The International Monetary Fund (IMF) is the world's central organisation for international monetary cooperation. It is an organisation in which almost all countries in the world work together to promote the common good.
The IMF's primary purpose is to ensure the stability of the international monetary system—the system of exchange rates and international payments that enables countries (and their citizens) to buy goods and services from each other. This is essential for sustainable economic growth and rising living standards.
The IMF was conceived in July 1944, when representatives of 45 governments meeting in the town of Bretton Woods, New Hampshire, in the northeastern United States, agreed on a framework for international economic cooperation on a post-World War II economic environment. They believed that such a framework was necessary to avoid a repetition of the disastrous economic policies that had contributed to the Great Depression of the 1930s.
During the 19302s attempts by countries to shore up their failing economies—by limiting imports, devaluing their currencies to compete against each other for export markets, and curtailing their citizens' freedom to buy goods abroad and to hold foreign exchange—proved to be self-defeating. World trade declined sharply, and employment and living standards plummeted in many countries.
Seeking to restore order to international monetary relations, the IMF's founders charged the new institution with overseeing the international monetary system to ensure exchange rate stability and encouraging member countries to eliminate exchange restrictions that hindered trade. The IMF came into existence in December 1945, when its first 29 member countries signed its Articles of Agreement. Since then, the IMF has adapted itself as often as needed to keep up with the expansion of its membership of 187 countries as of July 2010 (if we consider that there 192 member countries of the United Nations...it means that the world as a whole has agreed to be governed by the IMF) and changes in the world economy.
The IMF under Article IV - Obligations Regarding Exchange Arrangements and in Section 1. General obligations of members point (iii) clearly defines that...I quote 'avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members'
One of the main issues regarding the imbalances of 'China's Huge Trade Surpluses' vis-a-vis 'US Huge Trade Deficits' is related to the perception that China (an IMF member) is manipulating its currency in a sort of 'Beggar-Thy-Neighbour Policy' of currency manipulation.
Paul Krugman's in his New York Times column has brought this issue to the forefront in a recent short and very convincing article entitled 'Chinese Rumbles'.
2. Beggar-thy-neighbour predatory currency manipulation?
It has long been recognized that the global financial structure — built as it is around the dollar as the world’s reserve currency — has a fundamental design flaw that makes it inherently unstable. The problem was first identified back in the early 1960s by the Belgian-American economist Robert Triffin, in 'Gold and the Dollar Crisis.'
Such policies attempt to remedy the economic problems in one country by means which tend to worsen the problems of other countries.
The term was originally devised to characterise policies of trying to cure domestic depression and unemployment by shifting effective demand away from imports onto domestically produced goods, either through tariffs and quotas on imports, or by competitive devaluation. The policy can be associated with mercantilism and the resultant barriers to pan-national single markets.
An obvious example, is the use of tariff barriers. A country may place tariff on imports to help promote local domestic industry. This may help local unemployment, but, be at the expense of the other country's export sector. Another example is the manipulation of exchange rates...keeping them artifically low in order to help exports.
There is one problem though with Paul Krugman's and the US government 'simple and clear argument'...and that's related to the US $ being the de-facto 'world reserve currency'.
A reserve currency, or anchor currency, is a currency which is held in significant quantities by many governments and institutions as part of their foreign exchange reserves. It also tends to be the international pricing currency for products traded on a global market, and commodities such as oil, gold, etc.
This permits the issuing country to purchase the commodities at a marginally lower rate than other nations, which must exchange their currencies with each purchase and pay a transaction cost. For major currencies, this transaction cost is negligible with respect to the price of the commodity. It also permits the government issuing the currency to borrow money at a better rate, as there will always be a larger market for that currency than others.
3. The 'Triffin Dilemma'
The IMF under Article IV - Obligations Regarding Exchange Arrangements and in Section 1. General obligations of members point (iii) clearly defines that...I quote 'avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members'
One of the main issues regarding the imbalances of 'China's Huge Trade Surpluses' vis-a-vis 'US Huge Trade Deficits' is related to the perception that China (an IMF member) is manipulating its currency in a sort of 'Beggar-Thy-Neighbour Policy' of currency manipulation.
Paul Krugman's in his New York Times column has brought this issue to the forefront in a recent short and very convincing article entitled 'Chinese Rumbles'.
2. Beggar-thy-neighbour predatory currency manipulation?
It has long been recognized that the global financial structure — built as it is around the dollar as the world’s reserve currency — has a fundamental design flaw that makes it inherently unstable. The problem was first identified back in the early 1960s by the Belgian-American economist Robert Triffin, in 'Gold and the Dollar Crisis.' Such policies attempt to remedy the economic problems in one country by means which tend to worsen the problems of other countries.
The term was originally devised to characterise policies of trying to cure domestic depression and unemployment by shifting effective demand away from imports onto domestically produced goods, either through tariffs and quotas on imports, or by competitive devaluation. The policy can be associated with mercantilism and the resultant barriers to pan-national single markets.
An obvious example, is the use of tariff barriers. A country may place tariff on imports to help promote local domestic industry. This may help local unemployment, but, be at the expense of the other country's export sector. Another example is the manipulation of exchange rates...keeping them artifically low in order to help exports.
That's the key argument here as the US is very critical of China's low exchange rate. The US argues that it increases Chinese growth at the expense of a US trade deficit.
There is one problem though with Paul Krugman's and the US government 'simple and clear argument'...and that's related to the US $ being the de-facto 'world reserve currency'.
A reserve currency, or anchor currency, is a currency which is held in significant quantities by many governments and institutions as part of their foreign exchange reserves. It also tends to be the international pricing currency for products traded on a global market, and commodities such as oil, gold, etc.
This permits the issuing country to purchase the commodities at a marginally lower rate than other nations, which must exchange their currencies with each purchase and pay a transaction cost. For major currencies, this transaction cost is negligible with respect to the price of the commodity. It also permits the government issuing the currency to borrow money at a better rate, as there will always be a larger market for that currency than others.
3. The 'Triffin Dilemma'
Writing about Europe’s accumulation of dollars, he argued that the system carried the seeds of its own destruction. Foreigners could acquire dollars only if the United States ran current account deficits — that is, spent more than it earned. But lending money to someone who lives beyond his means has obvious dangers, and the same is true of countries.
Thus, the American deficits necessary to supply dollars to the world for international transactions simultaneously undermined confidence in the currency. It was only a matter of time, Triffin predicted, before the system would be hit by a crisis — which it duly happened in 1971 when President Nixon ended the dollar’s convertibility into gold.
Whereas Triffin had been primarily concerned about the European accumulation of dollars, the spotlight is now on Asia. In the wake of the 1997 financial crisis there, countries in East Asia set out to build up war chests of dollars as insurance against domestic banking runs or downturns in the global economy. At about the same time, China embarked on a program of export-led growth, engineered by keeping its currency artificially low.
The Main Point of Triffin's Dilemma is...
The use of a national currency as global reserve currency leads to a tension between national monetary policy and global monetary policy. This is reflected in fundamental imbalances in the US balance of payments, specifically the current account.
The dilemma is reflected in that:
In order to meet the world demand for the reserve currency dollars must flow out of US, but
In order to maintain a stable value of the US $, dollars must flow into the US, but
Both can't happen at the same time.
This relationship forces most of the governments into a strict budgetary discipline. Too large a budget deficit and you will end up with inflation as well as a large external account deficit. Currency reserves are finite and eventually you need to cut back on your external deficit as well as budget deficit to balance your accounts.
4. The US 'Free Lunch'...time is running out?
There is one exception. If your external account can be funded by simply printing more money, you can keep on spending indefinitely as long as the world is willing to accept your currency as good money. Large trade deficit? Simply print more dollars and pay it off. Large budget deficit? Issue more treasuries that will be bought by your suppliers with the dollars you gave them. This cycle suited everyone, especially the US.
The real gain for the US in this arrangement comes from the fact that as an issuer of currency of the world, it can create wealth at the expense of everyone else...IN A NUTSHELL THE US 'FREE LUNCH' It has been done before, particularly in the medieval economies when public finances in the current sense of the phrase did not exist, Princes had to borrow and repay debts like everyone else; except that they had the right to issue currency. Adam Smith pointed this out more than 200 years ago in Wealth of Nations:
…the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees diminished the real quantity of metal, which had been contained in their coins… By means of those operations, the princes and sovereign states… were enabled, in appearance, to pay their debts and fulfill their engagements with a smaller quantity of silver… their creditors were really defrauded of a part of what was due to them.
This applies to the world even today. In the short term, an abundant supply of dollars does not seem to have any impact. But in the longer run, people are defrauded as true value of the currency falls on a continuous basis. In fact, if you measure the value of dollar against a more enduring store of value, precious and base metals, the dollar has been debased quite drastically over past few years. It has also taken a lot of other currencies down with it, ensuring that the loss of real wealth is not limited to dollar alone.
The 'world reserve' status of the US dollar created a demand for it, but through this, it also created a glut of Treasury bond holdings in foreign central banks, and an unserviceable national debt in the US. The combination of removing the dollar from the gold standard (President Nixon in 1971) in tandem with gaining world reserve advantage allowed the US government (along with central bankers) to create the most precarious illusory fiat currency in history.
Could this process continue indefinitely? It's possible, but only if the demand for dollars continues to rise annually. As long as people want dollars in greater and greater amounts, the US could simply continue to expand its debt...well into infinity and beyond!...but what happens if demand for the dollar falls, or disappears entirely? The massive liabilities the US has already accrued will no longer have the crutch of perpetual Treasury investment. The US would no longer receive the busloads of foreign capital needed to continue functioning. The system the US has staked its future would just disintegrate.
Anyone who uses common sense would easily conclude that it is highly unreasonable if not outlandish to expect that other countries will continue to pump more and more money every year into what's a very unstable system. Eventually, every undisciplined debtor hits a state of critical mass; a point at which he runs out of options in extending his ability to outrun bankruptcy.
We are seeing this right now in the U.S., most prominently in municipal debt in states such as California and Illinois. These are not just 'local problems'...the growing insolvency in states is a direct reflection of the growing insolvency in the Federal Government.
Enter IMF's SDRs- The Chinese Proposal to the 'Triffin Dilemma'...to be continued
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