Emerging markets have fallen victim to unstable capital flows in the wake of the financial crisis. In an attempt to mitigate the accompanying asset bubbles and exchange rate pressures that come with such volatility, a number of emerging markets resorted to capital controls. Although these actions have largely been supported by the International Monetary Fund, some policy-makers and economists have decried capital controls as protectionist measures that can cause spillovers that unduly harm other nations.

Recently-published research shows that these claims are unfounded. According to the new welfare economics of capital controls, unstable capital flows to emerging markets can be viewed as negative externalities on recipient countries. Therefore regulations on cross-border capital flows are tools to correct for market failures that can make markets work better and enhance growth, not worsen it.

This work has been developed by economists Anton Korinek, Olivier Jeanne, and others, and is summarised by Korinek in the August issue of the IMF Economic Review. According to this research, externalities are generated by capital flows because individual investors and borrowers do not know (or ignore) what the effects of their financial decisions will be on the level of financial stability in a particular nation. A better analogy than protectionism would be the case of an individual firm not incorporating its contribution to urban air pollution. Whereas in the case of pollution the polluting firm can accentuate the environmental harm done by its activity, in the case of capital flows a foreign investor might tip a nation into financial difficulties and even a financial crisis.

This is a classic market failure argument and calls for what is referred to as a Pigouvian tax (named after the 20th century Cambridge economist Arthur Pigou) that will correct for the market failure and make markets work more efficiently.

Of course, economists such as Keynes argued long ago that capital controls are important to prevent crises and to maintain an independent monetary policy that can strive for full employment and financial stability. This new work however elegantly models capital flows and capital controls in a broader contemporary economics context and thus could be seen by some to be a more rigorous justification for policy action on capital flows.

This work is not just for the blackboard. With quantitative easing, and as interest rates were lowered for expansionary purposes in the industrialised world between 2008 and 2011, capital flows returned to emerging markets at an alarming rate, where interest rates and growth were relatively higher. With eurozone jitters in the final quarter of 2011, capital flight occurred to the “safety” of the US and beyond. This has caused significant asset and exchange rate volatility that has made for an uncertain environment for policy-making and investment alike.

In response, many nations deployed capital controls to regulate the negative effects of cross-border capital volatility. Like earlier studies confirming that capital controls can change the composition of inflows, make for more independent monetary policy, and ease exchange rate tensions, new studies are emerging that show how nations such as Brazil, Taiwan, and South Korea have been at least moderately successful as well.

In addition to the cries of protectionism by Gordon Brown and others, some have also argued that controls create negative spillovers to neighbouring nations. MIT economist Kristin Forbes and colleagues examined Brazil’s numerous taxes on capital inflows from 2008 to 2011 to test whether such measures were harming Brazil’s neighbours.

On the one hand, Forbes and colleagues found that Brazil’s controls were meeting their stated objectives. However, in some attempts the authors did find that Brazil’s actions impacted other emerging market nations. Some of these spillovers were positive — some fund managers steered away from not only Brazil but from other nations that have regulated cross-border capital in the past. In other cases global investors did indeed increase their allocations to neighbouring nations.

These mixed findings miss some of the broader context, especially when seen in the light of the new welfare economics of capital controls. First, Brazil’s taxes can be seen as Pigouvian measures to correct against the negative spillovers generated from quantitative easing and the dollar/real carry trade. Second, the ‘costs’ that Forbes et al find to a small number of nations are not juxtaposed with the benefit of preventing a crisis in Brazil — one only has to look at Brazil’s 1999 crisis to see its contagious effect on the region then.

Over a dozen  years ago, prominent trade theorist Jagdish Bhagwati reminded us that capital account liberalisation is not analogous to trade liberalisation and that measures to regulate capital flows are not inherently evil.  The new welfare economics of capital controls further show that such measures can be seen as the new “correctionism” rather than the new protectionism — at exactly a time when nations need as many tools in their crisis preventing arsenal as possible.

This piece was originally published at the Financial Times. It is based on Gallagher’s new working paper, ‘The Myth of Financial Protectionism:The New (and old) Economics of Capital Controls’.

Gillian Tett (“Fears of worse to come fuel debate over capital controls”, December 16) highlights the new and important Bank of England paper on capital flows and financial crises that argues how cross-border capital flows continue to plague the world economy and will continue to do so in alarming ways to 2050. The Bank rightly argues for cross-border regulation and co-ordination on capital flows – traditionally referred to as capital controls.

Traditionally, policymakers and the financial press would shudder when talk of regulating cross-border flows arises. Many have made the wrong analogy to trade, where tariffs are seen as distortionary to economic activity and thus a drag on potential growth. New research in economic theory and in econometric evidence shows that capital account regulations can make markets work better and that such regulations are effective. As the Bank of England notes, if nations co-ordinated such regulation they might work even better.

In the August issue of the International Monetary Fund Economic Review, economist Anton Korinek shows how, in an environment of uncertainty, imperfect information and volatility, capital account regulations are more analogous to Pigouvian taxes that actually correct for a market failure rather than cause a distortion. In other words, capital controls are “correctionist” not “protectionist”.

These theoretical advances come on the heels of a mountain of evidence by the IMF and the National Bureau of Economic Research that shows how developing countries that have used regulations were among the least hard hit during the crisis and have been stemming the tide ever since. This is truly amazing given that all the burden has been on capital recipient nations, not nations that are the source of the problem.

Like the Bank of England suggests, if industrialised countries co-ordinated with emerging market countries and, as Keynes said, regulated capital on “both ends”, the world would be a much more stable place for growth and prosperity.

This piece was originally published in the Financial Times.

The increasing global economic uncertainty and the prospects of a flight-to-quality, with money flowing out of developing towards developed countries, raise the question of how prepared developing countries are to protect their economies from external shocks in the coming year. But volatility of financial flows also means that, most probably, following capital flight driven by the eurozone crisis emerging markets will again experience a surge in speculative financial inflows. The threat of continued ‘boom and bust’ cycles and lack of responses from international forums like the G20 and the IMF to address global monetary chaos makes the need for central banks to take action even more urgent.

There is a welcome shift in Latin America as countries continue their slow process of acceptance and de-stigmatisation of capital account regulations. In September this year Costa Rica joined the group of countries using these regulations, when it established that short-term foreign loans received by banks and other financial entities will be subject to a holding deposit of 15% of the value of the investment.

The evidence collected in a new report by Bretton Woods Project and Latindadd, Breaking the Mould, shows that regulations on capital inflows and outflows are helping Argentina, Brazil and Costa Rica to achieve not only financial stability, but also to promote development goals like poverty reduction and employment creation. These findings challenge the current IMF stance, which gives inadequate consideration to the impact volatile capital inflows have on economic activity and employment.

There are many ways that regulating financial flows can contribute to the achievement of social goals. In addition to the now widely acknowledged negative social impacts of the financial crises that followed financial liberalisation in the region during the 1990s, the report examines unregulated capital inflows artificially inflated the value of the Brazilian and Costa Rican currencies and undermined the export capacity of their local industries. This potential destruction of local industries has direct negative implications for employment creation and poverty reduction, and explains why regulating speculative financial flows is an intelligent policy.

Roberto Frenkel, a Buenos Aires based researcher, pointed earlier this year to the link between unregulated flows of money and what is known as Dutch Disease. The policies in Brazil, Costa Rica and Argentina to disincentivise speculative flows underline the concerns of many in the region, concerns that unfortunately the IMF is currently pretending to ignore. One more time, the Fund is falling short of understanding the social implications of the policies it advocates for.

Although not always mentioned by analysts, a comprehensive set of capital account regulations is one of the keys behind the economic growth and social progress of Argentina in the post-2001 crisis period. Since 2002, Argentina implemented several measures to deal with both inflows and outflows, such as requirements for exporters to sell foreign currencies internally, regulations to deal with currency mismatches, and non-remunerated reserve requirements on short term investments, among others. These measures supported the maintenance of a stable and competitive exchange rate and increased monetary policy space, which in turn stimulated economic activity and employment creation. Furthermore, less reliance on short-term investment also places the country in a strong position in the current context of global economic uncertainty.

In this sense, while in Argentina the capital account regulations implemented since the 2001 crisis are part of a comprehensive policy ‘toolkit’ which represents a U-turn from 1990s financial liberalisation, in Brazil and Costa Rica the regulations implemented come as isolated policies responding to a particular context.

The inflows that flooded Brazil and Costa Rica during the period 2009-2011 are not productive but speculative investment, mainly what is known as ‘carry-trade’ investment, where investors borrow in countries with low interest rates and lend into countries with high interest rates. Historically low interest rates in rich countries, and high interest rates in Brazil and Costa Rica because of inflation targeting policies, stimulated a surge in flows. The surge both induced exchange rate appreciation and increased their exposure to a sudden stop. This was clearly expressed in September this year when the eurozone crisis stimulated a strong outflow of capital from emerging markets, depreciating the Brazilian real by 14% against the dollar in only one month, forcing the central bank to intervene for the first time in two years in order to support the value of the currency

In order to make speculation on the Brazilian real less profitable and stop exchange rate appreciation, Brazil implemented a 2% tax on foreign purchases of stocks and bonds in 2009 and a 1% tax on financial derivates in July 2011. The same motivations are behind the regulations implemented by Costa Rica in September this year. Several studies showed that the regulations in Brazil have been effective in slowing inflows and reducing the pace of exchange rate appreciation.

Despite this positive impact, in the case of Brazil, and especially in the case of Costa Rica, it could be argued that the regulations implemented are too late and too little. Too late because they only implemented regulations once the value of their currencies was already heavily affected and the composition of flows shifted to larger proportions of short term capital. And too little because the measures are not comprehensive.

In Brazil, continued high interest rates, tax exemptions to foreign investors, and record profits in the financial sector make a 2% tax look too small. In fact, the evidence shows that the impact of the tax was stronger when the tax rate was increased to 6% in November 2010. In Costa Rica, following IMF advice, they decided to take action only after three years of strong exchange rate appreciation. Furthermore, the reserve requirement implemented covers only short-term loans, and leaves other flows unregulated, including trading activities on stocks and bonds. This suggests that there is still scope for short-term investments to affect the financial stability of the country. It is important to note that Costa Rica faces limits on imposing further regulations because of existing Bilateral Investment Treaties (BITs) and Free Trade Agreements (FTAs).

Latin American countries should continue their efforts to regulate financial flows in ways that benefit their citizens. The available evidence shows that using capital account regulations as a last resort policy, as advocated by the IMF, increases financial instability and puts jobs at risk. In order to increase the effectiveness and development impact of capital account management techniques, they have to be implemented early on as part of a comprehensive policy framework. Their effectiveness will increase with regional coordination; current discussions at Unasur (Union of South American Nations) on coordinated response to the crisis are a good sign.

Juan O’Farrell is research assistant of Finance and IMF at the Bretton Woods Project. See their new report, “Breaking the Mould: how Latin America is coping with volatile capital flows”

The G20 meeting in Cannes earlier this month was derailed by the pressing eurozone crisis. Actors were disappointed if they were looking for concrete action on global imbalances and the food crisis, let alone the new global monetary system that French President Nicolas Sarkozyboasted would be the goal of the summit when he first took the helm as host. But behind the scenes, the G20 actually delivered on a set of “coherent conclusions” on the management of speculative capital flows in emerging markets that should not be overlooked, especially by the International Monetary Fund (IMF).

Sarkozy assumed his role as head of the G20 during a period of excessive volatility in global capital markets that continues to this day. Because of loose monetary policy, low interest rates and a slow recovery in the North Atlantic, accompanied by high interest rates and rapid growth in emerging markets, the world’s investors flocked from north to south – to Brazil, Chile, South Korea, Taiwan and others. More recently, in response to eurozone jitters, capital has retreated from emerging markets to the “safety” of the United States – showing how dangerous speculative capital flows can be. New work released by the IMF this week suggests they are picking and choosing their direction from the G20.

In a significant reversal of past policy, in 2010 the IMF began recommending that nations deploy capital controls to mitigate the effects of speculative capital. Indeed, IMF work in 2010 showed that those countries that deployed capital account regulations were among the least hard-hit during the worst of the global financial crisis. As numerous countries across the globe began using controls in 2010-2011, further IMF work showed that those measures showed signs of working, too.

Sarkozy thus called for a code of conduct on capital controls and tasked the IMF to propose a set of guidelines for reform. The IMF delivered a set of guidelines in April of this year that met stiff resistance from the emerging market and developing countries that have been most successful in deploying capital controls. The IMF’s proposed guidelines recommend that countries deploy capital controls only as a last resort – that is, after such measures as building up reserves, letting currencies appreciate and cutting budget deficits.

Developing countries thought the guidelines missed the point. In the cases where the IMF found controls to be effective, such measures were part of a broader macroeconomic toolkit, and were deployed alongside other measures – not as a “last resort”. In October, these concerns were echoed by an independent task force of academics and former policy-makers that I co-chaired. We stressed that “consigning such measures to ‘last resort’ status would reduce the available options precisely when countries need as many tools as possible to prevent and mitigate crises.”

By the runup to the Cannes meeting, most of the G20′s apparatus was focused on the eurozone. However, a working group was formed to take the capital flows issue to the highest level. Headed by Germany and Brazil, the group forged the “G20 Coherent Conclusions for the Management of Capital Flows Drawing on Country Experiences”. The document was “endorsed by the G20 finance ministers and central bank governors in October, then endorsed by the G20 leaders themselves in Cannes.

In stark contrast to the IMF guidelines, the G20′s conclusions say that “there is no ‘one-size fits all’ approach or rigid definition of conditions for the use of capital flow management measures”, and that such measures should not be solely seen as a last resort. Instead, the G20 now calls on nations to develop their own country-specific approach to managing capital flows and, as Sarkozy said in his final Cannes speech, “the use of capital controls, and this is very important, is now accepted as a measure of stabilisation.”

Throughout the crisis, the IMF has usually been keen to accept new direction from the G20, but there are signs that it may be resisting the new G20 consensus on capital flows. The IMF’s latest report addresses the fact that industrialised country policies trigger unstable capital flows to developing countries and that the rich nations need to design policies that are mindful of such negative “spillovers”. Yet, the IMF merely adds that such principles will be added to their existing guidelines – seemingly ignoring the fact that those guidelines have now been superseded by the G20′s decisions.

The IMF should not ignore the G20′s direction on capital flows. Rather than pushing ahead on a globally enforceable code of conduct that could eventually lead to capital account liberalisation across the globe, the IMF should instead work to reduce the stigma attached to capital controls, protect countries’ ability to deploy them, and help nations police investors who evade regulation. G20 finance ministers, central bankers and heads of state have endorsed the use of capital controls by emerging markets, and on their own terms. The IMF should not pick and choose which directions by world leaders it will follow.

This post was originally published in The Guardian.

When the first G20 Summit was launched in 2008 in order to provide an emergency response to the global financial crisis, the premise was that dramatic reforms were needed in a short period of time. Those reforms could never happen in the slow-moving machineries of the institutions with full representation of all countries, such as the UN, hence, the need for the G20.

Three years down the road, and based on the preliminary agreements that one can foresee happening in the coming Summit in Cannes, the G20 has negligible progress to show, calling such premises into question. The world veers dangerously close to a new global recession that, if it happens, will catch developing countries in a worse position than three years ago. The President of the World Bank informed last month that developing countries’ fiscal positions are, in the average, two percentage points of GDP down from where they were pre-crisis. In the face of what is arguably a more pressing emergency than three years ago, the Group cannot even agree to throw its full weight behind the coordinated stimulus measures of the kind and scale to which they’d previously agreed. The idea that grand agreements can be reached by the most powerful countries, if only small countries stop acting as spoilers or brakes in the multilateral machinery with their delaying tactics or parochial views, has evidently no merit to it.

The area where the G20’s failure to make progress will be most costly to the world economy is the reform of the international monetary system. Because of political and ideological constraints, the US and Europe seem to have run out of options to introduce stimulus measures, either fiscal or monetary. Agreements on a sensible set of steps to transit towards an international monetary system with a wider range of options for stimulus, support for trade stability and an adequate mechanism for adjusting global imbalances without recessionary consequences are, however, not to be expected from Leaders meeting in Cannes.

The G20’s agenda for the monetary system has, indeed, chosen the wrong priorities. In order to achieve better macroeconomic coordination, it has chosen to prioritize discussions on surveillance and lending tools within the IMF, rather than mechanisms to guarantee the credibility of such agreements.

In order to achieve more stability, it is promoting a “framework for managing capital flows.” This process seems headed towards curbs on the right of countries (under Article VI of IMF Articles of Agreement), to implement capital account restrictions, a recipe for greater, not less, volatility.

The existing diverse and more flexible regional monetary cooperation agreements that have evolved in line with the needs and history of countries in different regions, are being asked to fall together under an IMF-coordinated umbrella of one-size-fits-all principles. More uniformity in the behavior of economic units leads to greater, not less, systemic risk, one would have hoped is a lesson learned from the crisis.

Finally, after a promising start, the discussion on how to make Special Drawing Rights the cornerstone of the monetary system has been brushed aside. Instead, one sees a narrow agenda that seeks to broaden the currency basket not guided by any particular rationale to make the basket more stable and flexible, but by geopolitical realities and some countries’ push to make the renminbi a fully convertible currency.

Aldo Caliari is Director of the Rethinking Bretton Woods Project at the Center of Concern.

Read other Triple Crisis posts on capital controls.
Read more about GDAE’s work on capital controls.

When French President Nicolas Sarkozy took the reins as host of this year’s G-20 summit, to be held in Cannes on November 3-4, he called on the International Monetary Fund to develop an enforceable “code of conduct” for the use of capital controls (or capital-account regulations, as we prefer to call them) in the world economy. The IMF followed through by publishing a preliminary set of guidelines this past April.

Regulation of cross-border capital flows has been strangely absent from the G-20’s agenda, which is aimed at strengthening financial regulation. But they are a central element in the financial volatility that incited calls for stronger regulation in the first place. The IMF has shown that those countries that deployed capital-account regulations were among the least hard-hit during the worst of the global financial crisis. Since 2009, it has accepted and even recommended that such regulations are useful to manage the massive inflows of “hot money” into emerging markets.

That said, while the IMF’s proposed code is a step in the right direction, it is misguided. So, the G-20’s endorsement of the Fund’s guidelines would not be wise for a world economy trying to recover from one financial crisis while preventing the next one.

With low interest rates and a slow recovery in the developed countries, accompanied by high interest rates and rapid growth in emerging markets, the world’s investors flocked from the former to the latter – Brazil, Chile, South Korea, Taiwan, and others. Then, in recent months, they flocked out of those emerging countries, showing once again how volatile and dangerous such flows are.

Indeed, as the IMF has pointed out in its World Economic Outlook, these flows threaten to inflate asset bubbles, make it harder for countries to pursue an independent monetary policy, and trigger currency appreciation and associated losses in export competitiveness. Brazil’s currency, for instance, appreciated more than 40% from 2009 until August 2011, before weakening in recent months.

Some countries responded by doing nothing, but many, including industrialized countries like Japan and Switzerland, intervened heavily in currency markets. Some resorted to capital-account regulations on inflows, such as taxes on the foreign purchases of bonds, equities, and derivatives, reserve requirements on short-term inflows, and so forth.

Brazil’s finance minister referred to these numerous actions as the “currency wars.” This is where Sarkozy came in, using his platform as G-20 host to try to forge a set of enforceable guidelines to govern capital-flow management.

The IMF’s proposed guidelines recommend that countries deploy capital-account regulations only as a last resort – that is, after such measures as building up reserves, letting currencies appreciate, and cutting budget deficits. In response to these suggestions, an independent Task Force, made up of former government officials and academics, was established to examine the use of capital-account regulations and come up with an alternative set of guidelines for the use of such regulations in developing countries.

Among other findings and recommendations, our task force pointed out that in the cases where the IMF found capital-account regulations to be effective, such measures were part of a broader macroeconomic toolkit, and were deployed early on, alongside other measures, not as a “last resort.” Unless countries have signed trade and investment treaties that restrict the use of such regulations (and many have), the IMF’s Articles of Agreement give them full policy scope to manage capital flows as they see fit. Consigning such measures to “last resort” status would reduce the available options precisely when countries need as many tools as possible to prevent and mitigate crises.

Rather than embracing a globally enforceable code of conduct that could paradoxically lead to a compulsory opening of capital accounts across the globe, the IMF, the G-20, the Financial Stability Board, and other bodies should try to reduce the stigma attached to capital-account regulations and protect countries’ ability to deploy them. Indeed, the IMF could help countries to prevent evasion of the regulations, and, together with the G-20 and the FSB, should lead a global dialogue about the extent to which countries should coordinate such regulations.

Countries’ interests are considerably aligned in favor of such coordination. Industrialized economies are seeking to recover from the crisis, and want credit and capital to stay home to boost growth, while developing countries have little interest in gaining short-term capital inflows. This could form the basis for industrialized countries to adjust their tax codes and deploy other types of regulation to keep capital at home, while emerging markets implement measures aimed at changing the composition and reducing the level of potentially destabilizing inflows.

José Antonio Ocampo is a professor at Columbia University and former Minister of Finance of Colombia.

This piece was originally published by Project Syndicate.

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.

There has been a certain view, that was already quite popular around the time Strauss-Kahn still managed the IMF, that with Christine Lagarde the Fund has become less orthodox, not just regarding capital controls, but now also supposedly on fiscal issues. See for example the article in the NYTimes by Liz Alderman.

In the last World Economic Outlook, the Fund argues (WEO, p. 110) that Argentina’s inflation results from excessively expansionary policies (no analysis backs this claim and the effects of a more devalued currency and commodity prices are not discussed) and suggests (p. 42) that monetary tightening is necessary. Also, the report continues the tone of the previous WEO, suggesting that in developed countries fiscal adjustment should continue to reduce the debt burden, and in developing ones, like Argentina, to avoid overheating.

So fiscal and monetary contraction is their policy advice. The IMF forecasts a significant slowdown next year for Argentina (4.6% for 2012 down from 8% this year). The logic is that Argentina’s growth is not sustainable and perhaps a crisis is around the corner.

Andrés Velasco, ex-finance minister of Chile, suggests so much in his last column for project syndicate. This notion that Argentina is close to an external crisis is peculiar to say the least. Velasco had published a paper with Ricardo Hausmann after the 2001-2 crisis that recognized that the problems were not fiscal, but related to exchange rate misalignments, export performance and access to international financial markets.

Although shrinking, Argentina still has a current account surplus, has not depended on international financial inflows (but on its own exports), and the ratio of short term external obligations to reserves is relatively small. So if the whole world economy sinks into lower growth, Argentina, that is forecasted to be the second fastest growing economy after China in 2011, will probably slowdown, but there is no reason for the macroeconomic policy to push for a slowdown for fears of an external crisis.

In that sense, it seems that the default position at the Fund, and in mainstream academic circles (Velasco was at Harvard, before returning to Chile) is that fiscal adjustment is needed in Argentina. And apparently almost anywhere in the world. The New IMF looks a lot like the old one to me!

This piece was originally published at Naked Keynesianism.