Dialogue of the Debt

Well, that was awkward. The world's leading economic authorities just gathered in Washington for a weekend session of policy glowering. Heading into the regular fall meeting of the World Bank and International Monetary Fund, there was some hope that some constructive, multilateral dialogue could defuse tensions and calm talk of currency wars. It was not to be.

What happened? The United States went into the meetings pushing for multilateral solutions, in particular an enhanced role for the IMF. In a speech at the Brookings Institution last week, Treasury Secretary Tim Geithner addressed the issue of global misalignments: "This problem exposes once again the need for an effective multilateral mechanism to encourage economies running current account surpluses to abandon export-oriented policies, let their currencies appreciate, and strengthen domestic demand."

He noted that this was part of the long-standing mission of the IMF, then went on to argue that the world's powers had already agreed to address these issues: "When the world's leaders met in London in April of 2009 and then in Pittsburgh in September that year to set a strategy for confronting the crisis, they agreed to begin work on a new "Framework" for global growth and to reform the architecture for cooperation.

The Framework... was designed to create stronger incentives for rebalancing growth, as the world recovered from the crisis, with higher savings in countries like the United States, complemented by reforms to strengthen domestic demand in surplus countries like China, other emerging economies, Germany, and Japan."

The reference to reforming architecture was where Secretary Geithner added some teeth to the U.S. stance. He linked the rebalancing of the global economy with the rebalancing of power at global financial institutions. It is not clear whether that lever will move China or any other recalcitrant countries. It is certainly no incentive for surplus European countries, who are slated to see their voting weight shrink.

There is a risk that holding up institutional reform could weaken the IMF at a time when the Treasury wants to assign it a starring enforcement role. That may not matter, though, since the IMF is much better equipped to play the role of facilitator than enforcer. It has never had success strong-arming any country that was not in dire need of a loan.

Exchange rates matter, but are largely driven by monetary policies. Business climate and regulatory policies matter, but those are crude tools for revving up the economy in the short run.

The Chinese are certainly not in dire need of a loan. Nor were they receptive over the weekend to proposals for cooperative multilateral resolutions to global economic problems. To paraphrase, China's stance was: "No. It's not our fault. It's your fault." It didn't seem to matter much what the question was; that was the answer. Nor did it seem to matter that China's policy prescriptions do not add up.

In the past, China had voiced its concerns about profligate U.S. fiscal policy. This weekend, there were explicit complaints about loose U.S. monetary policy: "Zhou Xiaochuan, China's central bank governor, told the IMF meeting the focus on currencies was one-sided. "The continuation of extremely low interest rates and unconventional monetary policies by major reserve currency issuers have created stark challenges for emerging market countries in the conduct of monetary policy."

For those keeping score, that means China is uncomfortable with the United States using either monetary or fiscal policy to stimulate its economy. Economists argue about which of those policies is more effective, but they are the two big weapons in a country's macroeconomic arsenal. Exchange rates matter, but are largely driven by monetary policies. Business climate and regulatory policies matter, but those are crude tools for revving up the economy in the short run. Telling the United States to use neither monetary nor fiscal policy to stimulate its economy seems to demonstrate petulance, rather than a well-crafted plan to address the world's economic problems.

The truly unfortunate feature of this brewing confrontation is that the policy China seems to be pursuing--gradual currency appreciation along with efforts to boost domestic demand--is not that far from the policy the United States and others would like China to pursue; slightly less-gradual currency appreciation along with greater efforts to boost domestic demand. But the Chinese refusal to acknowledge the existence of a global problem or to discuss the issues constructively is raising tensions.

China's undervalued currency is likely more damaging to China than to the rest of the world, but the perception that global adjustment processes do not work is a dangerous one. Brazil's finance minister recently expressed concerns about a burgeoning currency war, in which countries loosen their monetary policies and try to depreciate against one another. In the face of worries about global deflation, such a battle would not necessarily be so bad, if it is confined to countries shooting money at each other. As soon as they start firing trade barriers and capital controls, the casualties could mount quickly.

This weekend's meetings in Washington did little to establish safe rules of engagement.

Philip I. Levy is a resident scholar at AEI.

Photo Credit: iStockphoto/Yong Hian Li

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