Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 20-39)

PROFESSOR MARCUS MILLER, MR DAVID WOODWARD AND PROFESSOR RICHARD PORTES

31 JANUARY 2006

  Q20  Angela Eagle: I doubt the US would listen.

  Professor Portes: We should perhaps get into that question of how the IMF deals with its major shareholders. I would point out one thing in respect of your basic question and that is that we have made progress on some of these issues, some of that led by the United Kingdom, and that is in particular in the European Union where the negotiations, which took a long time, actually got to the point of agreeing the cross-border transfer of information about bank accounts, in particular, to avoid tax evasion. It is just a very hard slog. You cannot impose that from some international organisation. It is a matter of national negotiation and we got there on that one. Also, the OECD has been involved in identifying tax havens and so forth. There is a range of international fora for dealing with these issues. I think a major problem with the Fund is that it has been drawn into too many things. One does not want to get too deeply into this one.

  Q21  Angela Eagle: The banking secrecy question did feature at its birth in terms of what Keynes wanted it to do, so it is not something new?

  Professor Portes: That is a very interesting and important point but it does remind us, too, that at its birth we had a world of capital controls, which Keynes of course strongly supported. That box is open now and it is not going to be closed up.

  Q22  Angela Eagle: Does not banking secrecy become even more important in a world without capital controls? That would be my view.

  Professor Portes: I quite agree, yes, but I think, as I say, that there are ways of going at that that do not necessarily involve the Fund trying to act as policeman.

  Q23  Mr Fallon: I want to come back to this issue of IMF reform. When the previous Managing Director, Horst Köhler, gave evidence to this committee back in July 2002, he identified as the fourth area for reform setting more of the rules for the macro-economic game, if you like, the reassessing of what can be done at the centre of our macro-economic systems. Is that reform really happening?

  Professor Portes: No, not really. You are correct to identify that as a major issue. What is the Fund's role in dealing—and Marcus Miller stressed this before too—with the global imbalances? We have seen very little. You can try to take this too far. Some people have called for the Fund to establish a set of reference exchange rates that would then be a standard by which you would evaluate whether countries are over-valued or under-valued and what policies they are to take, and so forth, to deal with that. I think that is a chimera as well, but for reasons that would take me a little more time to elaborate than I think you have. On the other hand, multilateral surveillance in accordance with some fairly basic economic principles is one of the core functions of the Fund, which it has not effectively pursued.

  Q24  Mr Fallon: I understand the surveillance, the kind of coastguard role and the lifeboat role. It is about whether it is possible for the Fund actually to develop and operate rules for the macroeconomic system without altering the articles. Is it possible for the IMF to do that?

  Professor Portes: Yes, I think so. I do not think there is any conflict or difficulty at all with the Articles on that account.

  Q25  Mr Fallon: Apart from improving surveillance, is it moving successfully in that direction in any way? Is the Medium Term Strategy taking us there?

  Professor Portes: It is not obvious to me.

  Professor Miller: I think your distinction between the surveillance role and the lifeboat role is very useful. The question arises: is there something in the middle? Richard Woodward I think is fairly sceptical. I think there is more they could be doing. For example, on the dollar, there is a very important paper by Obstfeld and Rogoff recently re-circulated which computes that there needs to be a 30% adjustment in the dollar and a big shift of demand from America to the Far East to correct the imbalances. These are two busy academics writing a paper. It seems to me there is a good case for the IMF to do this on a more regular basis and let us all know the numbers. What kind of exchange rates would be operative in a world of balance? Richard does not want them to do this. I would be quite interested if they did compute what are often known as fundamental equilibrium exchange rates. I think it would be a useful informational role. I differ from Richard on this and feel: why not have these expert economists they employ providing some calculations that we could all use? They do, of course, discuss these issues in their World Economic Outlook, so it is not as if they are doing nothing, but I feel they could do more on a more regular basis between surveillance and the lifeboats.

  Professor Portes: This is a longstanding difference between Marcus Miller and myself, you will not perhaps be surprised to know.

  Professor Miller: The person who is most keen on the fundamental equilibrium exchange rates is John Williamson. From time to time, he computes these numbers and they have often turned out to be quite useful in seeing whether countries are way out of the correct range. For example, in 1985, he was saying the dollar was far too high, and it came down. He is saying the same again now.

  Q26  Chairman: In October the Governor of the Bank of England mentioned that the big currency blocks should stop passing the buck and he called for international meetings to help agree a proper response to global economic imbalances. To what extent is the IMF the appropriate body for that?

  Professor Miller: I think that is exactly what we are talking about.

  Q27  Chairman: Should that be another function of the IMF now?

  Professor Miller: Yes, but it is largely about getting them to talk and co-operate. I do not think it is about setting rules.

  Q28  Chairman: You do not need another body for that.

  Mr Woodward: Again, the governance structure of the IMF raises real questions about that. If we are going to have those sorts of global discussions, can we have the terms of reference for those discussions being set by a body which is run by the developed countries which form one-sixth of the world's population and yet have 60% of the votes in the IMF?

  Q29  Chairman: In its present form it is not the appropriate body. Would you agree with that, Richard?

  Professor Portes: No, I would not agree. I fully accept that the current governance of the Fund is unbalanced, that the power relationships are unbalanced, and therefore that if the Fund is going to play its role properly, it has to be more equal. Given those constraints, for the time being, it has to be cognisant of that, but that does not mean that if the Fund convenes a meeting to discuss global imbalances, it should not have Brazil and China there. Obviously, it would simply not be fulfilling its role if it were to do that, and I do not believe that it would. The question is whether the major countries are willing to enter into those discussions seriously under the aegis of a relatively impartial, I think, body that also has a great deal of expertise to contribute to precisely this set of issues. May I go back for one second to the exchange rate question, because it is quite important? After all, this is one of the Fund's core defining issues. There the work that Marcus Miller was referring to is good work and it is generally right. There is a problem in trying to set up reference rates. We have FEERs, the Fundamental Equilibrium Exchange Rates; we have GS DEERs, the Goldman Sachs Dynamic Equilibrium Exchange Rates. There are all sorts of exercises like that. The issue is how fast you get to what you might define as a long-run equilibrium exchange rate. There we really have very little knowledge. We have conflicting views right now about whether the adjustment which Marcus referred to as necessary—with which I totally agree—is going to occur in the space of six months or at some point in what Paul Krugman calls "a Wile E Coyote moment". You will remember the Roadrunner cartoons: Wile E keeps running off the edge of the cliff and then suddenly he realises that there is nothing underneath him. That is one scenario, and I think that is a serious possible scenario. Another is that we have gradual adjustment, as some of our other economics models would suggest.

  Q30  Mr Love: I am not clear yet whether what is being suggested by our experts is a different role for the IMF in the sense of moving away from helping countries with adjustments where they have imbalances or suggesting exchange rates but not having a direct involvement. I want to pursue that a little. I was interested in Professor Miller's contribution to the committee when he talked about the changes over the last 10 years where quota lending has gone up significantly, 10 or 15 times, and of course that led the IMF into talking about debt restructuring and countries talking about the appropriate exchange rates. Of course what we have also seen during that period is countries like China pursuing very specifically a low exchange rate policy which has built up enormous balances for them. Some people suggest that those balances have been built up as a protection against having to go to the IMF. For all these countries building up balances so that they can, frankly, ignore what the IMF is saying to them about restructuring and their exchange rate, is there a continuing role for the IMF in that area?

  Professor Miller: As you say, there has been a lot of do-it-yourself insurance by countries, especially in east Asia. To that extent, they are finding a substitute for the IMF. It is pretty expensive. They have to save and buy American dollars and give resources to America, so it does not seem a very socially efficient mechanism. One feels it is better to have all this done centrally, as the IMF initially was set up to do. Another possibility is an east Asian mechanism. One of the papers I sent in was about the emerging of these swap agreements in the Far East that may achieve the same kind of result. I think there is panoply of different things one can do to try to cope with capital account shifts. The IMF has been meeting some competition. Frankly, I think competition is good. If the conditionality is inappropriate, as you say, get your own reserves; forget the IMF. It may be expensive but at least it is a challenge to the IMF, a challenge that may mean they change their conditionality. In general, I believe it is good to have competition. But I think it is silly for the Far East to be accumulating quite as many reserves as they are doing. I feel it is a challenge to the IMF to be more attractive as a global lender than it was a few years ago. I hope that that is what they are trying to do. There are, as you probably know, moves afoot or discussion of moves for a Country Insurance Facility to provide quick money to countries that look safe to lend to quickly. That would be, in my view, an improvement on existing resources and might economise on what we see going on in the Far East.

  Q31  Mr Love: I want to ask the question slightly differently to Professor Portes. If we assume, since the Chinese seem to have an inexhaustible supply of cheap labour coming from the country into the city, that therefore they can sustain this low exchange rate policy, assuming that the Americans will go along with it in the longer term—and of course we will get India coming along and they have not even started this process properly—does the IMF have any role with those countries, the larger countries that make come to dominate the world economy, or will it be with the smaller countries it has a continuing role?

  Professor Portes: Of course the IMF should, in principle, have a role. Marcus is absolutely right that the kinds of self-insurance that Asian countries, including India by the way which now has 100 million plus of reserves, are building up and the moves being taken, with some discussion of an Asian Monetary Fund and so on, are good for the Fund. It is good to have potential competition out there. But the Asian countries have what a distinguished Asian economist, who was in the Japanese Ministry of Finance for a brief period, said to me the other day: they have a fear of floating exchange rates and a fear of the IMF. If you put those two together, you get a build-up of reserves. I do not think it is easy to stop that. Marcus and I were discussing some recent work before we came in here that suggests that this is cost-effective for these countries. I do not buy that work entirely, but many of the Asian countries know all too well the costs of exposing yourself to the risks of financial crisis. The Chinese observed it in 1997 and 1998, and remember at about that time everybody was calling on the Chinese not to devalue. I do not think that they are doing things that are totally stupid.

  Q32  Mr Love: Short of waiting until there is going to be an abrupt adjustment where I suspect the IMF would undoubtedly have to have a role, are we talking about the IMF softening the conditions under which it wants to stop the fear of the IMF that relates back to the Asian crisis of whatever number of years ago? Is that what we are talking about or is there a negotiation that can be carried on here to get them to recognise the need?

  Professor Miller: An analogy here might be house prices. What should the Bank of England do about house prices? It does not really want to tell everyone to sell houses now because the prices are too high. It holds back and then at some stage finally Mervyn King has begun to warn people. I think house prices and the dollar are not too dissimilar. In fact, some people say that when the housing market crashes in America, the dollar will crash as well.

  Professor Portes: And conversely.

  Professor Miller: I think that is the sort of way to think about it. What would you do if you were the Governor of the Bank of England? Would you feel you knew enough about house prices to call the market exactly? or do you think you would wait until you thought it was really over-bought and then start dropping hints? I feel it may be the role of the IMF to orchestrate conferences in which people discuss the issues and maybe come to the conclusion that the dollar ought to adjust. I think the big issue is that it requires spending changes. America has to absorb less goods. A lot of the deficit is the counterpart of the US Government deficit. That is real politics and so there has to be some political realisation of the non-sustainability. Again, the IMF cannot tell America what to do but it can put the cards on the table. It is a very delicate issue. I do not think there is any magic solution.

  Q33  Mr Love: Finally, can I put Professor Portes on the spot in the sense that we know that Mr Woodward wants fairly radical restructuring of the IMF. You have accepted that there is an imbalance, that it is all the developed countries that currently have control of the IMF. What sort of restructuring do you think would be, if I can put it crudely, acceptable to the US that will sustain all of the developed countries in the IMF but give a much greater voice to the other parts of the world? Do you think there is a sustainable change?

  Professor Portes: Yes, I think the United States would be perfectly happy to accept a rebalancing of Europe as against other countries, in particular the so-called systemically important countries like Brazil, India, China and so forth. It is quite clear, if you are talking about real imbalances, that European representation is much too great in the Executive Board and very hard to justify now, especially when you have the euro and a joint monetary policy. For a number of those countries to be separately represented on the Board of the Fund does not make sense. Europe is hugely over-weighted. The US is not going to give up its blocking veto, and that is clear. That is just not on the table. We cannot expect that. I think there is a fair degree of agreement in Washington, and it goes across party lines, that a restructuring of governance along the lines I have suggested would be a good thing.

  Q34  Mr Todd: One of the core functions of the IMF is surveillance work and analyses of economic risk. Do you think that that is deployed effectively? We see reports for example on the UK by the IMF. Those of us old enough can remember that there was a time when active engagement with the IMF was a real political issue in this country, but nevertheless some time back. Are the resources deployed sensibly towards areas of highest risk or do people really just cover the ground?

  Professor Portes: That is a very good question. By the way, I once wrote a monograph entitled Crisis? What Crisis? You may remember that phrase.

  Q35  Mr Todd: I am old enough to remember.

  Professor Portes: Exactly, and the title was drawn directly from the 1976 remark.

  Q36  Mr Todd: A misquote, apparently.

  Professor Portes: I think you pose an extremely difficult question: how to rebalance, if you like, the surveillance function and where it could be focusing. I think the focus right now really does have to be on the few countries that are still at risk. Brazil is still at risk. Turkey is still at risk. These are systemically important. Those countries could be affected by the major global imbalances that we have been talking about: exchange rates and current account deficits. An adjustment of those imbalances, depending on the form it took, could have some strong impacts upon countries that are at risk. Then there are smaller countries that are also at risk. I am hesitating a bit because I am not sure about how I would go about it. That is testimony to the difficulty of the questions. Again, it is partly a matter of internal resource allocation of the Fund, but I think that the focus should be away from things that I think the Fund should not be doing and towards the issues on which you are focusing.

  Professor Miller: One idea here is competition. The problem with the Fund telling its bosses what to do is precisely that bosses do not like to hear this kind of thing from their economists. Often you find someone outside the organisation may do the job, say the OECD. One could encourage counter-assessments by the OECD as a challenge because I think there is this internal problem. I should also mention that on occasions there are problems of a conflict of interests. In these risky cases like Brazil or Turkey, the IMF is often in there as a big lender; it wants to get its money out. Sometimes its judgment and its position is suspect because of a conflict of interest. I think that is one issue that has to be taken account of, that it may not be trusted by all the parties because it is a big lender. That is unfortunate but maybe for reasons like that it is important to have some other external sources of assessment as well.

  Mr Woodward: Could I add that I think that raises fundamental questions about the central role that the IMF plays in the process of negotiating debt cancellation, that essentially we have a process for debt cancellation which is run not only by a creditor but by a creditor the majority of whose shareholders, the majority of the control, is in the hands of other creditors. In any national process you would not think of that as a state of affairs. In terms of debt cancellation, I think we need to move towards a process which is led by an organisation independent both of debtors and of creditors, or at least balanced between the two.

  Professor Portes: In what way did the Fund actually run or in any way seriously guide the debt restructuring and debt cancellation process, as you put it, for Argentina? Not at all. It goes back to what Marcus was saying: the Fund in part had a substantial conflict of interest in that situation. That was perceived by all the parties. For the Fund to go in and say, "And this is what Argentina can afford to pay, and, by the way, we are first in line" was not acceptable; it certainly was not acceptable to the Argentines, and it would not have been implementable.

  Q37  Mr Todd: What you are highlighting in this interesting little debate is that having analysed where risk lies, because the IMF is a lender as well, identifying what to do is complicated because there is an interest in it and it is complicated by the shareholder mechanism of governance of the IMF as well. Does it suggest that actually the IMF's brief of action to deal with the risk is beyond its competence or is it just that we are all adults and we all understand those complications, and then we work around them in the rather traditionally British way of doing things?

  Professor Miller: There has been a suggestion that the assessment of sustainability should be done by the IDB (the Inter-American Development Bank) precisely to avoid the conflict of interest. I do not think the IDB wants to do it. They may have to get some economists over from the IMF to help them with the task, but I think it illustrates the problem. It is a delicate problem and, as I say, I think external sources of assessment may be useful.

  Mr Woodward: Can I clarify, in the light of Professor Portes's comments? I was essentially referring, if you like, to the 1980s-style debt crisis led by government debts. The IMF plays a key role in recommending to the Paris Club what terms of rescheduling or debt cancellation should be offered. There is a very clear role. The 1990-style debt crisis where the Paris Club is not involved is a somewhat different kettle of fish.

  Q38  Peter Viggers: Dealing with the mechanistic point on the manner in which the IMF is run, do you think that it would be helpful if there were further clarity about the deliberations of the Board of Governors? There are no minutes made available, for instance. Would it be helpful if the method of decision making were less opaque, more open and more two-way?

  Professor Portes: That is an easy question to answer: yes, sir.

  Q39  Peter Viggers: Let us quit while we are ahead! Funding for the IMF has fallen and private cash flows have become more important in proportional terms. Is this a sign that the IMF is less important than it used to be or do you think there is prospectively a greater need now for the IMF and that the low level of funding actually poses a danger?

  Professor Miller: As I argued in the paper submitted at the beginning, I think it reflects a substantial change in the world, namely the liberalisation of capital movements. That has just raised the game enormously. I think it has suggested that the Fund size is not really adequate. Therefore, what has happened, in fact, is that they have tried to make bigger and bigger bail-outs until they failed. In the case of Korea, it was interesting that they found they simply could not assemble a big enough package and so the answer was to get the banks to play the game as well and to get the banks to stay in Korea, and so to get creditors to take some action. Otherwise the IMF found it was simply trying to raise enough money to allow all the big banks in the world to leave Korea at Christmastime. That is a lot of money and more than the IMF could put together and so you just persuade the banks to stay in. If it is only a liquidity crisis, then the answer is to persuade people to leave their money in Korea, which is what they did. I think there has been a shift towards getting creditors to play a much bigger role and not to have the IMF playing longstop, and I would encourage that kind of role. For the last 10 years the IMF has been trying to get creditors involved and taking losses or staying in crisis countries, if it is a short-term crisis. Another possibility is floating exchange rates, to persuade countries not to stay on fixed exchange rates too long. So there is a panoply of responses to a Pandora's Box.

  Mr Woodward: My perspective on it would be that the Fund is now facing a crisis which comes about pretty much as a direct result of its failure to deal either with the 1980s debt crisis or the 1990s financial crisis. Its membership is increasingly divided between one set of countries that, as a result of the failure still to deal with the 1980s debt crisis, are no longer able to borrow from the Fund on its normal terms. At the other end of the spectrum you have countries which are more prone to financial crises, but the Asian crisis and the Latin American crises of the 1990s shows that the instruments available to the Fund and the policy packages it has available are not equipped to deal with that, hence you have the build up of reserves, particularly among Asian economies, to prevent having to go to the Fund. So effectively you have countries which cannot afford to borrow from the Fund and countries which do not want to borrow from the Fund, but the Fund is dependent on its lending and the interest on its lending to cover its administrative costs and that risks getting squeezed out in between. In a sense this is something that could come about as a result of excessive success from the Fund, if it managed to maintain the international financial system so that nobody faced a crisis and nobody needed to borrow, but it is a result of its failures in that we have countries which either cannot afford to borrow or which are going to make every effort to avoid borrowing.


 
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