Can The US Save The World? (House Testimony)

Yesterday I testified to the House Subcommittee on International Monetary Policy and Trade (part of the House Financial Services Committee).  The hearing’s title was “Implications of the G-20 Leaders Summit for Low Income Countries and the Global Economy,” and the main topic was whether Congress should support an extra $100bn for the IMF that the Obama Administration agreed at the G20 summit in early April (witness list, webcast, and written testimony).

The committee was mostly in favor of the US continuing to play a leading role in supporting the IMF, but pressed the witnesses to explain whether the IMF could lose this money (highly unlikely), how this would protect American jobs (definitely, but hard to quantify precisely), and if the broader package of IMF reform should also be supported (e.g., the proposed gold sales are being reassessed, to see they could generate more resources for aid to developing countries).

Politico is reporting that US funding for the IMF is likely to be attached to the war supplemental spending bill.  The subcommittee’s chairman, Gregory Meeks, seemed positive – as did all the Democrats who spoke, along with Gary Miller, the Ranking Member/Senior Republican.  But, based on remarks made by at least two Republican members of the subcommittee, there is likely to be a big public fight at some point.  My guess is that the Democratic side will press hard for President Obama to more publicly explain why supporting the IMF (and the G20) is very much in the US interest.

The main points from my written testimony are below.  While Treasury represents the US vis-a-vis the IMF and traditionally has considerable scope for action, the views of Congress on IMF details are very important as both guidance and constraints.  In our advice on the wide range of IMF-related issues below, both I and the other witnesses laid out broadly similar views with varying emphasis – there was actually much more disagreement among committee members than at the witness table.

Main points

Low income countries have been severely affected by the global economic downturn.  Many of the worst consequences, including on the poorest people, have yet to be felt.

In that context, by contributing to the stabilization of the world’s financial system, the G-20 summit had a positive effect.  However, it left open a large number of important issues, some of which call for immediate congressional attention.

First and foremost, low income countries need to receive considerable additional resources in order to weather the crisis.  This crisis is not of their making and, prior to this shock, poorer countries were making considerable progress along the lines of implementing exactly the policies advised by richer countries and the International Monetary Fund (IMF).

The IMF has adapted its standard forms of conditionality to current circumstances.  The goal of protecting core social spending is commendable and long overdue, and the implementation in recent East European and Pakistan programs is encouraging.  However, the retreat from structural conditionality has probably gone too far and needs to be reappraised; the weaknesses of low income countries arise from and are manifest in disproportionate power of key individuals or sectors, and this needs to be addressed in a transparent manner wherever the IMF is engaged.  In situations where such issues have been taken on board – as with transparency for extractive industries – the reception among civil society has been very positive.

The potential US legislative package (including IMF gold sales, its new income model, and $100 billion for the New Arrangements to Borrow) is worth serious consideration but also needs careful congressional review.  The $250bn issue of Special Drawing Rights is a bold move which, while it involves some risks, is well worth taking – hopefully, this will be regarded as a pilot project for potentially larger increases in resources for troubled countries, on an “as needed” basis.

The G20 called for $6 billion of additional concessional resources from the Fund over the next 2-3 years for Low Income Countries, including some vague phrasing on money from gold sales. So far, the gold piece of this puzzle remains stalled at the level of the IMF’s executive board.  More transparency around board discussions on this and other items would reveal who is holding up change and for what reason.

Providing additional resources to low income is a very good idea, and increasing the resource flow from and through the IMF is timely and appropriate.  If these resources can come from “extra” proceeds from gold sales, that would be an attractive solution – particularly as the income model needs some adjustment in the light of (a) the increase in Fund lending over the past 12 months, and (b) the introduction of the Flexible Credit Line, which offers the promise of Fund revenue even during quiet times for the global economy.  However, it is too early to determine how profoundly the Fund’s income model will be affected by this crisis and how the world responds.

As long as the Fund lends at concessional rates to low income countries (and the relevant, Poverty Reduction and Growth Facility interest rate is only 0.5% per year currently), loans may be attractive relative to grants – the key issue is the resource flow that is available, i.e., does lending allow more transfers in a meaningful and sustainable manner.  Avoiding unsustainable debt burdens is of course of paramount importance.

Most important, we should take all available actions to shore up low income country defenses against this crisis.  We should also guard against any form of complacency.

For that reason, it is most important that the IMF be authorized to restore its budget to its early 2008 level (i.e., before the 15-20% across the board cuts were implemented).  Cutting the budget and letting go some of the most experienced IMF staff was the unfortunate result of gross macroeconomic negligence at the level of leading industrialized countries, including the US and its G7 partners.  At the same time as the IMF was warning, clearly and firmly, that a global crisis was developing, major shareholders pushed through budget cuts that resulted in some of the IMF’s best people leaving the organization.

Undoing the budget cuts would be embarrassing to leading European countries, but it should fine support from the Obama Administration – after all, it was their idea to make increasing IMF resources a central issue at the recent G20 summit.  The IMF simply does not currently have sufficient skilled staff to undertake all the important tasks it has been asked to handle.

The G20 summit effectively agreed to end the European monopoly on the position of Managing Director at the IMF.  Since the summit, there has been some indication of backsliding on this issue, but assuming that European countries can be kept to their commitments, this would be a major step in the right direction.  Given that the next leadership change is likely to take place in a little over a year, identifying and supporting sensible candidates from emerging markets would be most constructive.  If an Indian or a Brazilian, for example, could be brought in as Managing Director, that has the potential to greatly expedite the rebuilding of the IMF’s legitimacy and its engagement throughout the developing world.

Unfortunately, IMF credibility has been somewhat damaged by its inability to follow through on exchange rate surveillance, particularly with regard to China.  While there seems to be a movement towards implicit agreement among leading countries, in and around the G20, to take this issue of the table, that would be a serious mistake.  Countries must not think that competitive devaluation (or even sustaining accidental undervaluation) is a sensible or attractive policy.  This will lead to greater global imbalances and potential instability, as some countries compete to get current account surpluses and other countries – willingly or not – run deficits.

Unless and until countries are assured that there is an effective international lender of last resort, they will be tempted to try to accumulate large amounts of reserves.  This creates problems for reserve currency countries (e.g., the United States) as well as for the global system as a whole.  We need an international system that can handle these issues and prevent them from becoming destabilizing.  The IMF should be given another chance to show that it can help run the global system in a constructive fashion.  This is of paramount importance for the United States and for everyone who wants to participate in an open international trading system – particularly low income countries, which have few other opportunities to grow and which remain highly vulnerable to shocks of all kinds.

By Simon Johnson

27 responses to “Can The US Save The World? (House Testimony)

  1. More like…

    Can the U.S. save itself?

    or…

    Can the U.s save the world from itself?

  2. “Unless and until countries are assured that there is an effective international lender of last resort, they will be tempted to try to accumulate large amounts of reserves. This creates problems for reserve currency countries (e.g., the United States) as well as for the global system as a whole.”

    The statement of the problem is correct, but the competition for current acount surplus is not entirely driven by aversion to instability. Currency, as a store of wealth, allows countries to conduct intertemporal “trade” with themselves by creating obligations from other countries to deliver future value in exchange for present value. Thus, holding foreign currency is a form of savings and insurance.

    The argument for the IMF you present above – that currency-holding should be replaced by access to IMF loans – is precisely the argument for a credit-based economy instead of an economy that is (somewhat more) cash based. Yet there is a need for both credit and cash, and there’s no proof that countries which accumulated dollars would have chosen to instead consume more if there had been a better-behaving IMF.

    Indeed, the US ultimately takes the blame for abusing its status as reserve currency by allowing its currency to remain so inflated – and trusting in a pure free-trade and free-markets approach to trade. The best defense a reserve currency has against being overvalued is to actively manage its currency down – but in the US, we were told that an overvalued dollar was a sign of strength and we therefore enacted policies that encouraged consumption.

    The IMF, as one of the main advocates of tearing down trade barriers, helped facilitate the US’ self-destructive behavior. As part of its new role, the IMF needs to reconsider how and when countries should actively manage their currency – rather than providing the blanket answer “never”.

  3. I was wondering if Dr. Johnson could address the issue of whether no-strings-attached low-interest loans from sovereign entities to poorer countries compete with the IMF’s debt programs and therefore undermine the goals of persuading developing nations to take its good policy advice through the conditionality of the soft loans.

    I’ve recently read some articles about China’s extension of monies to African commodity exporters, and it seems increasingly clear that these “no questions asked” loans are approaching a conspiracy between China and a poor nation’s oligarchy to strip a nation of it’s natural wealth at the expense of its population and environment.

    The IMF tries to condition credit on the enactment of enlightened principles, but are such efforts futile in the face of such a huge and hungry independent operator?

  4. Alternatively, can the world save the U.S? More specfically, are there any credibile scenarios where the U.S. require a loan from the I.M.F.?

  5. tippygolden

    Or put another way:

    Can the world save the U.S. from itself?

  6. Since Moody’s is threatening to downgrade the US Bond rating, is this the right time to dole out another $100 billion in bailouts?

    The Obama Administration seems to think there is a long hidden cavernous money pit stocked full of green in the back yard at Fort Knox.

    That is of course if you believe that Obama actually wants to improve our economic situation. There are others of course who believe that Obama is following the ideas of follow community organizers Richard Cloward and Frances Piven who in a 1965 issue of Nation laid out a strategy of socialist takeover through the manipulation a series of “orchestrated crisis”. Much like it would be a shame to let a good crisis go to waste.

    The jury is still out. But with so many radical assaults on the rule of law, egregious spending and abandonment of our foreign allies, one has to wonder.

  7. Simon asks – “can the US save the world?”

    To which I can only say – I have my doubts.

    And I remain astonished that the government that has been viewed these last few decades as “the problem” is now regarded as the source of solutions to (and financing for) so many of the problems of the world….

    Where is all this money coming from?

  8. Tom connelly

    Anne is asking the best question. If the IMF will sell gold, for instance, the question is: who has the cash to buy it? As they say: who pays the piper, calls the tune.

  9. Just a couple of days ago, the Federal Reserve bought another three billion dollars’ of our own country’s national debt, because not enough people showed up to bid.

    Where are we supposed to get the money to invest more in the IMF? Won’t it do more harm to the world’s economy if we collapse the dollar than any good that could come out of printing more cash and handing it out to kleptocracies all over the Third World, where the entrenched oligarchies that control their finances are almost as bad as our own?

  10. Very nice work! Keep up the good work Simon!

  11. “Unless and until countries are assured that there is an effective international lender of last resort, they will be tempted to try to accumulate large amounts of reserves.”

    Mr. Johnson is showing his true colors here. What he basically wants is a federal reserve of the world that will produce debt on the lower and middle classes of the world. It also seems to me that he wants the debt free money to be in the hands of the few like himself and his central banking buddies.

    What the world needs is more savings in every country and practically NO DEBT. Then, there is no need for “an effective international lender of last resort”.

    You should have been fired a LONG time ago and made to work in a third world country. I am disgusted to no end that someone like you is allowed to testify before congress and they actually listen to you. No wonder the world is in such bad shape.

  12. A quote from Charlie Munger
    They say it’s not economics if you think about the consequences of good and evil, and good and bad business accounting. I think what we’re learning is that when you don’t understand these consequences, you don’t have an adequately skilled profession. You have big gaps in what you need. You have a profession that’s like the man that Nietzsche ridiculed because he had a lame leg and was very proud of it. The economics profession has been proud of its lame leg.

  13. I’d just like to say, writing as someone who has a background in international economics and experience in developing countries but doesn’t have as much time as you do to follow all this stuff, that the appearance of your blog has been extraordinarily helpful. It’s great to have people writing about this who both write crisp descriptions and are very clear about what their own agenda and opinions are. This is also a moment when your distinctive focus on the intersection between domestic and international financial policy is critical. Thanks.

  14. Can the world be saved from the US?

  15. raiph mellor

    Hello Fed Up,

    It’s clear to me that you are angry. Behind that I hear disgust at what I think you think is a morally bankrupt person being allowed to misguide our leaders at a critical juncture in the history of the human race, and I imagine further that you are scared about the mayhem going on, and perhaps have deep concern for the impact on the least fortunate in the world.

    I would prefer to first clarify that I have correctly guessed your underlying feelings, or to engage in dialog to ensure you feel completely heard, but such to-and-fro isn’t the way of online threads so I ask for your forgiveness if I haven’t correctly guessed about your feelings and/or if anything I write below seems to you less than fair. My intent is compassion for all and the best possible outcome in tough times.

    When I read your post, I got the distinct impression that you had misunderstood at least one part of what Simon Johnson was saying, and more generally, where he’s coming from. Perhaps I have it wrong, and I hope he will comment here himself, but I think Simon Johnson cares a great deal about the impact of the mess we’re in and that he cares far more about the impact on the poor than he cares about the impact on the rich. As such I want to speak up for him and what I think he’s saying.

    “Unless and until countries are assured that there is an effective international lender of last resort, they will be tempted to try to accumulate large amounts of reserves.”

    The above makes sense to me as being a factual
    statement, inasmuch as any statement of this
    nature could be said to be factual.

    To see what I mean, consider your perspective.

    As far as I can tell, given what you wrote, you would not only be tempted to save, you would actually save, and you would do so even if there was a lender of last resort.

    Now, if you decided that you could borrow money if you absolutely, positively had to have it, and if you decided that the best thing for the good of all was to only modestly increase your savings level, if at all, then, well, hopefully you would consider doing just that.

    Assuming I got that right, then, whether or not you or Simon Johnson like the implications of his statement, I think you will agree that your own perspective indicates the simple truth of what he said. That is, you, I, and most everyone, and most every country, will at least consider sharply increasing savings and indeed will probably do so.

    > It also seems to me that he wants the debt free
    > money to be in the hands of the few like himself
    > and his central banking buddies.

    To the contrary, Mr Johnson is one of the
    few to urge the US government to “break the financial oligarchy”, to take the central bankers on and dismantle their corrupt system. For more detail, I recommend a read of his Atlantic Journal article at http://www.theatlantic.com/doc/200905/imf-advice or listening to his interview with Bill Moyers.

    > What the world needs is more savings in every
    > country and practically NO DEBT.

    On the face of it, that sounds prudent.

    But a key issue is what is done in the immediate future. If people and countries immediately and sharply increase savings, an enormous amount of spending, loans, and investment will immediately and sharply reduce, and that in turn will rapidly bankrupt companies and increase unemployment, creating tremendous short term chaos.

    In fact, that’s actually what’s happening right now — people and countries are instinctively saving because it both feels right (ameliorates fear of not having money) and seems rational and morally sound (be fiscally responsible).

    Unfortunately, if we stay that course, I see a global economic collapse that will make the Great Depression look like a minor glitch in comparison. And the poor will be hit hardest, because they always are.

    I’m most definitely not seeking to generate fear, and I am completely open to hearing that I’ve got it wrong, but that’s what I currently see.

    Simon?

    love, raiph

  16. Munger is Warren Buffet’s lame leg. Just ask Doug Dutton. (Sorry, a little too “insidery”)

    Brad DeLong is going to be teaching a new course called “Political Economy” at Berkeley. It might just return some of the value to the profession.

    Still don’t get why we need economics though. Accountants, sure. Auditors… but if we just simplify everything, we have no more need or use for highly educated policy flacks.

  17. Raiph, you get it! Bravo.

    But why are you so sure that he’s not working for the forces of evil? Because he says many things that make sense? Because he seems extremely credible?

    It’s been asked a few times already… why are these guys doing what they’re doing here? Because they’re humanitarians? They met at a bar one day and decided they have a common interest — to explicate and then fix the economy? Doubt it… the people who are doing this in actuality, some very dedicated and benevolent people, have been marginalized by the mainstream press. These guys are exalted. Ask yourself why.

  18. “What the world needs is more savings in every country and practically NO DEBT”

    So all countries must save and they should not have any debt?

    Or all citizens in all countries must save more?

    What banks will do with those money if they cannnot lend money?

    How can I buy a house without debt? How can I buy a car without debt? Should I save 30 years before I can buy a house?

  19. Pingback: Is The Crisis Over Yet? The CBO Weighs In « The Baseline Scenario

  20. Pingback: ‘IS THE CRISIS OVER YET?,’ by Simon Johnson at : baselinescenario. com. ARE WE OUT OF THE PANIC PHASE OF THIS CRISIS? Read on….. « Want Less Blog

  21. Hello raiph mellor,

    I mostly disgusted, not scared yet. I am concerned about the least fortunate in the developed and developing world.

    To me, having an international lender of last resort implies something similar to the fed. It seems to me that means it will attempt to make real earnings growth negative, real interest rates negative, and bail out the bond holders whenever necessary without worrying about the people trying to make the interest payments.

    I don’t understand what is wrong with both spending some and saving a good bit.

    From the Atlantic IMF article:

    “But I must tell you, to IMF officials, all of these crises looked depressingly similar. Each country, of course, needed a loan, but more than that, each needed to make big changes so that the loan could really work. Almost always, countries in crisis need to learn to live within their means after a period of excess—exports must be increased, and imports cut—and the goal is to do this without the most horrible of recessions.”

    It seems to me that these “force an economy to become a net exporter” exports ended up in the high wage countries allowing crony capitalism in them. What happens when there is too much debt in most of the world and no one should be a willing importer?

    IMO, if he is against crony capitalism, he should be against the IMF. Could it become a worldwide crony capitalist organization because of debt?

    raiph mellor said: “But a key issue is what is done in the immediate future. If people and countries immediately and sharply increase savings, an enormous amount of spending, loans, and investment will immediately and sharply reduce, and that in turn will rapidly bankrupt companies and increase unemployment, creating tremendous short term chaos.

    In fact, that’s actually what’s happening right now — people and countries are instinctively saving because it both feels right (ameliorates fear of not having money) and seems rational and morally sound (be fiscally responsible).

    Unfortunately, if we stay that course, I see a global economic collapse that will make the Great Depression look like a minor glitch in comparison. And the poor will be hit hardest, because they always are.”

    I’ll ask this question in regards to that. If a Minsky moment happens, debt deflation sets in, more debt can’t and/or should not be created, and an economy can’t become a net exporter, what should be done?

  22. So all countries must save and they should not have any debt?

    IMO, all countries should save and have very little debt.

    “Or all citizens in all countries must save more?”

    No! There is plenty of wealth/income inequality in the USA, china, and other places. Some people have more savings than they need (think paulson, some sports players, some media people, high finance people).

    “How can I buy a house without debt? How can I buy a car without debt? Should I save 30 years before I can buy a house?”

    Higher real earnings, more savings, lower house prices, and lower prices for some cars.

  23. I would like to see some other people testify before Congress like Steve Keen, Michael Hudson, Paul Kasriel, or anyone else who focuses more on debt and asset prices instead of price inflation and wages.

  24. tippygolden

    Re: Politico link

    The $100bn to the IMF will be conditional on some recipient countries taking in Guantanamo detainees?

  25. One global currency for the world with local currencies that devalue?

    From and titled “Commercialise the SDR now”

    Latest Update: Sunday3/5/2009May, 2009, 09:50 PM Doha Time

    http://www.gulf-times.com/site/topics/article.asp?cu_no=2&item_no=288402&version=1&template_id=46&parent_id=26

    “The IMF’s management would also have to be empowered to decide on SDR issuance, just as the Fed can decide to offer currency swaps. For the SDR to become a true international currency, in other words, the IMF would have to become more like a global central bank and international lender of last resort.”

  26. One global currency for the world with local currencies that devalue?

    From and titled “Commercialise the SDR now”

    Latest Update: Sunday3/5/2009May, 2009, 09:50 PM Doha Time

    http://www.gulf-times.com/site/topics/article.asp?cu_no=2&item_no=288402&version=1&template_id=46&parent_id=26

    “The IMF’s management would also have to be empowered to decide on SDR issuance, just as the Fed can decide to offer currency swaps. For the SDR to become a true international currency, in other words, the IMF would have to become more like a global central bank and international lender of last resort.”

  27. I got a kick out of this article. We should print and borrow more to get us out of a problem created by…printing and borrowing (too much).

    Guatemala (where I live), was the recent beneficiary of a substantial loan from the IMF. The idea that the US is printing money to loan to the IMF who loans it to Guatemala so reparations can be paid to native people is, well, ironic.

    Guatemala is suffering because remittances are off, largely because Guatemalans in the US work in industries disproportionately affected by the recession. Instead of adjusting to the loss of revenue, the country will be propped up by the very nation whose poor financial practices led to the bubble which attracted those workers in the first place, and the inevitable bust that follows.