A ‘three-speed’ world is emerging, and the International Monetary Fund fears the consequences
As crisis-weary finance ministers and central bank governors from around the world kick back in Washington this week, on the sidelines of the twice-yearly International Monetary Fund meetings, they could be excused for feeling a tinge of optimism in the spring sunshine.
In the US, the bombed-out housing market is bouncing back; the stock market has hit fresh all-time highs; and there are hints that the Federal Reserve is starting to think about slowing the pace of its drastic quantitative easing programme. The latest data on consumer spending last week raised questions about how solid the recovery is – but there is hope.
Japan’s experiment with its radical new policy of Abenomics – the attack on deflation launched by new prime minister Shinzo Abe – may be in its early stages, but at least the country’s new policymakers have a plan. And even in the eurozone, where keeping the single currency afloat still demands relentless wrangling, the mood of imminent crisis has abated since the bailout with Cyprus was agreed.
But in a scene-setting speech in New York last week, IMF managing director Christine Lagarde stressed the deep divisions that remain in what she described as a “three-speed” global economy.
Lagarde placed emerging economies at the front of the pack, ahead of a middling group – including the US – that has begun to rebuild its battered economies; while Japan and Europe were trailing behind. She also warned that the world’s biggest banks remained a menace to financial stability, particularly in recession-hit Europe.
Some of these differences, between the leaders and the laggards, are likely to surface in the talks this week among the IMF’s 188 member countries, as central banks fret about their “exit strategy” from the emergency policies they have used to try to stimulate demand since the Great Recession.
A chapter of the IMF’s latest financial stability report, released to coincide with the build-up to the meetings, warns that long periods with ultra-low interest rates and so-called “unconventional” monetary policy, such as quantitative easing, can spawn serious long-term problems, even if they succeed in boosting short-term growth.
At home, “zombie” firms and households that would have gone bust can be propped up by super-cheap borrowing – only to face an even greater risk of collapse when interest rates finally go up.
Meanwhile, some of the cheap money created in the US, Japan and the UK will leak overseas, as investors seek better returns elsewhere. Emerging economies in Asia and Latin America are increasingly concerned about speculative investment flows pumping up their currencies and inflating asset bubbles.
“Despite their positive short-term effects for banks, these central bank policies are associated with risks that are likely to increase the longer the policies are maintained,” the IMF warned.
Depreciation is another welcome by-product of the hyperactive central banks’ policies, and there will also be a debate in Washington about the risks of a beggar-my-neighbour battle to create the cheapest currency.
Even before Japan’s dramatic expansion of its bond-buying programme, the sharp devaluation in the yen over the past six months had raised concerns in Europe that a strong euro will harm competitiveness.
Danny Gabay, of City consultancy Fathom, said an appreciating euro would drive Europe’s economies deeper into recession and put the region’s fragile banks at greater risk. “Do they think the banking system that is already under stress from high unemployment and non-performing loans can withstand a stronger euro too?”
Face-to-face talks, like those that take place at these IMF gatherings, can force policymakers to confront the consequences of their domestically motivated policies – but they are rarely persuaded to change their plans as a result. Sir Mervyn King, the outgoing Bank of England governor, is likely to repeat his frequently expressed fear that there remain deep, fundamental tensions in the world economy, between creditors and debtors, savers and spenders, which have never been tackled.
As he put it in a speech in New York in December: “The G20 in 2009 came together at the London Summit and agreed the easy part, which was stimulatory policies where every country could agree. But … since then … there has been no agreement on the need for working together to achieve some element of re-balancing the world economy.”
Instead of brokering such an agreement, which might involve creditor countries such as Germany and China agreeing to boost their demand, instead of relying solely on cutbacks in debtor countries to narrow the divide, the IMF has repeatedly been dragged into rubber-stamping botched bailouts and harsh austerity policies when tackling the eurozone sovereign debt crisis.
The IMF is due to reform its governance, including giving emerging economies such as China a stronger voice, but so far its board members have been unable to agree firm proposals. Meanwhile, it will stand ready to intevene whenever the next domino falls in the crisis that began more than five years ago.