That decoupling is a myth should not be surprising: after all, in a globally integrated economy it is impossible to insulate economies from one another. That the BRICs are performing well these days does not salvage the decoupling thesis: just like crises themselves, recoveries are always geographically and temporally uneven.

That said, a different sort of decoupling is now underway, and it may prove to be very significant in the coming years. This decoupling has two dimensions–policy and architectural.

Policy and regulatory decoupling

Instead of the customary convergence to the norms of U.S. economic policy and regulation, policymakers in some developing countries are moving in directions that are decidedly at odds with the path of the U.S.  As is well known, monetary policy in the country continues to be highly expansionary.  Moreover, the financial reform bill was a disappointment to progressives since it does very little to curtail the power of the country’s financial sector.

In much of the developing world, monetary and financial policies are trending in a decidedly different direction. Not only have central banks in rapidly growing developing countries been tightening monetary policy and taking other steps to reduce credit growth, they are also implementing restrictions on outsized activities of the shadow financial sector, and imposing a variety of controls on capital flows. In most cases they are now restricting capital inflows, though in some cases controls on outflows have been implemented as well. These measures have been driven by the challenges confronted by these rapidly growing economies—namely, high levels of foreign investment are fueling asset and price inflation, and are also placing currencies under pressure to appreciate.

To be sure, these measures reflect “fundamental” economic challenges.  But they also reflect a very different set of political forces: in the developing world, policy is turning in the direction of managing finance in the interests of the broader economy. In the rich countries, no such political realignment has taken place.

Architectural decoupling

To date there is little evidence that the IMF has been demoted from its perch as the critical institution of financial management. Indeed, the IMF has been the big winner from the crisis: the institution has discovered new vitality as a first-responder to economic distress, and its funding has been increased significantly by the G-20.  The newly revitalized Fund is playing its familiar damaging role of promoting pro-cyclical macroeconomic policies in those countries to which it has provided assistance.

But, as I argue in a recent paper, today the geography of IMF influence is significantly curtailed as a consequence of the rise of relatively autonomous states in the developing world (some of which have even emerged as lenders to the institution) and the emergence of new financial architectures. The Fund now faces competition from other national, multilateral, and regional and sub-regional financial institutions that are beginning to play a greater role in the area of crisis management and project lending. These include the Inter-American, Asian and African Development banks, Brazil’s BNDES, the Latin American Reserve Fund, Chiang Mai Initiative Multilateralisation, Argentina and Brazil’s Agreement on Reciprocal Payments and Credits, and the Andean Development Corporation.  The Bank of the South and the Bolivarian Alliance for the Americas (ALBA) are newer initiatives that may hold promise in the future, though each is still in its infancy.

At this point it remains unclear just how significant these architectural changes will prove to be as competitors to the IMF. However, it is clear that we are witnessing a slow process of structural transformation in the global financial architecture, a development that appears to be leading to a more decentralized, pluralistic, and heterogeneous financial architecture. We may well find that this more heterogeneous architecture is one that provides more policy space for development. Let’s face it: it could hardly do worse in this regard.

Last Monday, Triple Crisis contributor Ilene Grabel co-authored the following piece for the Financial Times with noted author Ha-Joon Chang, building on an FT-hosted debate that included an earlier contribution by Triple Crisis blogger Kevin P. Gallagher. They urge the leaders of the G-20 economies to acknowledge the need for a new international financial architecture in the wake of the global financial crisis and the widespread adoption of currency controls in the developing world at their upcoming summit in Seoul, on November 11-12. Their piece kicks off the Triple Crisis Blog’s “Spotlight: G-20” series. Starting today and running through the G-20’s crucial meetings, we will feature daily pieces from Triple Crisis bloggers and guest contributors on the key issues that need to be addressed at the upcoming summit.

Was it really just over a decade ago that the International Monetary Fund and investors howled when Malaysia imposed capital controls in response to the Asian financial crisis? We ask because suddenly those times seem so distant. Today, the IMF is not just sitting on its hands as country after country resurrects capital controls, but is actually going so far as to promote their use. What about the investors whose freedoms are eclipsed by the new controls? Well, their enthusiasm for foreign lending and investing has not been damped in the least. So what is going on here? In our view, nothing short of the most significant transformation in global financial management of the past 30 years.

Read full article at Financial Times

Read more capital controls from Triple Crisis and at the Global Development and Environment Institute.

For those of us advocating change in the global financial architecture, the last few months have been fairly exhilarating.  Let’s recap…

Capital controls, as I’ve written previously, have become the ‘new normal’ in the developing world.  It’s hard to keep up with developments in countries that have introduced or tightened existing controls since I last wrote about them here (see below). IMF staff now write about capital controls with a taken-for-granted attitude (see even the institution’s October 2010 Global Financial Stability Report, which contains the by now customary bland language on the role and efficacy of capital controls, e.g. p. 28).

Staff members of tin-eared credit rating agencies do not flinch these days when another rapidly-growing developing country implements controls.  Neither do private investors: to the contrary, they continue to flood developing country financial markets even after new controls are announced.

Depressed interest rates in the USA and Japan have added fuel to the boom in developing country financial markets. Investors are borrowing at low cost in rich countries and using those borrowed funds to buy higher yielding assets (like government debt) in developing countries. (Finance geeks:  this is called the “carry trade.”)  The rapid pace of international capital inflows into developing country markets has caused currencies to appreciate sharply, threatening export performance. In this context, policymakers are implementing precautionary and (in many cases) finely calibrated capital controls in order to staunch speculative bubbles and dampen currency appreciation.  Wasn’t it just yesterday that policymakers in the developing world either would not or could not take these steps? We should wonder how different recent history across the developing world might have been had policymakers in the 1990s imposed capital controls to curb the speculative bubbles and currency pressures during that ‘emerging market boom,’ a boom that ended with the East Asian financial crisis.

And there’s more. Today national, bilateral and regional financial architectures in the developing world are evolving in ways that may ultimately reconfigure the global financial architecture. Indeed, and as I argue in a forthcoming paper, in the new era both the IMF and the US dollar may be displaced from their privileged positions. And on top of all that there is the matter of the emerging “currency wars,” a phrase we cannot seem to escape in the last few weeks. We’ll return to that war in a moment.

I should pause here to emphasize that not all is well in the global financial system.  Basel III is a disappointment; the G-20 and the EU continue Hooverite calls for austerity and debt sustainability (though social movements in Europe are challenging retrenchment with great force); the IMF continues to resurrect the pro-cyclical prescriptions it perfected in program countries over the last decades; IMF governance reforms that the G-20 was pushing last year have been shipwrecked on the shores of USA-Europe rivalry and conflict between larger and smaller European countries; and the prospect of serious financial reform in the USA…well, that seems to have gone about as far as Wall Street and the Tea Party will allow it. So there’s plenty of bad news alongside the hopeful indicators of fundamental change.

On the bright side, the last few weeks have witnessed a great deal of new capital market regulation. At the beginning of this month, South Korea added to the controls that were initially implemented in June 2010. Beginning on October 19, regulators will audit lenders working with foreign currency derivatives. The goal is to reduce the financial instability and currency appreciation caused by the capital inflows associated with these transactions.  Also this month, Brazil strengthened the capital controls it first put in place in October 2009.  The new Brazilian controls double (from 2 to 4%) the tax it charges foreign investors on investments in fixed-income bonds. The Brazilian controls tax foreign equity purchases at a lower rate (i.e., the same 2% rate that has been in place since 2009), and foreign direct investment is still not taxed at all. This is a particularly good example of fine tuning controls so that they affect the composition, rather than the level of foreign investment. (Indeed, the IMF’s recent Global Financial Stability Report makes note of this composition effect in Brazil.)  Thailand also has been making news:  earlier this month authorities introduced a 15% withholding tax on capital gains and interest payments on foreign holdings of government and state-owned company bonds. And rumors in the financial press suggest that additional measures are under consideration. Finally, Peru has been deploying a variety of inflow controls since early 2008. The country’s reserve requirement tax (which is a type of control on capital inflows) has been raised three times between June and August 2010.

This gets us back to the currency war that Brazil’s Finance Minister, Guido Mantega, warned about on September 27, 2010. He cited the intensifying competition among states to reduce the degree of currency appreciation (or to bring about an actual depreciation). This strategy is driven by concerns about trade performance as countries struggle to recover from the global financial crisis. Central banks across the developing world are engaging in a variety of interventions, such as buying dollars that come into the country to finance foreign investment (so as to reduce pressures on the domestic currency to appreciate), and also implementing capital controls on inflows. Will these strategies solve the problem they aim to address? No, and indeed, in the absence of viable, representative mechanisms of global economic management, we may descend into a period of nationalist, beggar-thy-neighbor policies.  But in the short turn at least the strategies will help protect developing countries from the negative trade effects of currency appreciation. More importantly, they solidify the growing international sentiment that unregulated capital flows and currency markets are no longer viable across the developing world.

The only real, enduring solution to the problems at hand (i.e., currency pressures, trade dislocation, speculative bubbles and other global imbalances) lies in the urgent but politically difficult challenge of constructing a new global financial architecture that promotes mutually beneficial coordination across countries on financial regulation, capital controls, and currency policies.  Until this emerges, we cannot expect national policymakers to refrain from mercantilist currency interventions. Let’s hope that the G-20 has the courage to take up these matters at its November meeting in Korea.  Truth be told, I am not very optimistic given the timidity of the G-20. But I am hopeful that developing country representatives have put the matter of recasting the global financial architecture back on the table, not least due to the global attention garnered by their unilateral actions on capital controls.