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. Continue reading