Off Balance

by Paul Blustein

  Having covered half a dozen decades of institutional history from a wide perspective, this narrative is set for a turn to a much greater level of granularity. The chapters that follow examine two institutions in depth, showing how they have fared at a time of both highly mobile international capital and flagging American hegemony.

  4

  A Flop and a Debacle

  Prematurely Uncorking the Champagne

  Meetings of the IMF’s executive board, which typically take place several times a week, are almost invariably dull and stilted. By tradition, the outcome is agreed by consensus, having been negotiated beforehand, when the 24 people who represent the Fund’s 187 member countries gather in a 60-foot-long, oval-shaped chamber on the twelfth floor of the Fund’s headquarters. As a result, drama and tension are virtually unknown in these conclaves. Votes are uncommon; the meeting chairperson, who is the managing director or one of the deputy managing directors, usually ends the discussion with a summing-up that has been scripted in advance.

  On the morning of June 15, 2007, a rare phenomenon — excitement — permeated the boardroom. The directors were meeting to consider a hotly contested change in IMF rules by which the Fund would assess member countries’ exchange rates, the purpose being to prod countries to take action when their currencies were seriously under- or overvalued. News stories at the time reported that the decision was approved over the objections of the Chinese and a couple of others.1 What wasn’t revealed was how suspenseful the meeting was — and how discordant.

  1 See “China Cool to IMF Policy Shift” (2012), Montreal Gazette, June 21; Krishna Guha (2007), “IMF Set to Scrutinize Exchange Rate Policies,” Financial Times, June 19.

  A preliminary vote count circulated among IMF staffers on the morning of the meeting underscored the enormous uncertainty that prevailed about the final result. Based on the known opinions of executive directors, including written statements submitted for the record in advance, nine chairs holding a little over half the voting power favoured approval; they represented the G7 major industrial countries (which usually forged common positions), plus directors representing constituencies of countries led by Switzerland and Australia. But nine developing-country directors holding 25 percent of the votes were opposed, and others expressed reservations about “hasty adoption” of the decision. The top IMF officials who were responsible for drafting the proposed new rules hoped to win approval, but did not want to force a vote without overwhelming support; a narrow victory on such a contentious issue would be disastrously divisive. An email sent on the morning of the meeting by senior staffer Carlo Cottarelli warned, “As many of the supporters are unhappy to go ahead without broader consensus, we may not even have 50%.”

  The support of the director representing China, Ge Huayong, was clearly unobtainable. The Chinese government had no doubt that it was the main target of the proposed new rules, which envisioned applying the term “fundamental misalignment” to currencies judged to be egregiously out of line with underlying economic conditions. Chinese officials were, therefore, going to extraordinary lengths to stave off approval of the proposal, arguing that it was being rushed and needed further consideration. A few hours before the start of the board meeting, the People’s Bank of China had summoned the Fund’s Beijing representatives and handed them a letter, signed by Governor Zhou Xiaochuan, addressed to IMF Managing Director Rodrigo de Rato, who received it by email on the morning of the meeting. “The Chinese government expresses her deep concern over the Fund’s intention to call the Board of Directors to vote,” the letter said. “Such action will break the Fund tradition of passing major decisions based on broad consensus, and will also impair the cooperative relations between the Fund and its members.”

  But de Rato, a former finance minister of Spain, was determined to push the proposal through that day, provided he could reduce the number of “no” votes to a small fraction of the total. He was under intense pressure from the US Treasury, which was as eager to see the RMB designated as fundamentally misaligned as the Chinese were to avoid it. Moreover, he could legitimately claim that the issue had received lengthy consideration; the board had first met to discuss it almost a year earlier, in the summer of 2006, and IMF staff had written several long papers explaining the rationale and offering various formulations. So at 11:30 on that Friday morning, he called the board to order.

  Among the first to speak was Meg Lundsager, the executive director for the United States. She emphasized that in the process of drafting and re-drafting the proposed decision, the managing director and his staff had “made exceptional efforts to accommodate concerns” raised by some other countries. “We should finish this today,” Lundsager concluded, according to a written record of the meeting. Her stance drew hearty endorsement from several directors, including those from Canada, France and Japan, and a Finnish director representing the Nordic countries. But it met with strong resistance from a group of developing countries led by Shakour Shaalan, an Egyptian representing a constituency of 13 mostly Middle Eastern countries. Shaalan acknowledged that the “pro” forces had offered many concessions, but so had his group, and they still weren’t fully satisfied. “We have some further work,” he contended, a view supported by directors from major countries such as Brazil and India.

  A lunch break that started just before 1:00 p.m. stretched for three hours as staffers scrambled between offices with hastily written provisions that, they hoped, would appease most of the opponents without watering down the proposed rules so much as to anger the Americans and their allies. The most important compromise involved moving the words “fundamental misalignment” to a less prominent part of the text; another, which was drafted by the Brazilian executive director, Paulo Nogueira Batista, involved rewriting the preamble to make clear, beyond any doubt, that the rules did not impose any new obligations on member countries. When the board reconvened at 4:00 p.m., de Rato read out the proposed amendments, and as one director after another expressed support, it became evident that China would be nearly isolated in opposition.

  In a desperate bid for time, Ge asked for an adjournment until Monday, so as to give directors an opportunity to consult with their capitals. “There is no reason to rush to conclude at the end of this meeting,” he said. Ordinarily such a request is granted as a matter of course — but not this time, to the shock and discomfort of some of those present, who saw the episode as adding insult to Beijing’s injury.

  De Rato was deeply concerned that the fragile coalition now supporting the proposal might come unstuck. After conferring briefly with aides, he said he would adjourn the meeting only if all directors agreed. Lundsager immediately said she would not, arguing that as members of a resident board they were supposed to be decision makers, and several others echoed those sentiments, including Japan’s Shigeo Kashiwagi, who noted humorously that this meeting was his last as an executive director so he would like to see the matter finalized. When the roll was called, only Shaalan and a director from Iran joined China’s Ge in voting no.2

  2 Shaalan later requested that his vote be changed to yes.

  That evening, de Rato summoned to his office the coterie of staffers who had worked closely with him on the decision. To their pleasant surprise, the managing director poured champagne and toasted their triumph — yet another rarity on an already exceptional day.

  The cliché about prematurely uncorked champagne applies literally, and with force, in this case. The “2007 Decision on Bilateral Surveillance over Members’ Policies,” as it was officially known, would end in one of the most embarrassing debacles in the IMF’s history. To this day, passions run high among the IMF policy makers and those from the main countries involved in the decision. Some IMF economists describe the 2007 decision as the worst policy blunder they can recall in their careers, a shameful example of the Fund allowing the United States to bully it. The opposite view, espoused by some US officials and scholars, is that Chinese pressure kept the IMF from anywhere near as far as it s
hould have. Both of these interpretations, though supported to some extent by the evidence, miss key elements of the story — in particular, a spirited effort to make the Fund adopt a more even-handed, “symmetrical” approach to its dealings with member countries. But even those who defend the decision as well-intentioned, acknowledge the dreadful errancy of its eventual course.

  A Saga with Relevance

  The meeting recounted above is one episode in a saga full of twists and turns, which are detailed in this chapter and the next, regarding the IMF-led initiatives to address global imbalances in the years prior to the Great Crisis. In addition to the 2007 decision, these initiatives included the “multilateral consultations,” in which the IMF convened representatives of five major economies — the United States, China, the euro zone, Japan and Saudi Arabia — to discuss plans for shrinking imbalances.

  News reports and scholarly commentary have long made clear that neither of these initiatives ended well.3 The 2007 decision came to naught because Chinese officials effectively blocked efforts to label the RMB with the term “fundamental misalignment”; Beijing repeatedly staved off the Fund’s annual assessment (the so-called Article IV report) of the Chinese economy. As for the multilateral consultations, when they concluded in April 2007, the plan released by the five participants was derided in the media as essentially a restatement of commitments they had made already — notwithstanding the Fund’s efforts to depict the talks as successful.

  3 See Scheherazade Daneshkhu (2007), “Big Economies Renew Vow on Imbalances,” Financial Times, April 16; Bob Davis (2009), “An Empowered IMF Faces Pivotal Test,” The Wall Street Journal, March 31; Alan Beattie (2009), “IMF in Discord over Renminbi,” Financial Times, January 26; Edwin M. Truman (2009), “The International Monetary Fund and Regulatory Changes,” Working Paper 09-16, December, Washington, DC: Peterson Institute for International Economics; Chris Giles, Christian Oliver and Alan Beattie (2010), “Pledges Stir Uneasy Sense of Deja Vu,” Financial Times, November 12.

  But behind these basic, publicly known facts lies a much richer tale that reveals the depths to which these undertakings sank, as well as the heights to which hopes occasionally soared that they might lead to breakthroughs in the governance of the global economy. This chronicle of events provides a substantial amount of new evidence to explain how and why these efforts went awry. It recounts a number of episodes that were previously secret, as well as new details about key turning points that have been only hazily understood. In the process, it helps illuminate the trouble besetting international coordination in general, and the weaknesses of the Fund in particular. A lengthy retelling is required to do justice to the machinations, which are often suggestive of the aphorism about sausages and laws: “Better not to see them being made.”

  Each of the IMF’s initiatives took different approaches to the issue — roughly analogous to a parent who tries to settle differences among several unruly children by telling them, “we can do this the nice way, or the not-so-nice way.” The nice way was the multilateral consultations — a collaborative exercise, based on the idea of bringing policy makers from a number of countries together to tackle a common problem, the theory being that they would be more likely to grasp the value of acting in concert and might find it politically easier to strike a bargain. The not-so-nice way was the 2007 decision, an exercise in devising rules for the international system, with provisions to clearly identify violators in the hope of inducing compliance.

  But both initiatives ran up against cold, hard facts: First, the governments of sovereign nations — especially big and powerful ones — can’t be compelled to act in the global interest. Indeed, ruling elites sometimes resist taking such action even when their own people broadly stand to benefit, often because they have political motives for avoiding measures that might incur short-term adjustment costs. Second, international institutions such as the IMF have little leverage over major countries, or even minor ones, other than those to whom they are lending money. If anything, these institutions are often obliged to indulge the wishes of, and avoid offending, their biggest shareholders. To stretch the parent-child analogy a bit further, countries are typically too surly for the “nice” approach, and institutions too timid for the “not-so-nice” one. Obvious as these facts may seem, their robustness can only be appreciated through an in-depth examination of failures such as the two chronicled herein.

  Historical interest is far from the only reason for exploring the inner workings of the IMF in granular fashion. The failures of the 2007 decision and the multilateral consultations are profoundly relevant to the efforts currently underway in the G20 to deal with imbalances. G20 leaders have established a Mutual Assessment Process (MAP), which incorporates both elements of rule making and the “let-us-reason-together” approach. Periodic summits of leaders and gatherings of finance ministers are supposed to help generate pressure for collective action toward lower imbalances; additional pressure will presumably come from the use of “indicators” to help highlight which countries are making progress toward the goal and which are not. Thus, a thorough account of the pre-crisis initiatives, and scrutiny of what went wrong, is essential to informing the public debate about whether the G20 is on a more promising track.

  Viewed more broadly, this tale is a parable about why international coordination so often proves elusive, whether the issue at stake involves macroeconomics, or financial regulation, or trade, or the global environment, or security-related matters. Underlying both the 2007 decision and the multilateral consultations were theories about how to improve the workings of the global system that, while hardly uncontroversial, were eminently defensible. Perhaps not everything that could have gone wrong with these initiatives did, but a lot did, and a retrospective shows how tricky it is to keep even the most reasonable-sounding exercises in multilateral diplomacy from going off course.

  In these pages, the multilateral consultations receive considerably less attention (at the end of this chapter) than does the 2007 decision, which is the subject of chapter 5. Not surprisingly, the “not-so-nice” approach involves greater drama, with the story taking tragicomic turns as the IMF quails from applying the “fundamental misalignment” label in country after country.

  The 2007 decision is also more revealing, in particular with regards to how the decline in US power has eroded Washington’s capacity to exercise leadership and work its will in the global economy. As we shall see, the US Treasury did attempt to intimidate the Fund, but ultimately got nowhere. Even when the United States got its way — as it did at the June 15, 2007 meeting of the IMF board — its victories were short-lived and hollow. One particularly ignominious example was a series of events in August and September 2008, just as the crisis was approaching full fury. The Fund staff prepared an Article IV report on China that included an accusation of fundamental misalignment. But the report was never released publicly, because after Lehman Brothers went bankrupt on September 15, the effort to label the RMB was abandoned — for the obvious reason that picking a fight with Beijing at that particular juncture would have been foolish in the extreme. Washington desperately needed Chinese cooperation in quelling the turmoil.

  Before delving into these developments, however, it is necessary to recount the circumstances that engendered both of the IMF initiatives. Their origins can be traced to the fall of 2005, an unusually tense period between the Fund and its largest shareholder.

  Bright Ideas Needed

  Among international economic policy makers and experts, the phrase “asleep at the wheel” evokes fond memories for some, bitter ones for others. Whether positive or negative, its impact was resounding. It was used by Timothy Adams, the US undersecretary of the Treasury for international affairs, in his first major speech after being named to his new post in August 2005. An earnest 43-year-old with an all-American demeanour, Adams wanted to say something meaningful and noteworthy for his debut on the international stage, which was to take place at a conference about the IMF. So when
he tasked one of his staffers, Robert Kaproth, with drafting the speech, Kaproth obliged with a draft using the incendiary phrase to chastise the Fund. The harshness of the wording generated consternation among others on Adams’s staff, and the undersecretary knew that his boss, Treasury Secretary John Snow, favoured much more measured language, especially in public. But Adams resolved to keep the wording, and delivered the speech without consulting or even informing the amiable Snow about the passage in question.

  The speech, delivered on September 23, 2005 at the Institute for International Economics in Washington, DC, was a broadside aimed at the IMF’s handling of China’s foreign exchange rate, although China was not mentioned by name.4 To Adams and his Treasury colleagues, China’s currency policy was exactly what the founders of the Fund had in mind when they wrote rules aimed at preventing a recurrence of the beggar-thy-neighbour conflicts of the 1930s. (The Chinese authorities had briefly appeared set on a new course in July 2005, when they lifted the value of the RMB by about two percent and began to allow it to move more flexibly, but the rate of appreciation had been tiny thereafter.) Whether or not China’s exchange rate was depriving millions of Americans of their jobs, as some in Washington were claiming, it struck the Treasury team as a classic malfunctioning of the international monetary system. And Adams, a staunch internationalist in an administration with a penchant for unilateral action, wanted to see the Fund take up the cudgels. He was acutely aware that Washington’s incessant harping and browbeating was likely producing a counterproductive effect in Beijing, and if Congress got so carried away as to impose sanctions, the result could be ruinous. Multilateralizing the issue, using agreed rules and a re-energized IMF, was both the principled way to go and the most likely to work — on that, Adams was prepared to try to make his mark as a financial diplomat.