IMF considers 'new tool kit' to head off market meltdowns and hoarding

By Howard Schneider
Washington Post Staff Writer
Friday, July 2, 2010; A16

The world's top economic powers and the International Monetary Fund are studying creation of a global financial safety net that would give countries quick access to large amounts of cash as a way to stave off crises and discourage emerging-market nations from hoarding foreign reserves.

In what would be a significant reordering of IMF operations, the proposals would change the agency from a solely reactive one -- waiting for countries in trouble to ask for help -- to a more activist organization that tries to anticipate where a crisis will spread and move in with enough money to calm markets and prevent broader problems.

The idea may require a substantial increase in the amount of money that countries pledge to the IMF and a significant liberalization of its lending rules, potentially controversial changes. Advocates, however, say it would not only temper future crises but also alleviate a core imbalance in the world economy by reassuring China and other emerging markets that they do not need to sock away trillions of dollars in reserves to protect themselves from global shocks.

The concept was broadly endorsed by the Group of 20 nations at their recent meeting in Toronto, at which leaders asked their finance ministers and central bank governors to prepare proposals for a November meeting in Seoul. Two programs are already in development by the IMF and due to be considered by its executive board later this month.

"Some of these growing imbalances can't be sustained. . . . The U.S. cannot permanently spend more than it earns," said Il Sakong, head of South Korea's planning committee for the Seoul meeting. South Korea has become a key advocate of creating a global emergency pool. "With the safety net, surplus countries will have less incentive to accumulate. It'd be very helpful," he said.

'Intellectually appealing'

A U.S. official familiar with the discussion said the Obama administration considered the idea "intellectually appealing" but would vet any proposal closely to ensure "the design is sound and safeguards IMF resources." As the world's largest economy, the United States is responsible for about 17 percent of the fund's more than $300 billion in quota contributions and has a roughly equivalent share of voting power on the IMF board.

World reserve holdings have jumped 50 percent since the start of the U.S. financial crisis, according to recent IMF data, from $5.5 trillion at the start of 2007 to $8.3 trillion as of April.

Almost all of that increase occurred in the holdings of emerging and developing nations such as China. These countries run large trade and other surpluses and have felt compelled to stockpile "war chests" to uphold their economies -- money that in fact proved useful in the recent crisis. Instead of holding onto those funds and investing them in relatively low-yielding U.S. Treasury bonds and other safe securities, the countries should spend more on social programs, infrastructure or other measures that would lessen their dependence on exports and possibly lead them to buy more from the developed world, say the IMF, the United States and others.

To achieve those results, however, the countries need to be assured that they can access cash easily -- and with few questions asked -- if global investors turn on them or if the financial system falters as it did in 2008.

The aim is not to help profligate nations -- traditional IMF loans for troubled countries come with a list of conditions to repair their economies, and that will remain the case -- but to give those that are well managed a way to cushion the blow from an outside shock.

"We need a new tool kit," IMF Managing Director Dominique Strauss-Kahn said this week during a presentation at the Peterson Institute for International Economics, where he discussed ways the fund could better keep "systemic" problems from spreading around the world.

Billions in reassurance

During the recession last year, the IMF established a process to pre-approve loans for countries that it considers economically and financially sound. Mexico, Poland and Colombia were approved for credit lines of $40 billion, $20 billion and $3.4 billion, respectively, but did not have to draw the money; just having it available reassured markets.

The IMF is studying how to expand on that program and loosen the rules so that more countries can qualify for emergency loans. It also is looking at a broader "systemic risk mechanism" in which groups of countries might be offered IMF help at the same time. That program would change what has historically been a passive role for the fund and try to eliminate the stigma associated with receiving its assistance.

"No country wants to go first," Strauss-Kahn said, envisioning an effort in which the IMF would "proactively channel liquidity to countries under pressure."

Such programs would have been helpful in the recent European crisis, when debt problems in Greece caused markets to doubt the ability of other nations such as Spain and Portugal to repay their bondholders. There is general agreement that Greece's hesitancy to ask the IMF for help and Europe's slow response to the larger threat made the crisis far more expensive to resolve, and posed greater risks to the world economy than were necessary.

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