Six years ago, finance ministers and central bank governors gathered in Washington for the annual meeting of the International Monetary Fund with the global financial system teetering on the brink.
It was less than a month since the collapse of the US investment bank Lehman Brothers and in the aftermath no institution, however big and powerful, looked safe.
After staring into the abyss, they put together a co-ordinated plan to rescue ailing banks. This was followed by further joint moves when the drying up of credit flows plunged the world economy into recession. A second Great Depression was averted, but only just – and at a price.
Last week, the IMF and World Bank celebrated their 70th birthdays, but there was a distinct lack of party atmosphere in Washington. While not as tense as during the dark days of October 2008, the mood was distinctly sombre as the two organisations –created at the 1944 Bretton Woods conference – worked their way through a packed agenda that was dominated by six big themes.
THE NEVER-ENDING CRISIS
Ever since the global economy bottomed out in the spring of 2009, the hope has been that the world would return to the robust levels of growth seen in the years leading up to the financial crash. Time and again, the optimism has proved misplaced, with the IMF repeatedly revising down its forecasts. This year was no exception. “The recovery continues but it is weak and uneven,” said the IMF’s economic counsellor, Olivier Blanchard, as he announced that at 3.3%, growth rates would be 0.4 points lower than anticipated in the spring.
What concerns the IMF is that the slowdown – particularly in the advanced countries of the west – may be permanent. The phrase being bandied around in Washington was “secular stagnation”, the notion that there has been a structural decline in potential growth rates. Blanchard said it was entirely possible that developed countries would never return to their pre-crisis growth levels, and that even achieving the lower rates of expansion now expected would require interest rates to be maintained at historically low levels.
Last week, the Bank of England announced that its official interest rate would be pegged at 0.5% – comfortably the lowest in its 320-year history – as it has been since March 2009. Although the City expects borrowing costs to start rising early next year, the peak is predicted to be far lower than the 5% average seen in the years since Gordon Brown gave the bank its independence in 1997. The message from the fund is that low interest rates, like low growth, are here to stay.
BLOWING THE NEXT BUBBLE
Having failed spectacularly to spot the last financial crisis coming, the IMF is now alert to the possibility that a long period of ultra-low interest rates is storing up problems for the future.
José Viñals, the IMF’s financial counsellor, said: “Policymakers are facing a new global imbalance: not enough economic risk-taking in support of growth, but increasing excesses in financial risk-taking posing stability challenges.”
This is not what the central banks intended when they cut the cost of borrowing and cranked up the electronic-money printing presses in the process known as quantitative easing. They expected cheap and plentiful money to rouse the animal spirits of entrepreneurs, encouraging them to invest. Instead, they have provided the casino chips for speculators.
The IMF has identified three main problems:
■ First, while the traditional banks have been strengthened since the crisis by the injection of new capital, they are not really fit for purpose. The IMF conducted a survey of 300 banks in advanced economies and found that institutions accounting for almost 40% of total assets were not strong enough to supply adequate credit in support of the recovery.
■ Second, risk is shifting from traditional banks to what is known as the shadow banking system – institutions such as hedge funds, investment banks and money market funds that do not take deposits directly from the public, but have grown in size and importance over the past decade. The fund thinks the next crisis could well stem from the shadow banks.
■ Third, by guiding financial markets to expect only limited and slow increases in interest rates, the fund fears it has made investors complacent. Prices of a range of financial assets have risen; there has been little distinction between investments that are safe and those that are risky; and markets have been eerily free from volatility. Asked where the next sub-prime crisis was going to come from, Viñals said he did not have a crystal ball. Clearly, though, the IMF fears there is something nasty lurking out there.
All the symptoms are there. An economy that staggers in and out of recession. An inflation rate that is barely above zero. An ageing and falling population. It was inevitable, therefore, that IMF managing director Christine Lagarde should be asked: Is Europe the new Japan?
The answer from the IMF boss was that, yes, in some respects the eurozone was displaying some symptoms of “Japanification”. Her advice was that Europe should follow its own version of the three-arrow policy being pursued by Japan’s prime minister Shinzo Abe. Abenomics, as it is known, involves more monetary stimulus in the form of quantitative easing, more fiscal stimulus in the form of higher public spending, and structural reform to make the economy more efficient.
Lagarde suggested a similar package could help Europe avoid the risk of recession, which the IMF puts at 40%.
“There is a serious risk of that [recession] happening,” she said. “But if the right policies are decided, if both surplus and deficit countries do what they have to do, it is avoidable.”
Poor economic data from Germany allowed finance ministers from outside the eurozone to pile on the pressure.
George Osborne said the slowdown across the Channel was affecting UK growth. Germany, though, was resisting pressure to run down its budget surplus to boost growth. German finance minister Wolfgang Schäuble said writing cheques was not the answer.
By the end of the week it was clear that the eurozone’s two biggest economies were at loggerheads, with France saying it would not reduce its budget deficit to hit the 3% target set by Brussels until Germany did more, and Berlin arguing that it was up to Paris to move first.
One of the architects of the IMF at Bretton Woods was Britain’s John Maynard Keynes, and there was a Keynesian tone to much of the IMF’s analysis. Keynes argued that when monetary policy – interest rates and QE – were exhausted, the state should step in and boost activity, through either tax cuts or public works. The IMF has taken up this idea with relish, and says its member governments should be looking seriously at the option of increasing spending on infrastructure projects.
With many countries needing to upgrade their roads, railways, energy supplies and water systems, the fund thinks infrastructure spending is what the former US treasury secretary Larry Summers last week called a “free lunch”. Borrowing costs are currently extremely low, lower than the expected economic returns on the investment.
In the short term, economies would enjoy higher levels of demand, as orders were placed and people were hired. In the longer term, the supply side of the economy would be improved, and this would raise underlying growth rates. Blanchard said it was “an irony”, but that sometimes borrowing more was the right way.
It was hard to move in Washington without hearing the “I” word: inequality. There were seminars on making extractive industries work for the poor, there were seminars on the challenge of “job rich and inclusive growth”, and there were seminars on building a coalition for youth employment. Both Lagarde and World Bank president Jim Kim have put inequality at the top of their personal agendas. The IMF has produced academic papers showing that tackling inequality is good for growth.
Some observers have been impressed by the change of emphasis. Justin Wolfers of US thinktank the Brookings Institute said it was extraordinary “how quickly this organisation [the IMF] has turned around. The answer to any question used to be austerity. Now it says the brutal trade-off between equality and growth simply doesn’t exist.”
Others are more sceptical, waiting for the lofty rhetoric to be turned into action. A group of Francophone low-income countries said the global tax system was loaded in favour of paying taxes in the countries where multinationals had their headquarters rather than in the countries where raw materials were produced. Nicolas Mombrial of Oxfam in the US said there was a mismatch between what IMF and World Bank leaders were saying in Washington and what their organisations were doing on the ground.
In many ways, the rush last week to put together an international response to Ebola was like a rerun of 2008. As then, the global community was woefully complacent about the problem. As then, the response was slow and inadequate. As then, the penny finally dropped when it became clear that Ebola – like the sub-prime mortgage crisis – was not a localised problem that could be easily contained in Guinea, Sierra Leone and Liberia, but a serious global threat.
As the first cases appeared in Spain and the US, and as stock markets tumbled, policymakers at last decided it was time to get serious.
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