Chapter 6 Financial Integration and Global Governance

6.1 Instability now and then

6.1.1 Number of Banking and Currency Crises, 1950-2014

6.2 Role of the International Monetary Fund (IMF) / World Bank (WB)

The role of the IMF and the World Bank, in a historical perspective: * A monetary system or pragmatic agreements? * The supremacy of the U.S. dollar in question. * What currencies could play an international role? * The rapid growth of central bank reserves in the world and its potential consequences. * The IMF: fireman, policeman, lender?

6.2.1 Creation of IMF

  • The IMF (the “Fund”) was established in July 1944 at a UN conference held in Bretton Woods, New Hampshire (United States).

  • Forty-four governments represented at the conference wanted to establish a framework for economic cooperation that would avoid a repetition of the vicious circle of competitive devaluations that had contributed to the Great Depression of the 30s.

  • Number of member states: 189 states

  • Headquarter: Washington, United States of America

  • Executive Board: 24 Executive Directors representing member-countries or constituencies representing four or more countries.

  • Staff: around 2663 from the 148 countries

  • Total quotas: US$650 billion (as of 9/3/16)

  • What we do? http://www.imf.org/external/about/whatwedo.htm

  • How we do it? http://www.imf.org/external/about/howwedo.htm

  • Membership: http://www.imf.org/external/about/members.htm

6.2.2 IMF System in Context

The Gold Standard (1870-1914)

  • Gold as Common denominator
  • Currencies pegged to gold
  • Incentivized surpluses in gold

Excessive printing of currency for war efforts Great depression and competitive devaluation to boost exports

Bretton Woods System (1944-1973)

  • US dollaras new commonde nominator, convertible to $35 ounce of gold
  • US(then):70% of global GDP, trade surplus, high productivity

Post-Bretton Woods (1973 – present)

  • Increase in US money supply by Lyndon Johnson
  • US ran trade deficit in 1971, but US obligated to $35 per ounce of gold, so rush on putting gold into foreign central banks
  • Other countries increased productivity
  • May 1971 Germany allowed its currency to float
  • Now: No commonde nominator; diversity of exchange rates

6.2.3 IMF Governance

The IMF is accountable to the governments of its member countries. At the top of its organizational structure is the Board of Governors, which consists of one Governor and one Alternate Governor from each member country.

The Board of Governors meets once each year at the IMF-World Bank Annual Meetings. Twenty-four of the Governors sit on the International Monetary and Financial Committee (IMFC) and normally meet twice each year.

The day-to-day work of the IMF is overseen by its 24-member Executive Board, which represents the entire membership; this work is guided by the IMFC and supported by the IMF staff.

A proposed Amendment of the IMF’s Articles of Agreement will introduce for the first time an Executive Board whose members are all elected. The Managing Director is the head of the IMF staff and Chairman of the Executive Board and is assisted by four Deputy Managing Directors.

  • Financial intermediary between countries:
    • Each country contributes funds to a pool through a quota system from which countries with payment imbalances can borrow
  • Provide loans to stabilize financial systems in difficulties
    • E.g. PIGS during financial crisis

Works to “foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world”

6.2.4 IMF Mission

The IMF’s primary purpose is to ensure the stability of the international monetary system—the system of exchange rates and international payments that enables countries (and their citizens) to transact with each other.

IMF promotes international financial stability and monetary cooperation. It also seeks to facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world. The Fund’s mandate was updated in 2012 to include all macroeconomic and financial sector issues that bear on global stability.

The first article of the IMF sets out the following key objectives: * promoting international monetary cooperation; * facilitate the expansion and balanced growth of international trade; * promoting exchange stability; * assist in the establishment of a multilateral system of payments; * make resources available (with adequate safeguards) to members experiencing balance of payments difficulties.

6.2.5 IMF Resources

  • Most resources for IMF loans are provided by member countries, primarily through their payment of quotas, based broadly on its relative size in the world economy.

  • Country leaders meeting at the G-20 (a) in April 2009 pledged to triple the lending capacity of the IMF, which would increase from 250 to 750 billion dollars. In response to this commitment, the current and future participants in New Arrangements to Borrow (NAB) has decided to increase the amount to about $ 570 billion; Decision came into force March 11, 2011 after completion of the ratification process of NAB participants.

  • Completing the 14th General Review of Quotas in December 2010, the governors have agreed to double the IMF’s quotas to wear 730 billion dollars and make a major reallocation of quotas between Member States.

6.2.6 IMF Expenses

  • Financial assistance: IMF financing provides member countries the breathing room they need to correct balance of payments problems.

  • A policy program supported by IMF financing is designed by the national authorities in close cooperation with the IMF, and continued financial support is conditioned on effective implementation of this program.

  • In an early response to the recent global economic crisis, the IMF strengthened its lending capacity and approved a major overhaul of the mechanisms for providing financial support in April 2009, with further reforms adopted in August 2010 and December 2011.

  • SDRs: The IMF issues an international reserve asset known as Special Drawing Rights (SDRs) that can supplement the official reserves of member countries. They amount to about SDR 204 billion (some $316 billion). IMF members can voluntarily exchange SDRs for currencies among themselves.

  • In a recent paper, the IMF explored various options that would strengthen the role that SDR plays to promote the stability of the international monetary.

  • Technical assistance: The IMF provides technical assistance and training to help member countries strengthen their capacity to design and implement effective policies.

  • Technical assistance is offered in several areas, including tax policy and administration, expenditure management, monetary and exchange rate policies, banking and financial system supervision and regulation, legislative frameworks, and statistics.

  • Quota subscriptions are a central component of the IMF’s financial resources. Each member country of the IMF is assigned a quota, based broadly on its relative position in the world economy.

  • A member country’s quota determines its maximum financial commitment to the IMF, its voting power, and has a bearing on its access to IMF financing.

6.2.7 IMF and Financial Crisis

In its latest Global Financial Stability Report, the IMF analyzes the effects of central bank policies on banks and financial stability since the global crisis.

Central banks have taken bold policy actions that have reduced banking sector vulnerabilities and stabilized some markets, such as the interbank and mortgage securities markets.

But the policies may have undesirable side-effects that could put financial stability at risk the longer they are in place. The IMF said so far these risks are not showing up much in banks, but could be shifting to other parts of the financial sector, such as to so-called “shadow banks.” There is also some concern that the prolonged period of low interest rates is encouraging banks to roll over nonperforming loans rather than repairing their balance sheets.

6.2.8 World Bank

  • International Financial institution that provides loans to developing countries for capital programs
  • Comprises two institutions:
    • The International Bank for Reconstruction and Development (IBRD)
    • The International Development Association (IDA)
  • Two main objectives:
    • To reduce at 3% the proportion of individuals living with less than $1,25 a day by 2030
    • To favor, in each country, income growth for the bottom 40%

6.2.9 Membership in the IMF/WB

  • Open to any country willing to agree to rules and regulations
  • 189 member countries as of 2015
  • Membership requires payment of a quota.
  • Quota size reflects global importance of country’s economy and political considerations.

The quota:

  1. determines voting power
  2. serves as part of official reserves 3.determines country’s borrowing power

August 2014 - US$362 billion

6.2.10 Number of Member Countries, 1945-2015

6.2.11 A Weighted Voting System

6.3 Impact of IMF programs

6.3.1 Incidence of IMF Programs, 1945-2015

6.3.2 Program Incidence, 1950-2014

6.3.3 Lending Volume, 1950-2014

6.3.4 IMF Programs Becoming Bigger, 1960-2014

6.3.5 Long-Term Effects

6.3.6 More Recently…

Iceland

  • IMF support in 2008 in exchange for austerity measures including a 30% decrease in funding to the health care system
  • Refusal of the measures and debt reductions
  • Debt repayment as of 2012 and economic growth since then

Greece

  • IMF support in 2010 in exchange for the privatization of state-owned enterprises and infrastructures, and reduction of the budgets allocated to social programs
  • Application of the plan and departure of firms
  • New requests for help; was still in a state of crisis in 2015

6.3.7 Total Arrears to the IMF 1984-2014 and Greek Loans

6.3.8 The Largest IMF Programs

Source : Reinhart et al. (2016)

6.3.9 Evolution of IMF Mission

Source : Reinhart et al. (2016)

6.3.10 Challenges

  • Surveillance:
    • New mission to stabilize the markets
    • Could not predict the 2008-2009 crisis
  • Conditionality
    • Conflict between governments and IMF
  • Crisis management in the case of sovereign debt
    • How to determine the solvency of a country
  • Reforms:
    • How to make the IMF impartial

6.3.11 IMF Forecasts for Global GDP Growth

6.3.12 IMF Forecasts for Global GDP Growth

Main risks:

  • Current trade war
  • Rise of interest rates in the United-States
  • End of economic stimulus in the United- States and Europe

6.3.13 What does the IMF think of Canada?

  • Housing market overvalued by as much as 30%
  • Growth forecast of 1.5% in 2019 and 1.9% in 2020
    • Above Mexico following Trump election
    • Below the United States of America (First)
  • Concerns over lower commodity prices and debt level
  • Concerns over aging population and readiness to deal with the shock
    • Public Pension Plans
    • Economic growth

6.4 Additional tools at the disposal of countries

6.4.1 China and Its Currency

6.4.2 China’s Foreign Exchange Reserves

6.4.3 China’s Exchange Rate Controls

6.4.4 Germany Versus China Account Surpluses

6.4.5 Germany’s Imbalances: A Chronic Problem

6.5 Data Challenge

6.5.1 Financial Risk

You work for an investment fund and the CEO would like to diversify his investment. Aware of the possible financial risks, he asks you to determine the country in which to invest. Based on the concepts currently being discussed and the data available to you, create a graph with a linear regression and explain which country would be the most favorable for the company.

The United States