August 19, 2022

Economix: Christine Lagarde and the Demand for Dollars

Today's Economist

Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of “13 Bankers.”

After receiving support from the United States 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, France’s finance minister, made various promises to emerging markets with regard to improving their relationships with the I.M.F. But such promises count for little.

The main impact of her appointment will be to encourage countries like South Korea, Brazil, India and Russia to back away from the I.M.F. 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 last decade.

From an individual country’s perspective, having large amounts of dollar reserves held by your central bank or in a sovereign wealth fund makes a great deal of sense – a rainy day fund in a global economy prone to serious financial floods.

From the perspective of the global economy, such actions represent a major risk going forward, because they will further push down interest rates in the United States, feed a renewed buildup in private-sector dollar-denominated debt and make it even harder to get policy makers focused on a genuine fix to our long-term budget problems.

Ms. Lagarde is sincere and will no doubt try to be friendly to her supporters, perhaps, for example, by creating a senior management-level job at the I.M.F. and making sure it 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 I.M.F.), 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 E.U. is indeed overrepresented at the I.M.F., both in terms of shares and — most egregiously — with 8 or so seats on a board of 24 members (the exact number depends on how you count some seats shared by Europeans and non-Europeans).

And the E.U. has proved to itself and everyone else that it both cares a great deal about who controls the I.M.F. and that it can continue to assert this control.

To be fair, the control this time was partly about organizing early to provide unanimous support for Ms. Lagarde – amid an understandable desire to appoint a woman, given the recent resignation of her predecessor, Dominique Strauss-Kahn, amid pending charges of sexual assault.

But the E.U.’s dominance also reflects disorganization among the emerging markets. These countries, though often grouped in a category, do not really see themselves as having convergent interests on many issues, either now or in the near future.

If you look at the current circumstances from the perspective of countries like South Korea, India, South Africa, Brazil, or Russia, what conclusion would you draw?

Emerging markets cannot rely on the I.M.F. to provide help on generous terms during a crisis – such support looks as if it is available to European countries but no 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 United States Treasuries that can easily be sold in a liquid market.

What else constitutes appealing foreign exchange reserves in today’s world? The euro has some use, but is limited as long as a serious sovereign debt crisis looms –- very few euro-zone governments 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 dollar, which, despite all the obvious problems in the United States, is still the world’s No. 1 reserve currency. Emerging markets are likely to follow increasingly in the footsteps of China -– trying to run current-account surpluses, intervening to prevent their currencies from appreciating by selling local currency and buying dollars and investing the proceeds in 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.

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