Off Balance

by Paul Blustein

  4 See Timothy Adams (2005), “The U.S. View on IMF Reform,” speech presented at the Conference on IMF Reform, Institute for International Economics, Washington, DC, September 23. Available at: www.iie.com/publications/papers/paper.cfm?ResearchID=564.

  The IMF was by no means oblivious to the issue. The missions it had sent to Beijing repeatedly exhorted Chinese officials to loosen the trading band around the RMB. Led by Steven Dunaway, a Fund veteran in the Asia and Pacific Department, the missions had a tough sell. Their Chinese interlocutors liked to point out that during the Asian crisis, the IMF had been applauding them for doing exactly the opposite — keeping the RMB fixed against the dollar, to help prevent currencies in the region from plunging out of control. The Chinese were also fond of citing a handful of prominent Western economists, including some Nobel Prize winners, who contended that the RMB was appropriately valued. To these arguments, Dunaway and his team responded with a host of data showing unmistakable signs of undervaluation — notably trends since early 2002, including a fall in the trade-weighted value of the RMB, a swelling of the current account surplus from already substantial levels and rapid increases in labour productivity and competitiveness. Above all, the IMF stressed (as US officials had done) that despite the short-term political costs of lifting the RMB exchange rate, considerable benefits would accrue to China, including a stimulation of consumer spending that would make the economy less dangerously dependent on exports and low-return business investment. In its 2005 Article IV report on China, the IMF had publicly declared that evidence “points to increased undervaluation of the renminbi, adding to the urgency of making a move...greater exchange rate flexibility continues to be in China’s best interest.”5

  5 See IMF (2005), “People’s Republic of China: 2005 Article IV Consultations — Staff Report; Staff Supplement; and Public Information Notice on the Executive Board Discussion,” IMF Country Report No. 05/411, November, available at: www.imf.org/external/pubs.ft.scr/2005/cr05411.pdf.

  But that language was a far cry from a warning that the Chinese were playing fast and loose with the rules of the system. As Adams noted in his speech, the IMF managing director was empowered to initiate “special consultations” with countries that were suspected of engaging in currency manipulation, with the implicit threat that the matter would be brought to the IMF executive board, where the alleged violator could be subject to further naming and shaming. This authority, however, had only been invoked twice (both times in the 1980s), Adams pointed out, and in the absence of stern action by the Fund, aggrieved politicians — such as those in Congress —might resort to unilateral measures. Hence his conclusion: “The perception that the IMF is asleep at the wheel on its most fundamental responsibility — exchange rate surveillance — is very unhealthy for the institution and the international monetary system.”

  Adams’s remarks landed with a thud in the IMF’s executive suite, where the initial reaction was to push back hard — both in public and private.

  About an hour after Adams spoke, de Rato mounted the same dais to deliver a rejoinder. His central point was that the IMF is not the sort of institution that can exercise power by punishing or censuring its members. “The influence of the Fund in the world comes almost entirely from its ability to persuade its members that they should follow its advice,” de Rato said. “If you’re in a room with a friend you don’t need to talk through a megaphone. And I think quiet diplomacy, as some have characterized it, has produced good results, and not just in the area of exchange rates.”6

  6 Rodrigo de Rato (2006), “The IMF View on IMF Reform,” in Reforming the IMF for the 21st Century, edited by Edwin M. Truman, Washington, DC: Peterson Institute for International Economics, available at: www.iie.com/publications/chapters_preview/3870/03iie3870.pdf.

  At an even deeper level, de Rato and many of his IMF colleagues were irritated by what they saw as yet another attempt by the United States to put the burden of adjustment for imbalances on other countries — and pressing the Fund to do Washington’s dirty work. Wasn’t America’s overconsumption, low savings rate and government budget deficit just as important as China’s currency in causing the imbalances, if not more so?

  The managing director thus maintained his resolute position when he met on October 7, 2005 with Treasury Secretary Snow, who had been unhappy with the tone of Adams’s speech, but was backing up his new undersecretary on its substance. According to a memorandum of the meeting, the US representative on the IMF board, Nancy Jacklin, who also attended, made a pitch for the Fund to be “more critical in public” about exchange rate regimes such as China’s. To this, de Rato retorted that, if anything, Fund reports on China’s currency policy were “more explicit than in many other cases.” He also dismissed the idea that the Fund should pursue a special consultation with the Chinese, emphasizing this would be “extremely divisive and partisan” on the board. On that score, he was undoubtedly correct; the view in a number of major capitals was that the RMB exchange rate was not as worrisome, nor as big a factor in global imbalances, as America’s faults. Finally, the managing director stressed the need for the IMF to avoid being “seen as influenced in its action by any one country” — a thinly veiled way of admonishing the Treasury to refrain from pushing the Fund around.

  Still, no IMF managing director can go too far in defying the United States, and de Rato had a special reason for wanting to patch up his rift with the US authorities. The Fund was in the midst of its existential crisis (detailed in chapter 1), trying to sort out what its role should be in a global economy that appeared in no need of an emergency firefighter. With the IMF’s own finances imperiled by the dearth of countries interested in its loans, de Rato needed US support for his efforts to instill the institution with fresh relevance. He had issued a “Medium-Term Strategy” for the IMF in September, but it had drawn a lukewarm reception for lack of clarity and vision. If Washington perceived the Fund as useless, especially on the China issue, the necessary political backing for maintaining the Fund’s viability would wane.

  De Rato, therefore, started casting around for ways to demonstrate the IMF’s utility to the US government. “The MD [managing director] would like a better idea of what the options are,” wrote Mark Allen, director of the IMF’s Policy Development and Review Department, in an email sent to senior colleagues a few days after de Rato’s meeting with Snow. The email cited a few possibilities, including the initiation of a special consultation with China (although that, Allen observed, almost certainly lacked the necessary board support).

  “Any other bright ideas?” Allen asked.

  There were. Or at least so they seemed at the time.

  The Multilateral Consultations

  A number of IMF staffers were in the audience at a conference in Washington on February 2, 2006, where they heard an intriguing suggestion from Yusuke Horiguchi, a former Fund department head. “Many of you might say that I am talking about a pie in the sky,” Horiguchi said.

  Horiguchi’s proposal was aimed at helping the IMF define a meaningful role for itself on the global imbalances issue, which had flummoxed the Fund up to that point. Although outspoken on the imbalances — IMF reports on the global economy invariably included warnings about the risks for the dollar, as did many speeches by its top officials — the Fund was all talk and no action. De Rato had advanced one idea in September 2005 that had gone nowhere. As part of his initial report on the Fund’s medium-term strategy, the managing director urged a “multilateral dialogue” on imbalances that would take place in the International Monetary and Financial Committee, a large, notoriously cumbersome group consisting of the entire Fund membership and prone to formal speechmaking rather than give-and-take.

  A much more promising approach, Horiguchi argued, was to use the special consultation procedure in a novel way: Instead of holding consultations solely with China or any other individual country, the Fund could dispatch “special consultation missions” simultaneously to the United States, China, Japan an
d the euro zone, to discuss how each could contribute to shrinking imbalances. The consultations with the Chinese would focus heavily on the RMB, while talks with the others would focus on actions they could take — curbing the US budget deficit and raising America’s savings rate being the most obvious. The findings of these missions would be wrapped together in a “comprehensive action program” for consideration and endorsement by the IMF board, and the Fund staff would issue periodic “scorecards” to show how each economy was performing relative to its expected results — with follow-up consultations “for those economies which are judged not performing.”7

  7 I am grateful to Mr. Horiguchi for providing a text of his remarks, which were delivered at the American Enterprise Institute conference, “The IMF’s Role in Foreign Exchange Surveillance,” February 2, 2006. His idea wasn’t entirely original; a previous managing director, Michel Camdessus, had convened Latin American ministers some years before for a consultation exercise, although that was not a “special consultation” per se.

  Therein lay the core of the exercise that would eventually be dubbed the multilateral consultations. Some Fund staffers recall returning to their offices excited and convinced that Horiguchi’s idea was the way to go. Although others didn’t believe his proposal was nearly so seminal, it did share many features with the approach that the Fund eventually adopted.

  Whoever deserves credit for its intellectual paternity, the term “multilateral consultation” was appearing in internal Fund documents by early March 2006. Although the US Treasury wasn’t thrilled with the idea — it would have preferred some sort of consultations for China alone — it went along, mainly because the Fund was also starting to work on revamping its rules on currency policies. The following month, de Rato unveiled the idea in a speech, saying, “What is needed is coordinated action....Global imbalances are the problem not of just one country but of many, and we need a multilateral format for consultations to address them.”8 On April 22, the Fund membership bestowed its blessing at a meeting of its ministerial steering committee.9

  8 Rodrigo de Rato (2006), “How the IMF Can Help Promote a Collaborative Solution to Global Imbalances,” remarks at Harvard Business School, April 4, available at: www.imf.org/external/np/speeches/2006/040406.htm.

  9 IMF (2006), “Communiqué of the International Monetary and Financial Committee of the International Monetary Fund,” Press Release No. 06/81, April 22, available at: www.imf.org/external/np/sec/pr/2006/pr0681.htm.

  One key element of Horiguchi’s plan, however, wasn’t included — the assumption, by the IMF, of its role as arbiter, ready to point fingers at participants that were failing to deliver the necessary adjustments in policy. This conception of the Fund had been gaining ground in influential quarters in early 2006. Mervyn King, governor of the Bank of England, argued in a speech on February 20 that the IMF should step up to its role as “arbiter of the international monetary system…not so much the referee brandishing the yellow and red cards of the football pitch, more the cricket umpire…making it clear when they believe the players are not abiding with the spirit of the game.” His counterpart at the Bank of Canada, David Dodge, delivered a like-minded speech the following month that also invoked the “umpire” analogy as an important function that the IMF was failing to perform.10

  10 King (2006), “Reform of the International Monetary Fund”; David Dodge (2006), “The Evolving International Monetary Order and the Need for an Evolving IMF,” lecture to the Woodrow Wilson School of Public and International Affairs, Princeton, New Jersey, March 30.

  But de Rato, sensing little enthusiasm among most member countries, demurred. Taking such an “outsider” stance, he asserted, would conflict with the IMF’s ability to engage in private persuasion and foster an environment of compromise. “Should we want to keep governments at a distance at a moment in which we want to get governments inside a multilateral consultation?” he asked rhetorically at a public forum on April 20. He concluded that if the IMF did so, “then those people are not going to sit at the table. No way.”11

  11 De Rato (2006), “The IMF View on IMF Reform.”

  Small wonder, given how events unfolded over the following year, that many who were involved recall being skeptical from the outset that much would come of the “MC,” the abbreviation often used by the IMF staff in emails and correspondence. With the benefit of hindsight, it seems obvious that the talks would never advance beyond the level of finance ministry and central bank deputies, and that plans for a high-profile ministerial would be scrapped. But internal IMF documents reflect a strong sense of optimism about the concept, at least in the weeks and months immediately after the membership endorsed it. Although some top staffers warned of the need to keep expectations in check, notes of meetings show that others cited the 1985 Plaza Accord as the type of outcome the talks should aim to achieve.

  Crossing the River, Feeling the Stones

  De Rato, for one, was raring to go. He envisioned presiding over a meeting of finance ministers from the five participating economies before the end of 2006, and internal IMF memos show he asked that ministers “pencil in November” for such a meeting. On June 5, the IMF announced the five economies that would participate in the consultations, with Saudi Arabia — like China, a non-industrialized country running a big surplus — being added to Horiguchi’s list to help avoid giving the Chinese the impression that they would be ganged up on by the richer-country representatives from the United States, the euro zone and Japan.

  Also “very gung-ho” (as he put it himself in an interview) was Raghuram Rajan, then the IMF economic counsellor. Rajan supervised the drafting of a confidential briefing paper that provides striking revelations about the IMF’s ambitions for the multilateral consultations. “The staff’s broad objectives for the next six months are to persuade the five participants to renew and possibly strengthen their commitment” to reducing their respective surpluses or deficits, and “to express their intention to make a down payment on those policies in the coming year (including some upfront action if possible),” the paper said. Expressing determination to avoid the sorts of mistakes that had plagued some previous efforts at international coordination on imbalances, the paper emphasized that the goal of the multilateral consultations was “for countries to accelerate actions that are generally perceived to be in their own long run interest.”

  What, though, was in each country’s interest? There was the rub. The paper spelled out a long list of measures for possible inclusion in a final package, all of which, the Fund contended, would generate significant benefits for the individual economies that adopted them as well as for the world as a whole. But they would also have “clear political costs,” the paper acknowledged. They included “near term currency appreciation” for China, and for the United States, limiting the tax deductibility of mortgage interest costs and introducing a national sales or value-added tax.

  Gung-ho though some at the IMF may have been, the official with major responsibility for the multilateral consultations, First Deputy Managing Director John Lipsky, held the view that the Fund itself could not take too assertive a role in prodding countries to take the desired actions. “As the Chinese say, we are crossing the river by feeling the stones,” Lipsky, an American economist, said at the beginning of the first meeting of deputies — that is, high-ranking officials from finance ministries and central banks of the five participating economies — which took place in Singapore on September 18, 2006. “But let me emphasize up front that this is your consultation, and not the Fund’s,” Lipsky continued, according to a copy of his prepared remarks. “I see the Fund’s role primarily as a facilitator.”

  By that time, the outlook for the exercise was already darkening, mainly because at the Treasury, Tim Adams had a new boss who did not share his multilateralist instincts. Hank Paulson, who was sworn in as secretary on July 10, 2006, came to Washington with little knowledge of — or interest in — institutions like the IMF. Having risen to the CEO job at Goldm
an Sachs partly on the strength of his success in expanding the firm’s business in China, he intended to tackle Sino-US economic problems by going the bilateral route — not by issuing public threats but by cajoling and persuading, making the most of his deal-making skills and relationships he had developed over many years in the Chinese leadership. His attention span was congenitally short: he was acutely conscious of the limited time he had to chalk up accomplishments, given the looming end of George W. Bush’s presidency, and he had no patience for the subtle coalition building required to muster a consensus on bodies such as the IMF executive board.

  Whatever the reason, the talks never even went far enough to justify holding the ministerial meeting that de Rato had dreamed of hosting.

  At the deputies meeting in Singapore, little happened beyond a series of self-congratulatory statements by each participant about how much progress his or her own government was already making in reducing imbalances, a confidential summary of the meeting shows. Nor was much of substance achieved on the two other occasions the deputies met, in January and March 2007, both times in Paris. On both occasions, Lipsky stuck to the same unobtrusive stance he had taken when he chaired the first meeting, and US officials seemed “disengaged” or “detached,” according to internal IMF documents.

  Unbeknownst to anyone but the participants and the IMF, a crowning blow for the exercise came toward the end, when hopes were raised — and then dashed — that the talks might lead to at least a modest achievement. Chinese representatives, who at the second meeting had appeared to accept a change in the method of setting the RMB exchange rate that offered improved prospects for a rise in the currency, refused to make a formal commitment when the time came to draft a final document. They insisted on inserting watered-down wording into the document when it was circulated for all parties to sign. Lipsky implored them to reconsider: “I worry that if [the original] phrase is not included, it will represent a serious disappointment to the other participants,” he wrote in a March 28 letter to Hu Xiaolian, deputy governor of the People’s Bank of China.