Christine Lagarde And The Demand For Dollars

By Simon Johnson

After receiving US support at the critical moment, Christine Lagarde was named Tuesday as the next managing director of the International Monetary Fund.  In campaigning for the job, Ms. Lagarde – the French finance minister – made various promises to emerging markets with regard to improving their relationships with the IMF.  But such promises count for little and the main impact of her appointment will be to encourage countries such as South Korea, Brazil, India, and Russia to back away from the IMF and to further “self-insure” by accumulating larger stockpiles of foreign exchange reserves – the strategy that has been followed by China for most of the past decade.

Seen from an individual country perspective, having large amounts of dollar reserves held by your central bank or in a so-called sovereign wealth fund makes a great deal of sense; this is a rainy day fund in a global economy prone to serious financial floods.  But from the perspective of the global economy, such actions represent a major risk going forward – because it will further push down US interest rates, feed a renewed build up in private sector dollar-denominated debt, and make it even harder to get policymakers focused on a genuine fix to our long-term budget problems.

Ms. Lagarde is a sincere person and will no doubt try to be friendly to her supporters, for example perhaps by creating a new senior management level job at the IMF and making sure this goes to China or another emerging market.  But what the emerging markets really want is more “quota” (the term used for share ownership and therefore votes at the IMF), as well as more seats on the fund’s executive board.  These are not within Ms. Lagarde’s purview to grant – rather the European Union, at the highest political level, would have to agree to give up some of its votes and reduce its voice.

The European Union is overrepresented at the IMF, both in terms of shares and – most egregiously – with 8 or so seats on a board of 24 members (the exact seat count depends on how you score some seats that are shared by Europeans and non-Europeans).  But the EU has just proved to itself and to everyone else that it both cares a great deal about who controls the IMF and that it can continue to assert this control.

To be fair, the control this time was partly about organizing early and unanimous support for Ms. Lagarde – and there was an understandable desire to appoint a woman, given recent events.  But partly EU predominance in this forum continues to be about disorganization among the emerging markets; countries which, despite the widely used collective moniker, do not really see themselves as having convergent interests either now or in the near future.

If you look at these events from the perspective of countries such as South Korea, India, South Africa, Brazil, or Russia, what conclusion would you draw?

Emerging markets cannot rely on the IMF to provide help on generous terms during a crisis – such support looks like it is available to European countries but not to others.  As a result, an appropriately cautious strategy is to hold a great deal of reserves – the only form of unconditional “foreign” support in a serious financial crisis comes from your own hard currency, perhaps in the form of US Treasury securities that can easily be sold in a liquid market.

What else constitute appealing foreign exchange reserves in today’s world?  The euro has some use, but this is limited as long as a serious sovereign debt crisis looms – very few eurozone governments now look to be “risk-free”.  The Swiss franc continues to do well, but this is a relatively small volume of available assets.  The British pound and the Japanese yen have lost a lot of their traditional allure as reserve currencies.

This leaves the US dollar which, despite all our obvious problems, is still the world’s number one reserve currency.  Emerging markets are likely to increasingly follow in the footsteps of China – attempt to run current account surpluses, intervene to prevent their currencies from appreciating (selling local currency and buying dollars), and invest the proceeds in US dollar assets.

If our fiscal and financial house were in order, the resulting inflow of foreign capital would constitute a bonanza – allowing us to invest productively while paying low interest rates.  But given the way our financial system operates and the dysfunctional nature of our budget politics, the availability of this capital will just encourage us further to overborrow, both in the private sector and in the public sector.

An edited version of this column appeared this morning on the NYT’s Economix blog; it is used here with permission.  If you would like to reproduce the entire blog post, please contact the New York Times.

25 thoughts on “Christine Lagarde And The Demand For Dollars

  1. Would it be helpful to have a North Dacota State Bank type bank at the international level instead of or in addition to the IMF and/or WB?

  2. Hmm. Then the appointment of Lagarde seems quite short-sighted on the part of the EU then? Her appointment suggests that, insofar as the IMF becomes an EU tool, discouraging contributions from BRIC nations, it becomes a replica of the EFSF bailout fund. That in itself is pointless. But I’m also thinking in terms of the imbalance in global surpluses and deficits here. Insofar that appointing Lagarde encourages BRIC nations to build up surpluses and cut themselves off from the global financial community, indebted EU nations remain in deficit. Hence rebalancing the global economy becomes that much harder – meaning that though Lagarde’s appointment is meant to aid EU nations, it becomes counter-productive. Gah!

  3. There is one other “reserve asset” which all the CB’s possess in
    varying degrees, and it has held its’ value in crisis far better than’
    those named above. (hint: it’s been in use for 5000 years, it’s
    yellow, and it doesn’t default, because it doesn’t know how)

  4. If Brazil, Russia, and India, et al… received encouragement to accumulate reserve currency funds, would they increase direct purchases or buy from China and/or Japan? If China and/or Japan believes they are overexposed on U.S. holdings, Lagarde’s suggestions could provide a more orderly dilution.

  5. And the US does not have a sovereign debt problem? The US deficit will be 11% of GDP, vs. 10% for Greece, and Republicans seem quite determined to wreck the economy if their favored constituencies do not get to keep their tax cuts.

  6. Europe has tens of hundreds of years perfecting the art of shortsightedness.

    I do hope the U.S. dollar rallies; it will allow me to get out of my greenbacks at a better price. (I doubt it will ever reach the levels of 2002 again.)

    Unless there is a new industrial/technological boom (that actually requires people, not primarily machines) in the U.S. (or anywhere in the world for that matter) — or there is massive wealth, property, and people destruction — not on U.S. soil, the dollar is on it’s way to being a has-been such as the British pound.

    I do not want war nor needless suffering; of course I don’t always get what I want.

  7. @ JDM, nice post.

    How else can this insoluble insolvency, debt, depressed demand, massive unemployment, derivatives-fiasco, war-economy, oil-soaked, earthquake-tsunami, nuclear meltdown crisis be resolved, absent massive cataclysmic destruction?

    When an entire world economy is based on ripping off natural resources, via war, and conquest, and imperial aggrandizement, and the people driving the thing are so criminally psychotic and perverse, I can’t imagine a happy ending. What an apt title for a film depicting the early days of oil exploration: “There Will be Blood”.

    @ Simon, with all due respect: The IMF is a HUGE part of problem, and certainly not the solution. This mechanism forces privatization, disenfranchises citizens of national assets, strips private wealth holdings via imposed austerity (serfdom), and perpetuates the ponzi finance schemes for oligarchy-benefit. The Greek people are correct in opposing it, and the national legislative body in Greece sold their country down a hopeless river.

  8. As usual I like Professor Johnson’s column. I think it’s factually sound and that if the main message of Professor Johnson’s thoughts is that the USA should be more disciplined in lessening and moderating its public and private debt (which I think is Johnson’s main message here) that this is very constructive to the dialogue. However, I do have some slight differences with his thoughts I would like to point out.

    1. Professor Johnson says Miss Lagarde is “sincere”. Well, fair enough, maybe Miss Lagarde is not the “demon woman”. But my question is: who is she “sincere” for??? World markets??…. NO Not sucking more U.S. Federal Reserve dollars into the ECB???…. NO The obvious answer is that in fact Miss Lagarde is sincere for two interest groups. French banks and European bondholders. These are the two groups Miss Lagarde is “Sincere” for. PERIOD

    The most qualified person for the IMF Managing Director was/is Stanley Fischer. A man who, I might add, no one in their right mind would believe would so much as give a dirty glance to a girl in the IMF conclaves (or a Manhattan hotel). A man with experience much more suitable for the job of Managing Director of the IMF, and a man certainly more objective on the question of Europe swinging its schlong around the room and the interests of emerging markets. But much more importantly Stanley Fischer is a man who would clean up this system with the most pragmatic, practical, and least pain-inducing mixture of austerity and default. And make no doubt about it, there must be some default pain put on these European bankers and bondholders to teach them a lesson, and maybe clean up some of the crony capitalism which is prevalent currently between big European bankers and European politicians.

    That crony capitalism, was put up in a large bright neon sign for all the world to see, when French and German bankers swung their schlong and forced Lagarde on the world without even due consideration of Mr. Fischer.

  9. “A World Overwhelmed by Western Hypocrisy”

    “Western institutions have become caricatures of hypocrisy.
    The International Monetary Fund and the European Central Bank are violating their charters in order to bail out French, German, and Dutch private banks. The IMF is only empowered to make balance of payments loans, but is lending to the Greek government for prohibited budgetary reasons in order that the Greek government can pay the banks. The ECB is prohibited from bailing out member country governments, but is doing so anyway in order that the banks can be paid.”

    excerpt from:

  10. “For decades the IMF has fostered long-term dependency, perpetual indebtedness, moral hazard, and politicization, while sullying true market reform and forestalling revolutionary liberal change. The solution is not for the IMF to impose free markets, even if it had the will or the ability. That would smack of imperialism and, writes former World Bank economist William Easterly, would have “patronizing echoes of the White Man’s Burden.”

    “The IMF should be scrapped and the people suffering under kleptocracy left to discover for themselves the requirements for improving their own lives. How much more “help” from the West can they stand?”

    excerpts from:

  11. I should have typed in the above “It’s difficult to get them 100% right kiddies”. Oh damn, I got a decent crystal ball, but I need to work on that spelling. Just when I was doing my Barney Five snort and hiking my britches up….

  12. @Anonymous

    China will throw the IMF and ECB (and Federal Reserve, for that matter) out the window the moment it no longer has use for “Western hypocrisy”. As usual, Gore Vidal was twenty years ahead of his time when he wrote:

    “Now the long-feared Asiatic colossus takes its turn as the world leader, and we – the white race – have become the yellow man’s burden.”
    —–The Day the American Empire Ran Out of Gas (1985 essay)

  13. The Euro, a overvalued currency, is a gift to the emerging markets(Just compare Greece to it´s neighbor, Turkey). The Chinese are already on the record saying that they want to “save the euro”.

    So, that´s the reason why they supported Lagarde, including all commodities exporting countries(With the exception of Colombia and Mexico) in Latin America. They want the Euro to survive.

  14. Good people of the metropolis, IF you’re feeling melancholy about Glenn Beck’s exit from FOX 24 hour circus show for freaks, I want you to sing this Barbra Streisand classic “The Way We Were” with a box of kleenex nearby as you watch the video links below.
    Light the corners of my mind
    Misty watercolor memories
    Of the way we were
    Scattered pictures
    Of the smiles we left behind
    Smiles we gave to one another
    For the way we were”—glenn-beck-s–war-room-

  15. @ Carla, thanks for the economic-blog link; that writer sure has a low opinion re: efficacy of IMF economists, and lashes out at their collective blindness.

    I’ve heard some of these folks referred to as “quackademics”, but I have faith in our Simon.

    Anyway, Happy 4th of July, Carla, God bless.

  16. Hell yes, i want write something like this but didnt be the subject regard occurrence, may i repost this Christine Lagarde And The Demand on the faction 1 in quest of Dollars « The Baseline Scenario says:
  17. I know I’m over-commenting here. I just wanted to make sure everyone who wanted to catch it was aware that Professor Johnson was on PBS “Need To Know”. I remember many years ago Alison Stewart hosted late night news on ABC with Anderson Cooper. TMI Warning, TMI Warning: I used to think Alison was pretty hot and would drool over her as she flirted with Anderson. I’m guessing she knew about Cooper then and kept it under her hat. They both had me very jealously hoodwinked.

  18. Simon,

    I do not get this. Either the US faces many eager sovereign investors that want to fund its budget deficits (and bop ones as well), thus keeping interest rates low and the trade weighted exchange rate relatively high, or they do not and both the USD and the budget face politically challenging constraints. What would make these countries become less eager would probably depend on the alternatives, underlying productivity relationships that drive the international migratiion of production (and much less of consumption) of tradables, and institutional cosntraints (like EU and Japanese desire to not have too much FX volatility or very large inflows like the US is used to), all of those effectively outside the reach of US policy. So there is not much that would allow the US to be no longer at the mercy of sovereign creditors that do not behave militarily/foreign policy-wise like client states (like for instance Japan, Australia and the NATO countries). Likewise, these gountries prefer not to be client states, but self-interested independent agents, in an increasingly anarchistic world.

    To what extent a, say Zimbabwan, Icelandic or Chinese chairperson would change the willingmess of countries that value economic sovereignty (or the ability of their governments to be popular and mercantilist) i do not know, but I guess that a Chinese might only change China’s stance (and how? by abandoning international trade competitiveness? By diversifying away from the USD more than they are already doing?) . The IMF is blessed by having a talented politician and manager at the helm. It may allow it a few more years, despite its obsolescence.

  19. Puck’s truth there be said: “What fools these mortals be!”
    …..”let me live in my house by the side of the road and be a friend to man….”

  20. I wonder if you could shed some comments or thoughts on reserve accumulation by Emerging Countries, since I am from an emerging country. I clearly understand the logic of self-insurance in terms of having room for manoeuvre when there is a rainy day… But, I do not know if I am being extremely out of touch with reality and being far too alarmist in the following sense: with all the dollar money being printed, are we not trading real stuff (real products and services) in exchange for a piece of paper that is losing ground and value as time goes by… what will these dollars, in the end, buy??? Is this not long term idiocy?? Isn´t better to just keep the oil ( and other goods) underground and have it last instead of accumulatiing trash?? we may be accumulating reserves that later may not buy us even a quarter of the goods with which we earned them??? Are we not being greater fools in playing this game??

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