[Senate Hearing 109-909]
[From the U.S. Government Publishing Office]
S. Hrg. 109-909
OVERSIGHT OF THE
INTERNATIONAL MONETARY FUND
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
INTERNATIONAL TRADE AND FINANCE
of the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED NINTH CONGRESS
FIRST SESSION
ON
PROGRESS ON REFORM OF THE INTERNATIONAL MONETARY FUND, FOCUSING ON THE
GROWING ROLE OF INTERNATIONAL DEBT SECURITIES, THE INCREASE IN VOLUME
OF PRIVATE CAPITAL FLOWS, AND THE INCREASING INTERCONNECTION BETWEEN
FINANCIAL MARKETS
__________
JUNE 7, 2005
__________
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RICHARD C. SHELBY, Alabama, Chairman
ROBERT F. BENNETT, Utah PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado CHRISTOPHER J. DODD, Connecticut
MICHAEL B. ENZI, Wyoming TIM JOHNSON, South Dakota
CHUCK HAGEL, Nebraska JACK REED, Rhode Island
RICK SANTORUM, Pennsylvania CHARLES E. SCHUMER, New York
JIM BUNNING, Kentucky EVAN BAYH, Indiana
MIKE CRAPO, Idaho THOMAS R. CARPER, Delaware
JOHN E. SUNUNU, New Hampshire DEBBIE STABENOW, Michigan
ELIZABETH DOLE, North Carolina JON S. CORZINE, New Jersey
MEL MARTINEZ, Florida
Kathleen L. Casey, Staff Director and Counsel
Steven B. Harris, Democratic Staff Director and Chief Counsel
Skip Fischer, Senior Professional Staff Member
Steve Kroll, Democratic Special Counsel
Joseph R. Kolinski, Chief Clerk and Computer Systems Administrator
George E. Whittle, Editor
------
SUBCOMMITTEE ON INTERNATIONAL TRADE AND FINANCE
MIKE CRAPO, Idaho, Chairman
EVAN BAYH, Indiana, Ranking Member
CHUCK HAGEL, Nebraska TIM JOHNSON, South Dakota
MICHAEL B. ENZI, Wyoming ROBERT MENENDEZ, New Jersey
JOHN E. SUNUNU, New Hampshire
ELIZABETH DOLE, North Carolina
Gregg Richard, Legislative Assistant
Catherine Cruz Wojtasik, Democratic Legislative Assistant
C O N T E N T S
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TUESDAY, JUNE 7, 2005
Page
Opening statement of Senator Crapo............................... 1
Opening statements, comments, or prepared statements of:
Senator Bayh................................................. 6
WITNESSES
Randal Quarles, Acting Under Secretary for International Affairs,
U.S. Department of the Treasury................................ 2
Prepared Statement........................................... 34
Allan H. Meltzer, The Allan H. Meltzer University, Professor of
Political Economy, Carnegie Mellon University and Visiting
Scholar, American Enterprise Institute......................... 12
Prepared Statement........................................... 38
C. Fred Bergsten, Director, Institute for International Economics 15
Prepared Statement........................................... 40
OVERSIGHT OF THE INTERNATIONAL MONETARY FUND
----------
TUESDAY, JUNE 7, 2005
U.S. Senate,
Subcommittee on International Trade and Finance,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Subcommittee met at 10 a.m., in room SD-538, Dirksen
Senate Office Building, Senator Mike Crapo, Chairman of the
Subcommittee, presiding.
OPENING STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. This hearing will come to order.
Good morning. This is the hearing of the Committee on
Banking, Housing, and Urban Affairs, Subcommittee on
International Trade and Finance, on International Monetary Fund
oversight. Today, as the title of our hearing indicates, we are
here to discuss the International Monetary Fund. As the largest
contributor of the IMF, the United States has the
responsibility to ensure that our resources are being used
wisely. The United States, with the urging and support of the
U.S. Congress, has been a key supporter in moving the IMF in
the right direction in terms of getting more accountability and
understanding of what is happening inside the IMF.
I would like to recognize and thank our witnesses for the
significant contributions they have all made in making this
happen. None of any of this would have been possible without
the creation and hard work of the International Financial
Institutions Advisory Commission and the continued pushing and
prodding from the Treasury Department.
Although it is important that we recognize the real
progress that has been made, we are not yet done. More needs to
be done, and it is my hope that today's hearing will further
demonstrate what progress we have made and what progress we
need to make in the future. This will help us to determine what
specific measures need to be addressed next.
The other main issues before us today are Argentina's
attempt to conclude a new debt repayment agreement with the
IMF, China's 10-year-old fixed exchange rate between the dollar
and the yuan, and a potential IMF gold sale as a means of
financing additional IMF debt reduction. These are significant
challenges, and I look forward to a thorough discussion of
these issues as well.
For our first panel today, we welcome Randal Quarles, the
Acting Under Secretary of the Treasury for International
Affairs. In this capacity, Mr. Quarles advises the Secretary of
the Treasury on U.S. participation in the international
financial system, including subjects such as financial
regulation, macroeconomic policy, exchange rate policy, trade
and investment, and our participation in the International
Monetary Fund and the World Bank, among other institutions.
Prior to his most recent appointment at the Treasury
Department, Mr. Quarles served as the U.S. Executive Director
at the IMF from August 2001 through March 2002.
Our second panel will include two witnesses: Dr. Allan H.
Meltzer, the Distinguished Professor of Political Economy at
Carnegie Mellon University; and Dr. C. Fred Bergsten, Director
of the Institute for International Economics, here in
Washington, DC. Drs. Meltzer and Bergsten have extensive
experience with the IMF. In November 1998, as a part of the
legislation authorizing $18 billion of additional U.S. funding
for the IMF, Congress established the International Financial
Institutions Advisory Commission to recommend future U.S.
policy toward the IMF and the World Bank, commonly referred to
as the Meltzer Commission in reference to its Chairman, Dr.
Meltzer. Dr. Bergsten also served on this Commission and co-
authored the dissenting opinion. And I might note that we have
had them before us in different contexts many times on these
issues, and we appreciate both of them coming yet once again to
help us continue to address these issues.
With that, we will begin with the testimony, and I would
remind all of the witnesses that we have a clock. Because of
the small number of witnesses, we have doubled the amount of
time we traditionally allow for oral testimony, and so we are
allowing each of you 10 minutes. We would encourage you to pay
attention to the clock, though, because we do want to have a
little time for questions and answers and some dialog.
Mr. Quarles.
STATEMENT OF RANDAL QUARLES
ACTING UNDER SECRETARY FOR INTERNATIONAL AFFAIRS,
U.S. DEPARTMENT OF THE TREASURY
Mr. Quarles. Thank you, Chairman Crapo. I am very pleased
to be here today to talk about our agenda as a shareholder of
the International Monetary Fund. I will focus my oral remarks,
with your permission, on efforts to modernize the IMF, and if
my formal written testimony could be submitted for the record,
I would appreciate that.
Senator Crapo. Yes, the formal written testimony of each
witness will be a part of the record.
Mr. Quarles. And in that written statement, I have an
update on Argentina's economy and their engagement with the
IMF.
Reform of the IMF has been a high priority for the Bush
Administration. The growing role of international debt
securities, the increase in the volume of private capital
flows, the increasing interconnection between financial
markets, as well as the experience with crises in the 1990's,
all underscore the need for action.
The Meltzer Commission helped provide impetus for this
reform through the recommendations in their report of March
2000. Congress has been an active participant in this effort
for change.
Over the last 5 years, the progress we have made on this
front includes clearer limits and criteria for large-scale
official sector lending; a tighter focus by the IMF on its core
macroeconomic areas of expertise; greater concentration on
short-term financing; increased transparency in the IMF's
operations, as well as in the national data of the member
countries of the IMF; and adoption of collective action clauses
as standard market practice in sovereign bond documentation to
help promote orderly restructurings and reduce disruption.
I think those are all major steps forward, but as you noted
at the outset, we are not prepared to relax our efforts. In
response to calls from the United States and others, the IMF is
now undertaking a review of its role and strategy for the
medium term. We have several key priorities in this process:
One, strong surveillance and crisis prevention. We need to
further tighten the focus and the selectivity of analysis that
the IMF does to integrate more fully capital market and
financial sector analysis into the daily life of the Fund.
A second priority for the United States has been the
establishment of a new non-borrowing program. We strongly
believe that the IMF needs a new tool to provide a structured
engagement in support of strong economic policies where there
is no need for borrowing. We have proposed such a mechanism. We
have won the support of our partners in the G-7, and we expect
that proposal to be taken up by the IMF's Board this summer.
And demand for such an arrangement is already emerging from IMF
member countries.
We are also looking for more effective engagement of the
Fund with low-income members. Working with low-income countries
to help them achieve macroeconomic stability is a vital part of
the IMF's mission. At the same time, the Fund is not a
development institution, and its financial operations should
reflect its mission to provide short-term balance-of-payments
financing. We have urged the IMF to undertake a close
examination of its approach in low-income countries with a view
to helping these countries achieve better economic results.
Helping low-income countries depends also on ending the
lend-and-forgive cycle so that they can move into an era of
sustainable debt. And the Bush Administration has put forward a
bold proposal to provide up to 100 percent relief on
International Development Association and African Development
Fund loans to the heavily indebted poor countries. Action on
this debt is critical to putting these poor countries on a
sustainable path.
If there were any debt relief in the IMF, it would need to
be financed from the existing resources of the IMF. We do not
believe that gold sales--whether they were to be executed in
the market or off the market--are necessary or warranted.
Before concluding, let me draw your attention to the issue
of representation in the IMF, which is something else that we
have been pressing in our strategic review.
The IMF is accountable to its 184 member governments
through a weighted voting structure that is aligned with the
countries' global economic standing. But change in the world
economy over the last number of decades has outpaced that in
the IMF, particularly given fast-paced growth in emerging
market economies and given integration in Europe.
Secretary Snow has strongly signaled the need for the IMF
structure to evolve. In our view, this is vital to maintaining
the good will of its members and to preserving the centrality
of the IMF in the global financial system.
Change will not come quickly or easily, but we believe the
effort is essential to the long-term effectiveness of the
institution.
And with that, I thank you for the opportunity to be here
today, and I am looking forward to your questions.
Senator Crapo. Thank you very much, Mr. Quarles, and we do
appreciate the focus of the Treasury Department on the reform
of the International Monetary Fund and your continued efforts
to improve it.
I would like to first talk with you a little bit about
Argentina. Argentina's default was unprecedented in size and
for having the lowest recovery rate in history and for the
process that has stretched the guidelines of sovereign debt
negotiations. Argentina's sovereign debt restructuring has
widespread implications not only for creditors but also for
Argentina's long-term financial stability, developing country
debt markets, and guidelines for future sovereign debt
restructuring, as well as for IMF policies.
What lessons do you think we have learned by our engagement
with the IMF and the Government of Argentina throughout this
process?
Mr. Quarles. Well, I guess the first thing I would say is
that the learning process is not over. There will be continued
engagement between the Fund and Argentina.
I think that one of the central things that we probably
learned with respect to the debt restructuring process, which
was the focus of your question, is that it is not necessary for
the Fund to take an interventionist stance in debt
restructuring between a country and its private creditors for
that process to proceed. In our view, the debt exchange has now
been completed, and Argentina needs to have a strategy for
dealing with the remainder of its creditors. But the stance
that the IMF has taken with our support throughout this process
has been that the details of how that exchange is accomplished
and the details of that strategy going forward are for
Argentina to develop and for the creditors to evaluate, and
that as a systemic matter the system will operate better going
forward if parties do not feel that they are able to draw the
official sector, and particularly the IMF, into mediating or
directing those sorts of negotiations.
The IMF creates the macroeconomic framework in which the
negotiations can take place, but it is not more interventionist
than that.
Senator Crapo. Let me interrupt there. In this case,
Argentina has reached an agreement with 76 percent of its
bondholders. The 24 percent that are outstanding still remain
to be handled. Would your discussion there apply to that? In
other words, what would you think should be the IMF's position
with regard to the remaining 24 percent who did not participate
in the decision that was made previously?
Mr. Quarles. Well, I think that, as you noted, the official
sector's interest is ensuring that Argentina has somehow
resolved its situation with all of its creditors, though it
needs some strategy for dealing with the remaining 24 percent.
But I do not think that it is up to the IMF to dictate that
strategy; rather, the Fund says we need to ensure that you have
resolved the situation with your creditors; you have done a
debt exchange that has resolved that situation for 76 percent;
there is another 24 percent that remains out there; you need to
address that situation. But it is not for the Fund to say how
that situation should be addressed. These are issues that can
be worked out between sovereigns and their private creditors.
And I think the system will work better if they are left to
that solution, and as the system adjusts to the fact that the
IMF hanging out its shingle does not get all of the debt
restructuring business, if you will, the system will operate
better.
I think the fact that the debt exchange has been able to
proceed as it has and that Argentina has begun indicating it
will develop a strategy for the remaining creditors from some
public statements that have been made indicates that, contrary
to the views of some it would not be feasible for restructuring
to proceed with the IMF taking this stance--we create the
framework, but you do the deal--contrary to that perception, it
is, in fact, moving forward.
Senator Crapo. Then in the case of future sovereign
defaults, would I be correct in assuming that it would be
Treasury's intention to encourage the IMF to allow countries to
negotiate outcomes without IMF interference?
Mr. Quarles. Again, it depends on how one defines IMF
interference. I think that it is up to the IMF to say the debt
restructuring needs to proceed. It is up to the IMF to create
macroeconomic stability in the country, to engage with the
country to create a macroeconomic framework in which the debt
restructuring would proceed, but not to be interventionist in
the details of that restructuring. Those are negotiations for
countries and their private creditors.
Senator Crapo. So it would be a stimulus for the
restructuring, but not to dictate details.
Mr. Quarles. Exactly.
Senator Crapo. Now, Argentina has already given signals
that it plans to return to the international bond market in
just--I think it is 3 years after the default, the biggest
default in the history. Will this send a signal to other
countries to follow Argentina's example and basically default
and then renegotiate their debt?
Mr. Quarles. I do not think so. The costs that Argentina
has paid for the default were substantial. There were social
costs that included riots in which many people died as a result
of the disruption that was associated with the default. They
had to freeze the deposits in their banking system. I think
anyone who looks at the consequences of Argentina's default
would say that is not a model to emulate. I do not think is
going to be an attractive model to emulate. And certainly in
our discussions with countries in the region, we have not
gotten indications that there is any sort of groundswell of
view that Argentina's path is a model to emulate.
Senator Crapo. Thank you. I think one of the lessons that
we have learned from Argentina is that if the International
Monetary Fund provides funding, governments tend to postpone
tough decisions, and then ultimately the problem gets bigger.
When the IMF does not intervene and provide the additional
funding, do you think that that provides an incentive for these
countries to negotiate and resolve issues?
Mr. Quarles. I do. There are situations in which I think
IMF intervention can be helpful, but it needs to be focused on
achieving objectives that are clear and in the service of a
strategy that is well thought out. But, you know, as a general
matter, I do think that we need to be very careful about IMF
assistance, and particularly large-scale IMF assistance, as a
way of forestalling the tough decisions that countries need to
make.
Senator Crapo. Thank you. I just have one more area of
questioning, and I would like to shift gears now to China and
its exchange rate policies and, frankly, just to ask you to
share your opinion with us on the Chinese exchange rate issue
and what you think the United States action, if any, should be.
Mr. Quarles. Well, as Secretary Snow was recently before
the Senate testifying, we have delivered a foreign exchange
report that describes the situation with China. We have engaged
with them over the course of now nearly 2 years on dealing with
the obstacles to their moving to a more flexible exchange rate
regime as they have defined and described them.
I think that engagement has been successful enough,
fruitful enough that we have come to the conclusion that China
is technically ready, as the Secretary has previously
testified, to make that move. So as we consider this question
going forward, we look at China in that light. So, I think we
have been fairly comprehensive in the foreign exchange report
that we delivered as to the details of the situation. The main
point is that I think our engagement with China has been
fruitful, it has resulted in progress in addressing these
obstacles, obstacles on a path that they have said that they
want to move on, and so I think that, as the Secretary said,
they are now technically ready to move.
Senator Crapo. Thank you. We have been joined now by
Senator Bayh, the Ranking Member of the Subcommittee, who has
also been very helpful not only in terms of this Committee in
setting up this hearing, but also on a number of these issues.
And I would like to turn next to Senator Bayh.
STATEMENT OF SENATOR EVAN BAYH
Senator Bayh. Thank you very much, Senator, and thank you
for calling these hearings. And, Mr. Quarles, thank you for
your time and your service to our country.
I would like to begin by asking a couple of questions about
how Argentina got into trouble in the first place. As I
understand it, wasn't one of the difficulties there that they
had a large systemic budget deficit problem related to the
financing of the states that was assumed by the federal
government? And there was some political dysfunction as well,
but wasn't that one of the underlying problems that they had?
Mr. Quarles. In my view, it was the central underlying
problem, this question of fiscal federalism, which is an issue
we run into in a number of countries and how to appropriately
balance the fiscal obligations of a central government and a
state government and a federal system. Argentina under their
constitution had a system that allowed state spending which the
federal government was essentially required to fund without the
ability to----
Senator Bayh. In my previous capacity, as Governor, I might
have thought that was okay.
[Laughter.]
But taking a more global view, it really got them into
trouble, didn't it?
Mr. Quarles. Absolutely.
Senator Bayh. Which leads me to my second question. Given
that that was part of their problem and has occasionally led
other countries into difficulty as well, what ground do we
stand on with our own sizable deficits, which run the risk of
being systemic given the aging of our population? I mean, have
we not undermined our own credibility in terms of advising
other countries about fiscal probity?
Mr. Quarles. I think the path that the Administration has
outlined of shrinking the deficit in half over the course of
the next 5 years is, in fact, exactly the right path to
establish the credibility that we need. We need to perform on
that path, without question, but given where we are currently,
our debt to GDP----
Senator Bayh. Could I ask you something, Mr. Quarles?
Forgive me for interrupting.
Mr. Quarles. Not at all.
Senator Bayh. Do you encounter anyone from abroad who finds
that projection to be credible?
Mr. Quarles. I do. I guess I would say they want to see
continued performance, but over the course of the last 2 years,
the deficit has begun to shrink. It has begun to shrink as an
absolute amount.
Senator Bayh. Are we including the costs of the military
situation in Iraq and all the other things that are off budget
but really contribute to our actual deficit?
Mr. Quarles. Even over the course of the last 2 years, that
has begun to shrink even factoring those in. They factor into
both years. The total amount is shrinking as a percentage of
GDP, and a significant element of that certainly during the
last year has been an increase in revenues. So everything that
observers are looking at to see in the performance of the
United States in shrinking its deficit is the deficit actually
shrinking, not just as a percentage of GDP, although that is
certainly quite important.
Senator Bayh. Has the IMF not chastised us for our deficit
and said that there is a relatively narrow and potentially
closing window of opportunity to deal with it before the baby
boomers start retiring?
Mr. Quarles. I am not sure I would characterize it as
``chastising,'' but the IMF has certainly looked at the budget
deficit issue.
I think all observers agree that the key question is: Can
we keep the deficit under control? Can we shrink it? Not do we
need to close it immediately, because the consequences for
growth of the country of closing it immediately and, therefore,
for world economic growth would be substantial.
So what we need to do is establish a credible path to
shrinking the deficit as opposed to closing it immediately, and
so far we have been performing.
Senator Bayh. I certainly agree with the aspiration. I have
only been in this town for 6\1/2\ years, but it strikes me as
perhaps the triumph of hope over experience, but we shall see.
Our 6-percent GDP current account imbalance, are there
other countries that are running a current account imbalance of
that magnitude?
Mr. Quarles. At the moment there is certainly no large
economy that is running a current account deficit of that
magnitude. Australia has for many years run a current account
deficit of roughly that size, not quite 6 percent, but 4 or 5
percent of GDP.
Senator Bayh. If this occurred in another country, would we
refer to it as a sign of strength?
Mr. Quarles. It depends. I think we actually can view it as
a sign of strength in Australia. There are large differences
between the United States and Australia as economies. I think a
significant portion of the explanation of the U.S. current
account deficit is, if it results from a perception of capital
around the world that an economy is a superior place for
investment, then as a sign of strength of the economy, it
probably is one. Is there an imbalance building up that can
continue forever? It probably cannot continue forever. I think
Chairman Greenspan, among others, has said that. But is it an
immediate problem? Under those circumstances probably not.
Senator Bayh. My concern, Mr. Quarles, is that the only
thing I can predict with some assurance about the future is
that the unexpected will happen. Might there be some contagion
from abroad? Might there be an energy disruption? And we can go
down the list of potential horribles? Who knows? God forbid,
none of them will happen. But if you look back over the course
of history, something unexpected and perhaps adverse is almost
always occurring. And with an imbalance of this size, have we
not taken much of the slack out of the system and really run a
greater risk than would otherwise be the case of having a real
retrenchment in our currency with perhaps dramatic consequences
for our economy?
Mr. Quarles. When we look at the size of the deficit the
first place to begin is what base do we begin from; that is to
say, the current account deficit measures the growth in foreign
claims on the United States, so what base do we begin from? And
foreign claims in the United States, net foreign claims, are
about 25 percent of our GDP, which is not at all a concerning
level of foreign claims.
So they are growing, and while that cannot continue
forever, when you begin from a base of that size, again, I
think you say this is not a rubber band that is at the point of
snapping. It is being stretched. If it comes back into
adjustment, not in a disruptive fashion but in an orderly
fashion, then that is something that is to be expected and
something that is not likely to cause disruption to the
economy.
Senator Bayh. Economic theory would suggest that it would
get back into alignment through what, a continuing depreciation
in our currency?
Mr. Quarles. There are a variety of ways it could come back
into alignment, and one way would be an increase in the savings
rate in the United States, if you view it as the savings-
investment imbalance. Another way would be an increase in
growth outside of the United States in our peer economies,
particularly Europe and Japan.
Senator Bayh. Are you counting on an accelerating growth in
Europe?
Mr. Quarles. We are working with them to try to improve
their prospects.
Senator Bayh. I understand, but, I mean, it looks like a
difficult challenge at the moment.
Mr. Quarles. I would agree with that.
Senator Bayh. And the reason I ask, it gets back to Senator
Crapo's question, with our largest imbalance currently with
China and another chunk of it with Japan, both of which really
take steps to prevent the currencies from realigning, it
further exacerbates the imbalance in other ways.
Mr. Quarles. And that is one of the reasons why we have
emphasized the concept of a three-legged stool as the way of
dealing with the current account problem. We have the savings
issues in the United States, which we can deal with by measures
to increase private savings, by decreasing public dissavings by
bringing the budget deficit down. You have growth in Europe as
another leg of the stool, as a way of increasing the
attractiveness of Europe as a locus for investment. And then
you have Asian currency flexibility as a way of providing other
mechanisms for adjustment.
Senator Bayh. Well, that is why I started off with our own
budget deficit. It seems to me that is the one thing that we
have the greatest control over. We would like to promote
savings in the long-run, but that is a longer-term challenge.
Growth in Europe is a longer-term challenge. Currency
flexibility on the part of the Asian countries is something
that should be done right away, but I suspect will take a
little time to accomplish. And that is why, if we are looking
at trying to put a little more flexibility into our own system
to empower us to deal with the unknown, that is one thing we
can do in the shorter-term.
Mr. Quarles. We do. We need to be mindful of what the
effects on growth would be, of shrinking it immediately. I
think we also need to be humble about our ability to know what
the effect on the current account deficit would be of a
shrinkage of the fiscal deficit by any particular size. The
Federal Reserve has estimates that shrinking our current fiscal
deficit completely would only shave off about 1 percentage
point of the current account deficit, so at a 6-percent deficit
that still leaves 5 percent that needs to come from elsewhere.
Senator Bayh. It is better than nothing.
Mr. Quarles. It is better than nothing. But given, again,
when you take all the pieces of the puzzle and put them
together, what would the effect on growth be? What is the
likely effect on the current account deficit? How much of a
current risk as opposed to longer-term risk is the current
account deficit? I think the path that we are on is the
responsible one of shrinking that deficit over time, developing
credibility by performing on a predetermined plan, which we
have identified and so far for 2 years have been, in fact,
overperforming on. We are going to overperform this year. You
know, I think that is the responsible path, and so far we have
been able to stay to that path.
Senator Bayh. May I have time for two last questions,
Senator?
Senator Crapo. Yes, as a matter of fact, I do not have any
further questions, and so please go ahead.
Senator Bayh. I just have two more, Mr. Quarles, and then
we will set you free.
For a country trying to come to grips with a budget
deficit--Argentina before, some others--would the IMF
ordinarily recommend tax cuts as a part of a program to try to
come to grips with a deficit that a country is seeking to
shrink?
Mr. Quarles. Well, that depends on the situation. The IMF
certainly will frequently recommend to countries as a way of
improving their growth performance that they reduce marginal
rates and broaden the base.
Senator Bayh. I am not talking about that. I am talking
about net receipts. You are talking about a revenue-neutral
readjustment.
Mr. Quarles. Right, simply as a way of closing a budget
deficit, if you took other things totally equal, then, no, you
are not going to close a budget deficit by reducing receipts.
Senator Bayh. Thank you for your candor.
And, finally, there was a book written sometime ago by a
professor from Yale--I think his name was Paul Kennedy--called
``The Rise and Fall of Great Powers.'' And the central theme
running through the book was that when great countries have
security commitments and military commitments that exceed their
financial and economic ability to finance, if you look back
across history they have come to some heartache in those
circumstances.
That is one of the reasons I am concerned that we are
borrowing so much from abroad, even as our military and
security commitments are expanding. Does this concern you?
Mr. Quarles. Given the current situation where, as I said,
the net foreign claims on the United States are at a reasonably
moderate level for a country of our wealth and size, I do not
think that we are at all at a point of crisis with respect to
the growth on foreign claims or our borrowing from abroad. We
do need to increase domestic savings in this country, and we
need to be creative in finding ways to create the framework in
which those savings will increase. But we are certainly not at
all at a point of crisis as far as the growth of foreign claims
on the United States.
Senator Bayh. If the Chinese were to announce tomorrow they
were going to start diversifying out of dollar-denominated
assets, what would happen to the value of our currency?
Mr. Quarles. Well, I think that is hard to say. Rebalancing
the portfolio----
Senator Bayh. Would it go up? Would the dollar strengthen?
Mr. Quarles. I am actually not trying to be coy about this
at all. I do not think that we can say what the----
Senator Bayh. When the rumor was going through Seoul a
couple of months ago that they were going to diversify out of
dollar-denominated assets, the dollar went into a fall. And
when the Prime Minister of Japan, apparently inadvertently,
mentioned that perhaps they would start diversifying, the
dollar went into a free fall. It is reasonable to assume that
since we, in fact, borrow more from China, the effect would be
the same, only more.
Mr. Quarles. Those were very short term. I mean, what the
effect would be on any particular day I think, again, is hard
to say, although markets do not like new news, and so there
would be some movements. Those statements were immediately
retracted.
Senator Bayh. They were comments or rumors that were then
denied. I am asking what if another government--in this case
China--announced as its policy in fact that they were going to
be diversifying out of dollar-denominated assets.
Mr. Quarles. I do not think that the long-term effect, even
the medium-term effect on the U.S. economy would be dramatic at
all. What the near-term financial effects would be I think are
difficult to predict.
Senator Bayh. I will let you go. The reason I ask the
question is I think most people would assume that it would have
a downward effect on the dollar, perhaps dramatically so, for
at least a period of time. And I wonder whether that is a
position of strength, of independence, and whether, in fact, in
some ways our financial sovereignty is not impaired when we are
as dependent as we currently are on other countries to pay our
bills, including the bills of our military.
Mr. Quarles. We have actually had a demonstration effect on
that. People have been concerned about this. It is certainly an
issue we have looked at in the Treasury for some time as the
Asian official sector has been purchasing Treasury securities,
and this concern has been articulated that we are therefore
somehow beholden to the Asian official sector.
This was particularly said about Japan 2 years ago, and
then about a year ago--and that if at any time Japan were to
stop purchasing Treasury securities, that the effect on U.S.
interest rates would be significant.
Our stance at the Treasury based on our knowledge of the
Treasury market was that the likely effect on interest rates
would be quite small, if anything, because of the depth and
liquidity of the Treasury market, and that if even a large
participant were to withdraw, others, probably from the private
sector, would step in and take up those securities at a
relatively small increase in cost. What we saw when Japan
ceased intervening and, therefore, largely withdrew from the
Treasury market in March 2004, was that over the course of the
next several months, long-term interest rates, our 10-year
interest rates, actually declined in line with what our
hypothesis would have been before. Even the departure of what
at that time was the most significant single purchaser of our
securities, the complete departure from the market was largely
taken up by additional private sector purchases.
So, again, we are not Pollyanna-ish about this at all. It
is an issue that we look at. The holders of our debt is an
issue that we continue to look at. What the possible
implications rebalancing our portfolios are is something that
we give a lot of thought to. But I do think that we have had
this recent demonstration effect, that even the withdrawal of
the very large purchaser has effects on our cost of funding, on
the Treasury's cost of funding that are small, if even
measurable.
Senator Bayh. Well, perhaps you are right. Let us hope you
are right. It is a question of whether it is a risk we want to
run. And you are a good man, Mr. Quarles. I look forward to
working with you, and I am grateful for your willingness to
expose yourself to our questions today. Thank you.
Mr. Quarles. Thank you, sir.
Senator Crapo. Thank you very much, Mr. Quarles. We
appreciate your attendance.
Senator Crapo. We will excuse this panel and call up our
second panel which consists, as I indicated, of Dr. Allan H.
Meltzer, who is Professor of Political Economy at Carnegie
Mellon University, and Dr. Fred Bergsten, who is the Director
of the Institute for International Economics.
Gentlemen, we appreciate you being with us. We have
allocated, as I indicated at the outset, 10 minutes to each of
you if you choose to use all 10 minutes of it for your
presentation, and then we will engage in some questions, and we
will start with Dr. Meltzer.
STATEMENT OF ALLAN H. MELTZER
THE ALLAN H. MELTZER UNIVERSITY
PROFESSOR OF POLITICAL ECONOMY,
CARNEGIE MELLON UNIVERSITY, AND
VISITING SCHOLAR, AMERICAN ENTERPRISE INSTITUTE
Mr. Meltzer. Thank you, Mr. Chairman. Mr. Chairman, Senator
Bayh, it is a privilege to have this opportunity to review
progress on reform of the International Monetary Fund. I
commend the Chairman and the Members for their continued
interest in this important topic.
I am pleased to report that there has been progress on
central issues. On other important issues, much is unfinished,
and in some cases unstarted. From a comprehensive list of
topics proposed by your staff, I have chosen to discuss
progress toward the adoption of recommendations of the Meltzer
Commission, but I touch on the other questions that the staff
raised.
In the view of the Meltzer Commission, the IMF has two main
tasks. Its most important activity is to increase the stability
of financial markets, or if crises cannot be prevented, to
localize problems or crises and keep them from spreading to
countries or markets that would otherwise be unaffected.
A related but distinct activity is to reduce market risk by
improving the quality and increasing the quantity of
information available to lenders and creditors. The IMF has
made a sustained effort to improve the quantity and quality of
information on member countries. More is desirable. Especially
needed are reductions in the time before information becomes
generally available.
A remarkable change came to fruition this year. Argentina
settled its defaulted debt with about 75 percent of its
bondholders. This was the largest default ever, and it involved
hundreds of thousands of individual debt holders and more than
100 separate debt issues. Coordination did not at first seem
promising, but it was achieved and without outside
intervention.
Unlike earlier practice, the IMF was not a party to the
negotiations. It did not make additional loans to Argentina to
assist in the settlement and bail out the lenders. The
settlement was based on decisions between the Argentine
Government and representatives of the bondholders, particularly
my colleague, Adam Lerrick, who did much of the negotiation for
the bondholders. I am confident that in time Argentina can
settle with the remaining bondholders without IMF intervention.
I consider this a big step forward because risks and returns
were related. Lenders who received high interest rates on risky
loans had to bear the risk when it came. This improves the
functioning of markets, warns the bondholders and spares
taxpayers from paying for lenders' errors of judgment.
Also Argentina's financial problems were mainly confined to
Argentina. When they threatened to spread to its neighbor,
Uruguay, the IMF arranged a large loan. This is in keeping with
its principal function, preventing the spread of crises.
In its response to Argentina and Uruguay, the IMF followed
the spirit and often the letter of the Meltzer Commission
recommendations. It is not always so. The Meltzer Commission
made two unanimous recommendations. The first called for
writing off debt--even Fred Bergsten agreed with us on these--
the first called for writing off ``all claims against heavily
indebted poor countries (HIPC's) that implement an effective
economic and social development strategy.'' The second called
on the IMF to limit its lending to short-term loans leaving
long-term loans for poverty reduction to others. Instead, the
IMF created the Poverty Reduction and Growth Facility (PRGF).
The IMF has no special expertise in economic development and
poverty reduction. These problems should be left to the World
Bank. While I agree with those who say that the development
banks are ineffective, unfocused, and should be thoroughly
reorganized--I am certainly one who believes that--duplication
of their work at the IMF is not the right solution. The Poverty
Reduction and Growth Facility should be closed.
The IMF, the World Bank, and the G-7 countries have not
agreed on programs for debt relief for several of the heavily
indebted poor countries, the so-called ``HIPC countries.'' Some
agreements have been made and countries have agreed to use the
resources released thereby for education and health. Great
Britain is pressing for new agreements at the 2005 summit in
Scotland, and indeed here in Washington today.
Part of the discussion of debt relief is misleading, highly
misleading. The HIPC countries do not actually service most of
their debts and have not for a long time. To prevent default
the IMF and the development banks lend the country enough to
make payments, increasing the countries' indebtedness. A HIPC
country receives credit for payment, but little or no new
money. Debt relief, as usually discussed, is actually a way of
increasing HIPC country borrowing. It would increase the
countries' available resources, since debtors would receive the
same payment but would not have it offset by a debt service
payment of similar size to the international financial
institutions. The net transfer would increase.
The main issue in current discussion are how the transfer
should be financed and how the increased net transfer should be
used to improve social and economic conditions in the debtor
countries. Gold sales by the IMF are one option that has been
proposed. As you know, the Congress wisely disallowed the sale
of the U.S. gold deposit at the IMF without its consent. The
gold should be returned to the members and revalued by them.
Part of the profit could be used to reduce HIPC debt. Gold
sales would have to come before this Commission. I hope it
would be turned down.
One of the Meltzer Commission's main recommendations called
for replacement of conditional loans with loans based on a
limited number of preconditions accepted in advance by the
troubled country. The purpose of this proposal includes
reducing risk, increasing incentives for reform, and giving the
borrowing country a large part of a choice of its own policies.
To its credit, the IMF has reduced substantially the number of
conditions attached to its loans. It considered but did not
adopt preconditions. As part of the comprehensive review of
this strategy that is now under way, it proposes that future
lending should be ``anchored in strong country ownership.''
Now, I should say that the IMF is in the process of
examining its procedures and it will issue a final report on
what needs to be done at its September IMF/Bank Fund meeting
here.
This is a good step away from the command and control of
the 1990's based on the so-called ``Washington consensus.''
``Ownership'' means that the country has a major role in the
choice of policies. Much evidence suggests that reform is made
more likely when political leaders in the country choose it,
support it, and decide to implement it. The Fund's own research
suggests that much of the time countries do not implement the
conditions to which they agreed to get a loan.
Preconditions reduce risk in other ways. Countries that
avoid pegged but adjustable exchange rates, improvident fiscal
and inflationary monetary policies, and weak financial systems
are more prone to crisis. Reducing or removing these sources of
instability reduces the chance of a crisis. Further, negotiated
preconditions accepted in exchange for a commitment to assist
in a crisis reduce the long delay that often occurs before
assistance is given.
A critical part of this proposal is that countries would
have greatly increased incentives to reform. If they did not
agree to preconditions, they would not be eligible for
assistance. This alone increases the incentives for reform. But
this incentive increases because private sector lenders would
distinguish between countries that adopted reforms and those
that did not. They do not under the present long-time
prevailing arrangements have much incentive to do that.
The international private capital market is the principal
supplier of loans. It offers 5 to 10 times the volume offered
by international financial institutions. The private market
would offer more loans at lower interest rates to countries
that adopt preconditions. They are safer. Reformers in the
countries could replace arguments claiming that the IMF
requires reform with citation of the benefits to the country,
more capital at lower interest rates.
The IMF faces many possible challenges. Will other
countries follow Argentina by defaulting and renegotiating
debt, as your question asked a few moments ago? Will
recognition of increased risk reduce the amount of private
sector lending? Does the large accumulation of reserves by
Asian countries and other recent changes signal a decision by
these countries to manage future crises without the IMF? Have
the Asian crisis countries taken a further step toward
development of a regional financial bloc? If the IMF no longer
bails out private lenders, will private lenders object to the
IMF's preferred creditor status which has no legal basis?
The IMF's loans are heavily concentrated in the debts of a
small number of countries. Will one or more of these countries
default on the IMF?
We should recall that the IMF's original purposes included
monitoring and maintaining a fixed exchange rate system. The
IMF should take more responsibility for the exchange rate
system to adjust under or overvalued exchange rates. It is well
know that if more countries allowed their exchange rates to
adjust, there would be fewer crises. Many observers claim that
undervalued Asian exchange rates and the large U.S. current
account deficit will end with a major financial crisis. They
use the word ``unsustainable'' when they discuss the U.S.
current account deficit. I am far from certain, even skeptical,
about these claims. But we should recognize that there is a
risk that will not be removed and may be increased by the many
adjustments that follow an appreciation of China's exchange
rate. In keeping with its original purpose, the IMF should try
to implement a cooperative solution that revalues the yuan and
reduces the U.S. deficit, current account deficit.
Finally, corruption is a major problem in some developing
and developed countries. No one can rid the world of bribery
and corruption, but the IMF could do more than it now does to
limit it.
Thank you.
Senator Crapo. Thank you very much, Dr. Meltzer.
Dr. Bergsten.
STATEMENT OF C. FRED BERGSTEN
DIRECTOR, INSTITUTE FOR INTERNATIONAL ECONOMICS
Mr. Bergsten. I am delighted to be before the Committee
again, particularly because Dr. Meltzer and I completely agree
on the one issue I want to emphasize. It is the last issue he
mentioned, which has to do with the adjustment of the huge
international imbalances we now face and which Senator Bayh has
already emphasized.
I want to make just one point to the Committee, and it
echoes what Dr. Meltzer said at the end but puts it more
strongly. The International Monetary Fund (IMF) is failing to
implement its own rules on one of the most crucial issues
facing the world economy--the imbalance in currency
relationships. This imbalance in turn is a central problem in
the current account difficulties that we face, and that surplus
countries face, and that raise the crisis risks for both the
world economy and our own domestic trade policy. You here in
Congress see these risks every day when you confront pressures
to restrict trade, in large part because of the big currency
imbalances and their pass through to our big current account
deficit, of which the main counterpart is the surplus
countries.
I want to focus on why the IMF should be doing more in this
area and why the U.S. Government itself should be mobilizing
the IMF much more effectively, enabling and indeed pushing the
IMF to be much more effective at exercising its stewardship
responsibility for the world economy.
As Senator Bayh has mentioned, the global current account
deficit of the United States is very large. Indeed, it is now
getting close to an annual rate of $800 billion or 7 percent of
our GDP, and it has been growing by over half a percent of GDP
a year for 10 years. In short, it is on an unsustainable
trajectory. Not only is the level bad, but also its trajectory
and future growth.
On the flip side, the global current account surplus of
China is also very large. China's global surplus this year will
exceed $100 billion, more than 6 percent of its own GDP, and it
too is growing very rapidly. But it is not just China. A number
of other Asian countries have very large and growing surpluses,
most notably Japan, which still has by far the largest surplus
of any country in the world, but also Korea, Taiwan, Hong Kong,
Singapore, and Malaysia, all running substantial global
surpluses, which are the counterpart of the U.S. global
deficit. And it takes two to tango--you cannot get our deficit
down unless you get the surpluses of the surplus countries
down.
As Senator Bayh said, the United States has to lead the
correction of the imbalances by increasing its rate of national
saving. Incidentally, we have to borrow $5 billion of foreign
capital every working day to keep our own economy afloat. If it
does not come in happily at current interest rates, exchange
rates, equity prices, property prices, and the like, we will
face financial instability, whether a crisis or not. It is a
vulnerability we want to avoid. So we have to take the lead.
But an essential part of the correction inevitably is a further
large decline in the exchange rate of the dollar, which I would
estimate at being something like an additional 20 percent or so
on a trade-weighted average against the currencies of our major
trading partners.
Over the last couple of years, the dollar has already
declined a lot against the truly floating currencies--the euro,
the pound, the Swiss franc, the Canadian dollar, and the
Australian dollar. But the next phase of the dollar decline
needs to take place against the currencies of East Asia because
those countries are running the world's largest surpluses, they
have the world's fastest growth rates, and they have been
intervening massively in the currency markets to block
appreciation of their currencies--in the cases of China and
Malaysia--or to limit the appreciation far below what market
forces would have produced.
It puzzles me that our own Administration and the rest of
the G-7 governments, all of whom profess fealty to market
economics and letting the market determine these things, have
been very slow in responding to this blatant, sizable, and
prolonged intervention, which clearly blocks market forces.
China is the key. Some people do not even realize that China,
by pegging to the dollar, has actually ridden the dollar down
over the last 3 years, meaning that the Chinese exchange rate
has not just stayed flat against the world but has actually
weakened, meaning that the most competitive country in the
world has become even more competitive by riding the dollar
down against the euro, the Canadian dollar, and even to some
extent the yen and other currencies in Asia.
Moreover--and this is really crucial--the other Asian
countries, from Japan all the way through India, are very
reluctant to let their exchange rates rise against their tough
competitor China and therefore are unwilling to let their rates
go up against the dollar, if that also means going up against
the renminbi, as it does, as long as China continues to peg to
us. It is a big problem.
What should be done about it? In my view, it is the
responsibility of the IMF to promote correction of such huge
costly and potentially destabilizing imbalances in the world
economy. In fact, the Fund's own Articles of Agreement enjoin
member countries to ``avoid manipulating exchange rates or the
international monetary system in order to prevent effective
balance-of-payments adjustment or to gain unfair competitive
advantage over other member countries.''
Back when floating rates became the norm of the system in
the 1970's, the Fund fleshed out that rule and laid out
principles to monitor exchange rate practices. Its principles
identified three variables as determining whether a country was
manipulating: Protracted large-scale intervention in one
direction in the exchange markets. China clearly meets those
criteria. Incidentally, up to a year ago, so would have Japan,
but it has not intervened for the last year. Malaysia also
meets the criteria.
To its great credit, Secretary Quarles and our own Treasury
indicated this in its latest semiannual report to the Congress,
after it had whitewashed China's behavior for a couple of
years, but still inexplicably fails to label China a
manipulator per se. It nevertheless strongly attacks the
Chinese exchange rate practices and calls for immediate action.
Whatever the language of the Treasury reports, the United
States and the rest of the G-7 should insist that the IMF
insist that China and a few others comply with its own rules,
which I just reiterated.
Several people, myself included, have talked about the
possible need for trade remedies to induce China to move its
exchange rate in a constructive direction. That may at some
point be necessary. But first we should certainly try the
multilateral, institutional, legal approach readily available
to us in the IMF. It amazes me why the United States and the
rest of the G-7 have not gone that route. If you had to bring a
trade case later in the World Trade Organization (WTO), you
would then have the requisite IMF underpinning for it, which is
required under WTO rules anyway. So it is a win-win
proposition, and we have to do it.
The Fund has limited its own activities in this area to
quiet efforts to persuade China to become more flexible in its
currency regime, which is certainly desirable over time, has
not focused on the immediate need to raise the value of the
exchange rate of the renminbi. Secretary Quarles and the
Treasury talked rightly about the need to flexibilize the
Chinese economy, its banking system, and its monetary policy,
so that over time it can move to a more flexible exchange rate.
And the Chinese themselves have said that.
But you do not need any of that to get what I think is
necessary, namely, a one-shot revaluation of the exchange rate
of the renminbi. They should keep the fixed exchange rate for
now, though widening the margins to make it more flexible. They
should keep the capital controls for now, given the weakness of
the banking system. But they should substantially change the
price of their fixed rate.
Our analysis shows that if China would revalue its currency
by 25 percent, and the rest of the Asians would go halfway in
that direction, it would reduce the U.S. current account
deficit by at least $60 billion. If the rest of the Asians went
all the way with China, which the markets might well push them
to do--and they might then be prepared to do--the United States
would achieve something like $100 billion of current account
correction.
As I said before, we are running an $800 billion deficit
now. We need to cut it by $300 billion to $400 billion--not to
zero but roughly in half--and this achievement from the
correction of the Asian currency relationships would carry us a
substantial way down the path. We still have to increase our
own saving rate and the Europeans still have to grow faster but
we would get at least a quarter to a third of the needed
correction if we got the adjustment of the Asian currencies.
So the bottom line--and I want to emphasize that one point
today because I think it is so crucial and so urgent--is that
our own government and the rest of the G-7 should insist that
the IMF take the lead and implement its own rules. It does at
the end of the day come back to the United States and the G-7.
The G-7 finance ministers are meeting this weekend. I hope
they agree to launch this initiative. The G-8 summit is meeting
in a month. Tony Blair is here talking with President Bush
about it today. It is well and good for the G-8 to take new
steps to help Africa develop and to worry about climate change
but we have a critical, large, and urgent problem facing the
world economy. I hope and recommend that the G-7 countries, at
the finance ministers' meeting this weekend and at the summit
next month, mobilize the IMF to implement its own rules to get
this crucial part of the global adjustment under way.
Thank you.
Senator Crapo. Thank you very much, Dr. Bergsten.
I will start out with you, Dr. Meltzer. You indicated in
your testimony--in fact, let me go back to a previous hearing
about 3 or 4 years ago, when we were talking about the Meltzer
Commission's report and the World Bank. And this is going to
tie in to my first question. I am recalling at that time that
one of the reforms that was proposed for the World Bank was
that instead of just making loans to national that were
basically over which we did not have any real oversight, that
we instead--and I am not remembering the exact mechanism--but
that instead that we focus on the exact services that were
intended to be provided and pay for the services, rather than
simply making an unmanageable loan. Could you clarify that a
little bit for me?
Mr. Meltzer. Yes. What we wanted and what we recommended
was managed grants.
Senator Crapo. That is right.
Mr. Meltzer. To its credit, the Bush Administration has
pushed that. It has met a lot of resistance from some of those
people who are out there today saying, ``We need to give $50
billion more.'' They resisted the idea of giving monitored
grants, but they eventually made a small step in that
direction. We need to take a much larger step.
What we would do is we would say, ``Pick a problem. Let the
country pick its problem.'' It says, ``We want water, potable
water in the villages. We will hire somebody, take bids, get
potable water in the villages, and pay them when it is there.''
Senator Crapo. We pay the provider of the service?
Mr. Meltzer. The World Bank, yes, pays provided the water
is there. That way we get around some of the corruption that is
involved, some of the non-feasance perhaps.
Senator Crapo. Is the World Bank operating that way to any
significant extent?
Mr. Meltzer. To a very limited extent. The World Bank
fought the idea, the French particularly did a lot of talking
right after the report came out. The French said, maybe we will
do this by 5 percent or something, of the amount that we give;
a trivial amount and only as a sop to the United States.
Senator Crapo. The reason I ask is that, as you know, the
Meltzer Commission unanimously recommended that the IMF should
get out of the business of poverty reduction loans.
Mr. Meltzer. Right, and I still recommend that.
Senator Crapo. I think you still recommend that, and if I
understand your testimony correctly, you recommend that the
Poverty Reduction Growth Facility simply be eliminated. Dr.
Bergsten I think recommends it be transferred to the World
Bank.
Mr. Meltzer. That is essentially the same thing.
Senator Crapo. And that is about the same thing. So the
World Bank is doing that function, and the question I was
getting at is do you both agree that it should not be a
function that is performed by the IMF. First of all, do you
both agree with that?
Mr. Meltzer. Yes. I think the main reason is that it does
not believe that the World Bank is an efficient mechanism for
doing what it is supposed to be doing.
Senator Crapo. Dr. Bergsten.
Mr. Bergsten. I certainly continue to agree with that view.
I would add that there have been a couple of management changes
at the IMF since the issuance of the Meltzer report, and under
one of those moving the Poverty Reduction and Growth Facility
to the World Bank was seriously considered. The management, in
fact, was convinced that it was the right thing to do.
When the management toured Africa and talked to the
beneficiary countries however, they all very strongly resisted
the idea. It was not just the French on the donor side. It was
the recipient African countries who argued that the only
benefit they could get from IMF membership was the credit from
this Poverty Reduction and Growth Facility.
Moreover, when faced with the alternative of shifting it to
the World Bank, the African countries said, ``Ah, but that is
not really quite the same thing. The IMF is a much more serious
institution; and if we pass muster with the IMF, we get a lot
better rating in the credit markets.'' Both Dr. Meltzer and I
would like to see them move toward that.
It was very interesting how that issue evolved.
Implementing the transfer, not elimination, but the transfer
from the Fund to the Bank was seriously considered. In fact, in
their usual bureaucratic way, they had even cooked up a swap,
where the Fund would transfer the PRGF to the Bank and get
something back in return so they would not have to fire too
many of their bureaucrats.
Senator Crapo. But you still support that transfer.
Mr. Bergsten. I support the transfer. It needs to be done.
It is way overdue.
Senator Crapo. All right. Dr. Meltzer, in your testimony,
again, you also talked about the preconditions to assistance
that we need to assure are in place. Could you specify a little
more detail about what those preconditions should be?
Mr. Meltzer. Yes. They would be fiscal solvency, proper
monetary policy, an adjustable exchange rate, opening the
banking system, the local banking system to foreign banks,
which, incidentally, is an agreement that we have, that
countries have with the World Trade Organization, so it is
something that just says they ought to do what they have agreed
to do and slowly they have been doing it. Those would be some
of the principal things we would do. We would avoid some risks
with foreign banks in the country. When there is a banking
problem they would run to the foreign banks instead of run from
the currency, which is a much better solution, and with a more
flexible exchange rate they would be less prone to crises. The
biggest problems that we have had in recent years have been
combinations of banking crises and exchange rate crises. The
preconditions would try to get rid of those, but would
recognize that there are other sources of crisis and,
therefore, we would lend to them automatically when they came
through. Automatically means that the IMF would continue to
monitor them and would keep them on the preferred list, if you
want, and that would be a market indicator to people in the
private market which says, hey, this is a good country or this
is not a good country.
Senator Crapo. And would you agree that that is probably
the most significant reform that we should focus on at the IMF
at this point?
Mr. Meltzer. Yes. That is hard to get. I mean, they have
thought about it. They actually announced something which is
very close to that called CCL. You know, they could not get
very many countries to agree to it. One reason that countries
would not agree to it was the IMF would not make the guarantee
that the country would get the assistance.
Senator Crapo. So why make the reform if I do not get the
assistance.
Mr. Meltzer. Exactly. Why make the commitment?
Senator Crapo. Dr. Bergsten, I want to get to your points
on China, but, first of all, your thoughts on the suggestions
about the preconditions to assistance and that being the next
strong focus.
Mr. Bergsten. I am very pleased that Dr. Meltzer's views on
the nature of the preconditions--it is fair to say--have
evolved a bit over the years, because when the Commission
report was prepared and issued--it is fair to say--he will have
to correct me as the chief author.
Mr. Meltzer. I will.
[Laughter.]
Mr. Bergsten. I am sure.
Senator Crapo. It would not be a hearing between you two if
we did not have a little bit.
Mr. Bergsten. As I recall, the overwhelming emphasis in
terms of preconditions from the majority was the soundness of
the banking system in a developing country.
Mr. Meltzer. Not true.
Mr. Bergsten. Well, let us go back and parse the language.
That is an eminently desirable requirement, but it is not
enough. The point that the minority emphasized in our dissent
was that limiting the preconditions in that way might have two
very adverse effects. One, it might enable a country to get IMF
credit even if its macroeconomic policy was way out of whack;
and, two, it might preclude assistance to a country which
needed the help and was systemically important but had had a
weak banking system.
Let me illustrate by referring to the country you discussed
earlier--Argentina. My recollection--and I am basing this
largely on a study done at my institute by Michael Mussa, the
former Chief Economist of the IMF--is that the Meltzer
Commission majority's criteria would clearly have qualified
Argentina for IMF credits deep into its crisis period because,
prior to the crisis, Argentina had a sound financial system
with lots of foreign banks. Indeed, Charles Calomiris, one of
the chief architects of the majority report, said so publicly.
So if one of our goals--and I address that in my written
statement--is to avoid big IMF mistakes like the big credits to
Argentina, which prolonged the crisis and expanded the agony,
the Meltzer majority's remedy would not have done that. So the
broadening of Professor Meltzer's criteria to now focus first
on fiscal policy, second on exchange rates, and third on the
banking system sounds a lot better. But it is not complete.
There is monetary policy, as he well knows. There are lots of
other things. I think any set of preconditions is going to be
limiting, but I like Meltzer 2005 a lot better than Meltzer
2000.
Senator Crapo. Well, I am going to let Dr. Meltzer have the
last word on my testimony here, and then in the second round I
will come back to you, Dr. Bergsten, on your issues regarding
China.
Dr. Meltzer, you can have the rest of my round.
Mr. Meltzer. Rather than argue about the past, which is
written down in print and I know what is there, let me just say
that I am very happy that we agree now, at least we seem to
agree now that preconditions would be a very good way for the
Fund to go. That is the important point going forward, not
arguing about the past.
Mr. Bergsten. I did not say that I would go for
preconditions. In fact, my last comment was that any set of
preconditions is almost certain to be too constraining.
Senator Crapo. Dr. Bergsten, you do not agree with
preconditions?
Mr. Bergsten. No, and I think the experiment that Professor
Meltzer mentioned with the contingency credit line, the CCL, is
evidence of the problem. There were no takers.
Senator Crapo. Okay. Anything else, Dr. Meltzer?
Mr. Meltzer. There were no takers because I sat in a
meeting with the Managing Director of the Fund--and there were
four or five of us there--it was pretty clear that the Fund
bureaucracy would not agree to making a contingent credit line,
CCL, would not agree to do that and say if you meet the
conditions you get the assistance. What they said is, well, we
want to take another look-see, we want to see whether
everything is okay. That is what stretches out the problem. And
Mexico was a good example where we stretched out the problem
for months. Things got worse and worse and worse, and
eventually we faced a big crisis. It would have been a crisis
but a smaller crisis if we had handled it early along the lines
that we suggested, that I suggested.
How much earlier? Well, that crisis was clear and apparent
as early as July of the year before they devalued. That is when
the United States started to give 700--what the United States
used to do was almost--was just terrible. They would lend them
the money on Friday so that it would show up on the statement
of the Mexicans on Monday, and then on Tuesday the Mexicans
would pay it back.
Senator Crapo. Let me interrupt because Senator Bayh is
under a time pressure. I want to give him some time for
questions here.
Senator Bayh. Thank you. I apologize. It is a fact of life
around here that sometimes you are required to be in two places
simultaneously. I have yet to figure out how to accomplish that
without feeling like I am shortchanging both sides of the
equation.
I want to thank both of you. Just real quickly, Dr.
Meltzer, it sounds as if you feel that the outcome in Argentina
has occurred in a way that will limit the risk of moral hazard
going forward.
Mr. Meltzer. Correct.
Senator Bayh. One of the last meetings we had of this
Subcommittee, we had a roomful of the creditors, and I do take
some exception to the actions of the Argentine Government. But
at the same time, we looked at the creditors and said, you
know, they call it a risk premium because it is risky?
Mr. Meltzer. Right. And they will learn that much better if
they go through the Argentine--where they lost a very large
amount.
Senator Bayh. And I do not want to put myself in the middle
of your conversation here, but in your view--the Argentines
defaulted for 24 hours and then made their payment to the IMF.
Was that correct? They technically defaulted?
Mr. Meltzer. No. They defaulted on their debt in December--
--
Senator Bayh. I am talking about to the IMF.
Mr. Meltzer. The IMF, oh, yes, but that was just--that was
nothing.
Senator Bayh. In your remarks, in your testimony, you
posited the risk of other defaults going forward and that kind
of thing.
Mr. Meltzer. Right. As Secretary Quarles said--and I asked
this question of the Brazilians, especially the Brazilian
Finance Minister, how would they feel about defaulting on their
debt as a result of Argentina? They said the Argentina
experience was rather bad, so that has quieted the people in
Brazil who think we should default on the debt because it was
so bad. And that is encouraging.
Senator Bayh. Are we talking about private sector debt or
IMF debt?
Mr. Meltzer. As well as government sector debt. I think the
pressure in Brazil was to default on both, but especially on
the public sector debt. So, I think that is encouraging.
On the other hand, it is a long time, and we have
countries--we had Peru at one point, Alan Garcia defaulted on
the IMF debt, and it stayed defaulted until he was thrown out.
Now he is a candidate for President again and we do not know--
Peru is not doing too badly.
Senator Bayh. You think the lesson that some of the other
countries have taken away from this is that----
Mr. Meltzer. They got rid of 70 percent of their debt.
Senator Bayh. I was going to say that from what I can tell,
just as a lay person observing from afar, they have not
concluded that default led to their problems but was perhaps
one step in getting out of them which is a dangerous conclusion
to reach.
Mr. Meltzer. Well, but I think it was your comment before--
that is right. It is a dangerous conclusion to reach. But your
comment before was Argentina is going to return to the debt
market. My prediction to Mr. de Rato a couple of months ago was
that when they settled this, as I thought they would, the
investment bankers would be on the next plane down to Argentina
with a suitcase full of bonds. So why did they do that? Well,
they say, you know, Argentina does not have much debt anymore;
you know, 70 percent of it has been wiped out, or thereabouts.
Senator Bayh. It is collective amnesia?
Mr. Meltzer. Or the greater fool theory.
Senator Bayh. They are all evaluated on short-term
performance and do not think about the long-term risks perhaps.
But my final question to you, and then, Dr. Bergsten, a couple
of things for you. As I understand it, Argentina has in some
respects not followed the conventional economic advice from the
IMF and others in trying to get their country back on the right
track, and yet things seem to have stabilized, and at least
temporarily there is some growth taking place there.
Now, is the lesson that they and others are going to derive
from that just, you know, hey, we can flout conventional wisdom
in these areas and things will turn out just fine? So my
question to you would be the sort of stabilization of
Argentina, return to some growth, is this a lasting phenomenon
there? Or what lessons will be derived from that?
Mr. Meltzer. I do not think it is a lasting phenomenon, but
it certainly has been a successful couple of years for
Argentina. It is growing fast and all that. It has not gotten
its GDP back to where it was before it defaulted and before it
devalued.
Senator Bayh. Let me ask the question a little bit
differently. If you are a country that is on the cusp of
getting into some difficulty, are you going to follow the IMF's
advice? Or based on Argentina's experience, are you going to
follow their path? I mean, they might look at this and say,
hey, things turned out okay for Argentina, maybe we should try
that, too?
Mr. Meltzer. Yes, the history, first, is that countries, I
think according to the IMF's own evaluation, countries follow
about 50 percent of the advice that they agree to when they
make these agreements. So there has not been a strong record,
and there has been study after study to show, is there an
effect of the IMF? Well, it is hard to see. Even the IMF study,
it is hard to see that there is much effect of the advice that
they give.
Senator Bayh. I am not sure Congress takes 50 percent of
the advice we get. What do you think?
Mr. Bergsten. Bringing down the average badly.
Mr. Meltzer. In the case of Argentina, I would say
Argentina, in my experience with a large number of countries,
even Brazil, is one of the most nationalist countries I have
ever seen. I mean, we are Argentines, we do not have to take
advice from anybody. And they do not. So they did not follow
too much of the advice.
Senator Bayh. I am more concerned about what other
countries will think going forward, observing this experience.
Will they conclude, hey, the IMF prescriptions, you do not need
to follow them in order to get back on your feet and heading in
the right direction?
Mr. Meltzer. One hopes not, but, I mean, I would not want
to make a prediction as to what is going to happen in Latin
America, especially, which is where the IMF has been most
active. You have a lot of countries--Venezuela is certainly not
going to take advice from anybody. Bolivia could take advice
from almost anyone and do better than it is doing.
Senator Bayh. Do you have a take on all this, Dr. Bergsten?
Mr. Bergsten. Yes, I would be more optimistic. One of the
remarkable elements of this whole episode has been the failure
of the Argentine example to spread to other countries. We do
not know whether it will over the long-run. But so far, so good
on that count. There was a lot of fear that the Lula
government, when they took office in Brazil, might have been
tempted to follow the Argentine example. After all, they had
problems. They had to go to the IMF. Many people thought Brazil
would have faced a debt crisis. There was legitimate debate
about that.
Brazil rejected the Argentine model very explicitly and
went the more conventional way. But here is what I think the
explanation is. One has to be very careful about the timing of
when the Argentines defaulted. On my reading, the Argentines
defaulted when they were already well into their crisis. They
had huge and unsustainable fiscal deficits. They had a hugely
overvalued exchange rate which they had maintained way too
long. And, incidentally, the IMF had failed to criticize them
on both counts.
A huge failure of the IMF was not using the good times--
when Argentina was doing well in the mid-1990's--to lean on
them on the budget and on the exchange rate system. The IMF
failed to do that. The IMF is culpable for the onset of the
Argentine crisis and then for prolonging it by giving them a
big loan after it was too late.
But from the Argentine standpoint, the key element is that
they were well into the crisis. Things were crumbling all about
them. So it was not whether to default to avoid a crisis but to
default to avoid an even deeper crisis, even deeper recession,
which would have been required to keep paying the debt on
schedule.
So in that sense, the default has been a huge success for
Argentina, as their president reminds us every day. But as I
tried to document in my statement, none of the feared spillover
effects have been observed, at least to date, and I do not
think will be, because everybody realizes that what Argentina
went through is devoutly to be avoided. When the Lula
government in Brazil looked at the alternative of taking
preventive action to head off getting into a crisis, including
continuing to pay its debt, that looked a lot better than
letting things deteriorate and then having an excuse to
default.
So the timing element is really crucial. In that sense, the
Argentine episode is probably sui generis, at least relative to
most countries see it coming and can head something off, with
or without IMF help, at an earlier stage.
Mr. Meltzer. Before you go, Senator, I would like to object
or at least differ with Mr. Bergsten on one point that he made
to you on a subject which is of considerable interest. He
described the position of the United States and the need for
reform as urgent. I do not think it is urgent. I think there is
a risk. But I think it is wrong to make a crisis out of a
problem. We have a problem. It has been going on.
Senator Bayh. You are referring to our current account
imbalances?
Mr. Meltzer. Current account imbalance, the Chinese
exchange rate, and Southeast Asian exchange rates. I think
there is a problem. But the problem comes--has been there for a
while and it is going to be there for a while. And it is not
going to go away, and we do not need to treat it as a crisis.
That is how we can make crises occur. We should recognize it as
a risk.
Senator Bayh. I am tempted to ask you whether you think
Social Security is a problem or in crisis, but I will not.
Mr. Meltzer. It is not a crisis. It is a problem.
Senator Bayh. My point simply is crisis/problem, it is kind
of in the eye of the beholder in some senses. We are trying to
deal with both short-term and long-term problems. But I
appreciate your comment.
Mr. Bergsten. I would like to make one comment back to Dr.
Meltzer, though, because he and I firmly agree on trade policy,
the need to avoid trade restrictions, and maintain an open
trade system.
Mr. Meltzer. Until today.
Mr. Bergsten. But we agree on the basics. Here is my point:
The current account imbalance and the continued overvaluation
of the dollar have two unsustainabilities. One is the
international financial unsustainability, the risk that the
foreign capital might stop flowing in, the dollar might drop
sharply, up goes inflation, up go interest rates, down goes our
economy. And Professor Meltzer rightly says we do not know
whether, that could be sustained for a while longer, we do not
know when, if ever, that risk will become a crisis.
But I would submit there is a second unsustainability,
which is already pretty close to becoming a crisis--the
domestic political unsustainability, the pressures you all face
every day to restrict trade as a tenth-best alternative to
getting the macro imbalances under control.
Senator Bayh. Let me follow-up on----
Mr. Bergsten. If you look at the record of U.S. trade
policy over the last 30 to 40 years, the best leading indicator
of U.S. imposition of trade barriers is not the unemployment
rate or any of our domestic economic variables, it is the
external imbalance in the valuation of the dollar. When the
dollar gets way overvalued, when we run big current account
deficits, the domestic politics of trade policy shift. A lot
more industries and workers look for import relief. Export
interests decline in interest and clout. The domestic politics
changes. That is when we risk breaking the trading system.
When Jim Baker did the Plaza Agreement in 1985 and drove
the dollar down 50 percent over the next 2 years, he did it not
because there was any fear that foreign investment in the
dollar was collapsing. It was because the Congress, as some of
my friends in the Ways and Means Committee put it at the time,
would have overwhelmingly passed the Smoot-Hawley tariff had it
come to the floor. It was the trade system that was at risk,
and that is where I think Dr. Meltzer and I probably would
agree.
Senator Bayh. If I could just conclude, I apologize I am
going to have to run to this other meeting. I was intrigued by
your suggestion that we go to the IMF. What suasion can the IMF
bring other than just--what leverage do they have on countries?
Mr. Meltzer. They can try to arrange a bilateral movement.
Senator Bayh. To put a fine point on it, why should the
Chinese listen to them if they are not listening to us?
Mr. Meltzer. The Chinese--it is useful when you think about
a problem of this kind to think about what is it that is
motivating the Chinese. What is motivating the Chinese is 150
million Chinese who would like better jobs. All right, so
keeping their exchange rate, we should understand that.
Employment is a big issue for us and always is a big issue for
us.
Senator Bayh. I appreciate their domestic motivations very
well.
Mr. Meltzer. All right.
Senator Bayh. If the IMF goes and begins to engage in these
discussions, why would the Chinese not just dismiss them?
Mr. Meltzer. It would try to make a bilateral change or a
multilateral change; that is, it would try to negotiate--
instead of our spitting at the Chinese and their spitting back,
we would try to get together and find something which would say
we will do something and you do something and, therefore, we
need an intermediary.
Senator Bayh. It gives them a multilateral cover for doing
the right thing, it is a loss of face, that sort of thing?
Mr. Meltzer. On both sides.
Mr. Bergsten. It is a name and shame campaign to mobilize
not the United States bilaterally, as Dr. Meltzer said, but the
global community through an institution of which China is
itself not only a member but also a very active member--it has
its own seat on the Executive Board--to bring a collective
judgment that what China is doing is hurting not the United
States job situation but the world economy as a whole.
Senator Bayh. So it is moral suasion.
Mr. Bergsten. It is moral suasion. It is a name and shame
campaign.
Senator Bayh. Unlike the WTO, though, there is nothing
concrete they can do to actually----
Mr. Bergsten. I am afraid that is right. But as I said, if
that did not work and we then had to go to the WTO, in a case
like that the WTO rules require the imprimatur of the IMF in
the first place. So you would have it, and then you could take
it to the WTO and say there is nullification and impairment,
there is a subsidy--you could use at least three WTO rules. But
you would have to have IMF validation.
Senator Bayh. My last question: Is there any doubt in your
mind in terms of what the IMF would conclude with regard to
currency practices of China?
Mr. Bergsten. If the IMF read its own rules literally and
in terms of common English, there would be no doubt.
Senator Bayh. The reason I ask is that our own Treasury
just issued a document that--well, it was curious.
Mr. Bergsten. I agree with that, as I said in my statement.
The IMF, like any international institution, is political. I am
sure the Chinese would lobby against a movement of that sort,
and it would be a test for the IMF. And that is one reason I
would like to pose it.
Senator Bayh. Gentlemen, thank you very much.
Senator Crapo. Thank you very much, Senator, and we
appreciate your support here.
Actually, Senator Bayh got into exactly the area that I was
going to get into at the conclusion of my questioning, my last
questioning period, and that is, I am intrigued, Dr. Bergsten,
by your suggestion that we turn to the IMF to try to get China
to take the right steps. And there has already been a
discussion here about just what authority and ability the IMF
might have.
I would like to pursue that a little further, and let me be
sure I understand your testimony correctly. You indicate that
you think that the current pressure to cause the Chinese to
simply float their exchange rate is not the right suggestion--
--
Mr. Bergsten. In the short-run.
Senator Crapo. In the short-run.
Mr. Bergsten. Right.
Senator Crapo. In the long-run it would be, but that in the
short-run we should just have one significant revaluation of
the exchange rate of the renminbi. Did I say that right?
Mr. Bergsten. You got it.
Senator Crapo. To have a revaluation, and that revaluation
would be, in your opinion, best if it were around 25 percent
and followed by the other Asian nations.
Is there anything that we could argue--in this discussion
that the two of you have indicated could and should take place
through the IMF to try to be a facilitator of this decision, is
there anything other than simply saying, hey, it is best for
the world that you do this?
Mr. Bergsten. Yes. I think--and here Dr. Meltzer is, of
course, right--the Chinese are going to be driven to a very
large extent by their internal considerations. One can make an
overwhelmingly persuasive case that this big revaluation is
very much in China's internal interest.
Senator Crapo. I had heard some discussion to that effect,
and that is why I asked the question.
Mr. Bergsten. There are three reasons. One, their top
leadership has acknowledged the economy is growing too fast.
They say they want to slow it down, at least a percentage point
or two, for the next couple of years. A revaluation would do
that by slowing growth of demand for their exports.
Two, they have inflation pressure. It has calmed a little
bit now, if you believe the official statistics, but it is
still substantial. Less than a year ago, it was running 8 to 9
percent on their inter-company producer price index. A
revaluation of the currency will reduce import prices and fight
inflation.
Three, huge flows of speculative capital are coming into
China, despite their capital controls, and ballooning their
money supply. They are adding $20 billion to $25 billion per
month to their foreign exchange reserves. They buy those
dollars to keep the price of the dollar up and renminbi down.
That is the way they keep their fixed rate and avoid the market
pressure for appreciation of their currency.
But the monetary effect is a huge increase in their
international reserves which in turn tends to increase the
domestic money supply and generate inflation pressure.
The People's Bank of China, like any central bank, tries to
sterilize that but they themselves admit they are not able to
do that fully because the capital inflow is so great. And that
is, therefore, expanding the money base; that it is adding to
the inflation pressure. Moreover, since that money goes through
the private banks, it is likely the private banks are making
bad loans, nonperforming loans to their state-owned enterprises
and others, thus reversing the progress they had been making in
reducing the instability of their financial system. So the IMF
should be arguing with them purely on domestic grounds.
In addition, they are getting a spate of external trade
barriers against their exports. We are seeing it every week
here--for example, against their textile products. But it is
not just textiles--it has been semiconductors, wood furniture,
color TVs, and shrimp. It is widespread and growing rapidly.
The Europeans are now joining in the game. So the Chinese face
a real choice on the external side-- taking more trade barriers
against their exports or revaluing the currency.
When you add that to the internal reasons, it makes for a
very powerful case, which our own Treasury and the IMF can, and
should, be making. It would clearly provide an internationally
defensible, persuasive case to mobilize the international
community through the IMF to go to the Chinese and argue sweet
reason. It might still not work, but it would be different if
the world as a whole through the IMF were doing this rather
than the United States bilaterally or even the rich-country
grouping in the G-7.
Senator Crapo. Dr. Meltzer, do you agree? And do you have
anything to add to that?
Mr. Meltzer. I do not think there is a crisis and people
have been warning about this crisis for quite a long time. I do
think that there is--of course, I understand and I am sure you
understand--the pressures that come on Congressmen and Senators
about trade. But it is important to remember that, gee, we are
pretty close to full employment in this country. We may be
losing jobs, but we are also gaining jobs. It is not true that
we are going to have a huge effect. I think Fred is simply way
off base if he thinks the Chinese are going to revalue by
anything like 25 percent. You know, I think they are talking
about something much smaller than that. It is not going to have
a big effect on our current account deficit. So we ought not to
run the risk of upsetting a system which has worked very well
since 1950 in terms of producing more growth in more countries
and more spread of freedom than any system that we have had at
any time in man's history. We ought to remember that we sit at
the end of a period of enormous progress all over the world,
and we do not want to disrupt that system, and the open trading
system is an important part of----
Senator Crapo. And you believe the disruption would be any
kind of trade retaliation.
Mr. Meltzer. I think the trade--that going the trade remedy
is a first step toward--we, after all, are the proponents. It
was Franklin Roosevelt and Henry Morgenthau that pushed the
idea of mutual reduction in tariff barriers. That got built
into the IMF originally, through the GATT, and now through the
WTO. We are the proponents of that. We pushed that. We open up,
we try to help countries to become democratic. One of the
things we do is we sign bilateral trade agreements with them,
so we say we are going to let you come into our market, but in
exchange we want to see some stability in that country.
I think we want to be very careful about throwing away a
system that has worked extremely well. But I do believe that
prudent people look at risks and say I do not know whether this
is unsustainable forever. But at least there is a chance that
it could disrupt in a crisis. Therefore, we want to take an
orderly approach where we make some concessions to the world by
reducing our current account deficit. And let me say that the
trade deficit, the second time--we saw this in the 1980's--the
budget deficit has come down; the trade deficit, the current
account deficit is not coming down. There is not a one-to-one
correspondence between those two things. We do need to do
things which increase our saving rate. Those are long-term
things, but they are very important. And that is where the
President is going to have a tax reform commission which is
going to come with a proposal for tax improvements, presumably
to help the saving rate. The Congress should really try to look
at that, take it seriously as a long-run fundamental change.
The Chinese need to do something about their exchange rate.
There is no question about that. But we need to do that slowly,
and they need to do it in a systematic way that affects all of
Southeast Asia. That is why I think a neutral, rather less
involved group like the IMF, which has responsibilities in this
area, is a good place to try to negotiate these differences on
a multilateral basis.
Senator Crapo. You know, the two of you together I think
have painted a pretty good picture of the positions and the
arguments that are made around this issue, and, in fact, you
have also raised the macro political issues that we deal with
here in Congress.
I tend to think that it would be a great thing, Dr.
Bergsten, if we could succeed in the arguments that you make
and the strategy that is proposed here that you both support of
having the IMF try to play a role in facilitating this and get
the Chinese to have a one-time revaluation up to 25 percent.
On the other hand, I also tend to think that Dr. Meltzer
might be right that it is not highly likely to success that
they would do that.
Now, I do not know and I would love to--I certainly think
we should try it. But it certainly raises the political issues
that we are dealing with here in Congress. The fact is that the
Chinese have been manipulating the U.S. dollar for a decade or
more.
Mr. Meltzer. At great cost to them. The cost to them is
something like 1 or 2 percent of their GDP every year.
Senator Crapo. That is at great cost to us, too.
Mr. Meltzer. Well, you know, we are----
Senator Crapo. Given things are so great here in the--I
mean, there is a lot of the positive you can point out. There
is a great cost here that we are paying.
Mr. Meltzer. That is right, but there is a great benefit. I
mean, we get real goods and services from them, and we give
them pieces of paper, which we can ultimately devalue if we
wish. We are not suffering terribly as a result of this. There
are local problems that come because of the wood industry, the
textile industry. But to think that we are going to save the
textile industry by a Chinese revaluation, that is going to
have more beneficial effect on Mexico than it is on us.
Senator Crapo. Can I assume that--and I would like you both
to just comment on this again. You have both touched on it
already, but I am hearing both of you say that the Congress
should avoid the political pressure to impose trade barriers as
a pressure to get a solution here. Am I correct there?
Mr. Meltzer. Absolutely.
Mr. Bergsten. I yield to no one, including even Dr.
Meltzer, in my zealous support of the free trading system for
50 years. I have been working very hard on it for all my
career. So, I absolutely concur with everything he said on
that.
I do observe, however, as I mentioned before, that the
politics underlying an open trading system are threatened when
there are big macroeconomic imbalances. It could be prolonged
recessions, like in the 1930's, but it could also be prolonged
currency imbalances. I cited the example of the mid-1980's,
when President Reagan, despite being clearly pro-market and
pro-free trade, put up more trade barriers than any President
in the 20th century because of the currency imbalances and the
big growth in our trade deficit.
During the Reagan Administration, voluntary export quotas
were foisted on Japan on almost everything--autos, steel,
machine tools, you name it; other countries did so as well.
Why? Because of big macro imbalances.
We were at risk of losing the open trading system, which
Dr. Meltzer and I both espouse so strongly, because of
macroimbalances--in that case, it was truly macro in the United
States, the fiscal policy, the fiscal/monetary mix, but also
the exchange rates, which threatened the system. Therefore in
defending the open trading system, I will frequently emphasize
taking tough measures, if necessary, to eliminate the currency
imbalances.
I acknowledge that it sounds paradoxical to say I want to
threaten trade controls against China to avoid the risk of
putting on trade controls. That is why I want to try everything
else first, and that is why I think this IMF strategy would be
the way to go right now. But if at the end of the day China and
the other Asian countries continue to resist any adjustment
from their standpoint, we may have to get tough. It was done in
the United States in the early 1970's; it was done in the mid-
1980's. It succeeded both times, with some crockery broken
along the way. You prefer not to do that.
But think back to what Secretary Quarles said. He talked
about the three-legged stool they have in mind for dealing with
this problem, and in broad terms I agree with that. One leg is
the Asian currencies. They have been trying sweet reason on
their own for 2 years. It has had zero impact. The question is
whether, with the step-up in U.S. action, per the Secretary's
latest report, there will be some response from the Asian side.
I dearly hope so. But I am also realistic enough to say there
may not be. And if they move, it might be a token step, and you
might not get any significant adjustment out of it.
So it is not just that they move but the move be big enough
to have a discernible impact. If they--China but also the rest
of Asia in part, using China as a justification--continue to
resist, then we face the choice of either letting the
imbalances get bigger, building the financial risks, and
clearly increasing the risks to the open trading system or
trying to deal with the problem, even if it means taking the
gloves off. I resist that. I prefer not to do it. But sometimes
in the real world you have to go that way.
Senator Crapo. Dr. Meltzer, what if we try this and it does
not work? Can we still face the Chinese manipulation of the
dollar?
Mr. Meltzer. We have the ultimate weapon which we have,
which is we can inflate and wipe out most of that debt. So that
is a weapon that we have. That is certainly not a weapon that I
recommend, but before I brought down the international trading
system, I would certainly think about what other weapons there
were in the arsenal.
Let us go back and before we make a crisis out of this
problem, let us go back and Think through. We receive valuable
goods and services from the Chinese, including things which
help us keep the cost of manufactures down, as well as the cost
of consumer goods. In exchange for that, we give them pieces of
paper. That is a great system for us because it does not cost
us anything to print those pieces of paper, and we get real
value for it.
Now, what makes it a problem? It becomes a problem because
there are many people who believe that it is unsustainable,
that it cannot go on, and, therefore, we should do something
about it. But before we use the sledgehammer, we ought to go
slowly. So that is why I describe this as a risk. There is a
risk that people who are--I am not convinced, but there is a
risk that the people who say that this is a problem will be
right. Therefore, a prudent man says, well, let us take some
steps in the direction of correction. And what are some ways of
doing this? Well, we have tried. I think the Chinese have
certainly moved--I do not think that it is correct, as Fred
says, to say that the Treasury's patience has been completely
lost and nothing has happened. I think the Chinese have heard
from us, from the Europeans, from others, and they are moving.
They never give the date and the action in the same
sentence, so we never know whether there is going to be a
Chinese move. But I think that they have gotten the message.
There is always a question in negotiations of this kind
whether, if you are quiet and not aggressive, you get more
action than you do if you are too aggressive. I mean, the
Chinese are proud. They are not likely to revalue their
currency because we ask them to or we demand it of them. So
that is why calm negotiation which deals with the risk of this
problem over a longer period of time, which says, you know,
what do we want? A one-time revaluation of the Chinese
renminbi? No. I would like to see Chinese put on a path which
would move them toward a floating exchange rate. That is not so
hard for them to do, and they know what they have to do. They
have to improve their banking system. Well, they have $700
billion worth of bonds. They could shore up their banking
system to some extent. What they need to do is to make the
internal changes, which are very important, and not keep
building up the bad loans of the banking system and using that
as an excuse for not being able to move their currency. So we
want to move the negotiations so that they look at their
problems and we look at our problem.
Senator Bayh talked about, sort of alluded to the fact that
Argentina had run a big deficit. The United States is in a
peculiar position. Its debt is all in dollars. Argentina's debt
was in dollars. But we can produce dollars, so that puts us in
a unique position in the world, and it is probably that more
than anything else which keeps us from having a crisis now
instead of a problem. So I say we do want to go to some neutral
agency; we do want to negotiate. Fred and I agree about that.
But we want to make really major moves on both sides--here to
increase the saving rate, there to shore up the financial
system and float the exchange rate.
Senator Crapo. Well, like Senator Bayh, I am starting to
run into some time pressures now, too. I know that both of you
also have a lot more to say. Dr. Bergsten, I know you were
trying to get in there. Can you just say it in a couple of
minutes?
Mr. Bergsten. I must admit I was shocked to hear Dr.
Meltzer, who has written a definitive study of the history of
U.S. monetary policy, suggest we might respond to this by
inflating our debt away.
Mr. Meltzer. We have been known to do that.
Mr. Bergsten. But I certainly do not advocate it, and I
know you do not.
Mr. Meltzer. I did not.
Mr. Bergsten. The trade measures I would contemplate, even
as a last resort, would be much less costly to the United
States and the world economies than for the United States to go
on an inflationary binge to, in that sense, devalue the
currency and inflate away our debt. So, I would not go that
way.
Mr. Meltzer. I do not recommend that. I just said that is
an alternative to the things that you were talking about, which
would be to bring down the world trading system.
Mr. Bergsten. A decidedly inferior approach, and mine would
not bring down the trading system. Mine would seek to defend
the trading system.
A final point. Timing is crucial, as you were emphasizing,
Mr. Chairman. Dr. Meltzer says go slowly. The Treasury has been
going slowly for 2 years. I do not think it has much to show
for it other than a bunch of very small technical changes in
the way the Chinese run their financial system. By the Chinese'
own testimony, it is going to be many years before they are
ready to move to a flexible exchange rate. When I asked them
about this over the last 2 or 3 years, they said, well, around
the time of the Beijing Olympics in 2008. That is only 3 years
away now but it is still pretty long, as these things go. And
my guess is it will be 5 to 10 years before their banking
system and the rest of their economy is in shape to really
support a true floating exchange rate system, which means
elimination of most or all of their capital controls.
That is not at all feasible on the kind of time horizon
that I worry about in terms of domestic political
unsustainability as well as international financial
unsustainability.
We have tried for 2 years. It has not gotten anywhere. I do
not want to wait 5 to 10 more for the Asians to move. I am
afraid all hell will have broken loose on both the financial
and trade sides long before that. Therefore, I want to think
about what has admittedly been the unthinkable of taking
tougher actions.
But before I get there, I do not know why we do not
mobilize the existing institution to defend its existing rules,
which are clearly being violated. That is a no-brainer, and it
seems to me the Committee ought to push hard for that.
Senator Crapo. And it seems to me the two of you agree on
that.
Mr. Meltzer. We do.
Senator Crapo. I want to thank you both for coming today,
and you always provide us with not only a lively interchange,
but with some very significant debate about very tough issues.
I appreciate you coming before us again to do that, and I think
you have given this Committee and this country some very good
ideas about how to proceed.
Thank you very much for coming.
Mr. Meltzer. Thank you, Mr. Chairman.
Mr. Bergsten. Thank you, Mr. Chairman.
Senator Crapo. This hearing is adjourned.
[Whereupon, at 11:47 a.m., the hearing was adjourned.]
[Prepared statements supplied for the record follow:]
PREPARED STATEMENT OF RANDAL QUARLES
Acting Under Secretary for International Affairs
U.S. Department of the Treasury
June 7, 2005
Thank you Chairman Crapo, Ranking Member Bayh, and other Members of
the Subcommittee. I am pleased to be here today to talk about our
agenda as a shareholder of the International Monetary Fund (IMF).
Reform of the IMF has been a high priority since the start of the
first Bush Administration. Former Under Secretary John Taylor appeared
before the full Committee last May and summarized our work to date in
both the IMF and World Bank. He laid out the underlying rationale for
our quest to update these institutions--noting the growing role of
international debt securities, the increase in the volume of private
capital flows, and the increasing interconnection between financial
markets. As he said at the time, those factors, combined with the
crises of the late 1990's, made abundantly clear that greater
predictability, accountability, and more systematic behavior on the
part of the official sector were vital to enhance the international
financial policy framework.
The Path of Reform
The International Financial Institutions Advisory Commission
(IFIAC), chaired by Dr. Allan Meltzer, helped provide impetus for
reform. The Commission's report in March 2000 provided important
insights about how the IMF and other international financial
institutions could better realize their goals. The Commission's
recommendations contributed to a serious debate about IMF reform, in
which this Committee was an active participant. With strong advocacy
from Treasury, the IMF has acted on reform. Specific steps by the IMF
have been detailed in a series of annual reports to Congress--most
recently in October 2004. Let me summarize some of the highlights over
the last 5 years:
The international community has clarified the limits and
criteria for large-scale official sector lending. Consistent with
the Meltzer recommendations, there has been no quota increase in
the IMF. With IMF liquidity at historic highs, there is no need to
add to its resources. Further, we have encouraged the presumption
that the IMF, rather than governments, is responsible for providing
large scale loan financing in the face of crises. With IMF
resources limited, this presumption provides an overall budget
constraint and thereby an overall limit on loan assistance.
Further, requests for large loans that represent exceptional access
to IMF resources now face new procedures, including a higher burden
of proof in the form of a special report that documents how IMF
financing will support strong policies in the borrowing country.
IMF programs are now more focused on its core macroeconomic
areas of expertise. In work on lending programs, the IMF is more
tightly focused on its core areas of monetary policy, fiscal
policy, the balance of payments, exchange rates, and the financial
sector. Further, the IMF relies more heavily on more robust
analytical tools, particularly for risk assessment, enhancing its
capacity to anticipate and deter financial crises.
We achieved changes to reorient IMF lending to focus more on
short-term financing, discourage casual or excessive use, and
provide incentives to repay as quickly as possible. This
includes higher interest rates for higher levels of access to
discourage excessive reliance on Fund resources. It also
includes limited use of Extended Arrangements, to reinforce the
focus on making resources available only for the short-term.
These changing incentives are having an effect.
The IMF is much more transparent than it was 5 years ago.
Seventy-eight percent of staff reports for lending arrangements
and Article IV's are made public. The IMF provides extensive
information publicly about its financial operations. And the
IMF has a permanent, independent evaluation office that has
been producing high-quality reviews of specific IMF policies
and activities.
As part of the effort to correct incentives and prepare for
more effective resolution of crises that occur, there has also been
a major step forward on making the process of restructuring
sovereign bonds more orderly. In that regard, the Administration
worked closely with other countries to make routine the use of
collective action clauses (CAC's) in sovereign bond documentation
to promote orderly restructuring and reduce disruption. One year
after the launch of this initiative, Mexico responded by including
CAC's in its New York law governed bonds. Brazil, Korea, South
Africa, and Turkey soon followed, and inclusion of CAC's quickly
became standard market practice.
These are major steps forward. Yet we are not prepared to relax our
efforts. More needs to be done to ensure that the IMF is positioned for
the challenges off the 21st century. In partnership with the G-7 and
others, the United States has called for a strategic review to identify
changes needed to make the IMF (and the World Bank) more responsive,
relevant, and helpful to their members. The IMF has taken up this
charge and is now undertaking a review of its role and strategy for the
medium term.
Pushing the Next Wave of Reform--U.S. Priorities
Like any other institution, the IMF must continually examine itself
to make sure that it is doing the best it can to achieve its core
objectives. Fostering international monetary cooperation and balance of
payments adjustment to support international financial stability and
economic growth clearly remains its key aim. The purpose of this review
is to make sure the institution is doing all it can to advance this
goal.
As we engage in this review with other members of the IMF, the
United States has several key priorities: Strengthening IMF
surveillance and crisis prevention; creating a more effective way for
the IMF to actively support strong policies without lending; and
realigning the IMF's role in low-income countries to achieve better
results. Let me explain what we have in mind in each of these areas.
Strengthening Surveillance and Crisis Prevention
The IMF's core mission is to oversee the international monetary
system to ensure its effective operation, and for that purpose to
exercise surveillance of the macroeconomic and exchange rate policies
of its members. In this way the IMF should help prevent crises and
foster adjustment in global imbalances.
This process offers the IMF a unique opportunity to assess risks,
influence policy, and help prevent crises. Indeed, surveillance has
proven a very useful tool. Yet the execution of surveillance needs
further enhancement. Action is needed, for instance, to further tighten
the focus and selectivity of analysis. We also believe that the IMF
needs to integrate more fully capital market and financial sector
analysis into the daily life of the Fund. In addition, the IMF has a
critical role to play in exercising firm surveillance over its members'
exchange rate policies to promote international adjustment. In recent
months, the IMF has called for multilateral actions, including greater
exchange rate flexibility in emerging Asia, and particularly in China.
Promoting Strong Policies without Lending
The IMF has traditionally had two levels of engagement with member
countries--either the IMF reviews economic performance and policies
annually through surveillance or, at the member's request, the IMF
provides financial support conditioned on implementation of economic
reforms that the IMF helps design and monitor. There is no middle
ground between routine review and conditional finance.
The United States strongly believes that the IMF needs a new tool
to provide for structured engagement in support of strong economic
policies where there is no need for borrowing. We have proposed a new
nonborrowing program to serve this role. Participation would be
voluntary for member countries. The process of laying out an economic
program would be led by each participating country, with the
opportunity for country authorities to engage closely with IMF staff as
they work to strengthen their country's macroeconomic policy framework
and macroeconomic institutions.
The proposal now has the support of our partners in the G-7, and we
expect it to be taken up by the IMF's Executive Board this summer.
Demand for such an arrangement is already emerging from IMF member
countries. We expect that some countries may actively seek to convert
their borrowing relationship with the IMF to this basis and that others
will welcome such a nonlending arrangement once their existing program
expires, as a way of maintaining a signal from the IMF about the
strength of their economic policies. This signal could be particularly
useful to countries with strong macroeconomic foundations that
nonetheless continue to depend on other donors for development
financing or that are transitioning to market-based financing away from
development finance. And it should help protect IMF resources for those
countries with specific balance of payments needs.
Supporting Low-Income Countries Effectively
Low-income countries face enormous economic and development
challenges. Engaging with these countries to help them achieve
macroeconomic stability--through policy advice, technical assistance,
and financing when appropriate--is a vital part of the IMF's mission.
Yet the Fund is not a development institution, and its financial
operations should reflect its mission to provide short-term balance of
payments financing rather than longer-term development aid.
While there is disagreement among economists about the impact of
IMF assistance on economic growth in low-income countries, the growth
performance of many of these countries has been disappointing over the
past two decades. A central challenge for the IMF is to improve the
effectiveness of its own engagement in low-income countries to help
them achieve sustained improvement in economic outcomes.
Prolonged use of IMF resources is a serious problem, particularly
for low-income borrowers, and is exacerbated by the Fund's practice of
rolling-over existing exposure. Nearly all (30 of 32) countries with
PRGF programs at the start of 2005 had at least two prior PRGF
arrangements, each of which lasts 3 years. Prolonged reliance on IMF
support can impede domestic ownership of economic policies and the
development of institutions and can blur the IMF's short-term balance
of payments role versus the longer-term development finance role of the
MDB's.
We have encouraged the IMF to undertake a close examination of its
approach in low-income countries--with a view to helping these
countries achieve better economic results. Good economic policies are
fundamental to the efforts of low-income countries to increase economic
growth and improve the lives of their citizens. The IMF needs to find a
way to support good policies more effectively, and in a way that is
consistent with its role as providing temporary and short-term
assistance in response to balance of payments shocks.
As a top priority, the IMF needs to establish and maintain high
standards for its support for countries' economic programs. Weak or
half-hearted policy efforts should not merit IMF financial support, in
emerging markets or low-income cases.
When countries are pursuing strong policies, the PRGF should be
flexible enough to respond to countries facing short-term adverse
developments in their balance of payments. The PRGF also needs to be
available to support needed macroeconomic reform over the medium-term.
It should not, however, be geared to provide long-term development
finance. Indeed, we believe that the proposed nonborrowing program that
I have described for you above would offer a particularly important
tool for low-income countries that have progressed through
stabilization and no longer need to rely on IMF financing.
And perhaps most important, helping low-income countries depends on
ending the lend-and-forgive cycle, so that they can move into an era of
sustainable debt. The IMF has recently implemented a new debt
sustainability framework, which establishes new standards for
determining whether countries can or should take on additional debt.
It is critical that the IMF and other lenders integrate this
framework into their operations. This, along with increased use of
grants in IDA and the AfDF, as well as further bilateral and
multilateral debt relief in those institutions for the HIPC countries,
can provide a clear path to end the cycle of repeat lending and debt
problems holding back the poorest countries.
With respect to debt relief, the Bush Administration has put
forward a bold proposal that would relieve the debt burdens of poor
countries. The proposal calls for immediate action to provide up to 100
percent relief on IDA and AfDF loans to the Heavily Indebted Poor
countries (HIPC's). Action on this debt is critical to putting these
poor countries on a sustainable path.
Any debt relief in the IMF would need to be financed from existing
resources in the IMF.
We do not believe that gold sales--whether they were to be executed
in the market or ``off-market''--are necessary or warranted. I know
that the issue of gold is of particular interest. Treasury has
repeatedly voiced our opposition to a sale of IMF gold. Gold provides
important underlying strength to the IMF's financial position. Selling
IMF gold requires an 85 percent majority vote; since the United States
has a 17.1 percent voting share in the IMF, our agreement is required
before such a sale can go forward. Congressional approval is required
for the U.S. Executive Director to vote in favor of such an IMF gold
sale.
Modernizing the IMF's Governance
The IMF is accountable to its 184 member governments through a
weighted voting structure aligned with countries' global economic
standing. However, change in the world economy has outpaced that in the
IMF's voting structure, particularly given fast-paced growth in
emerging market economies and integration in Europe.
We feel strongly that the IMF is a financial and shareholder
institution the governance of which should evolve along with the world
economy. If countries are growing strongly and making increasing
contributions to the global economy, then there should be a parallel
enhancement of their position in the IMF. This is vital to maintaining
the goodwill of members, on which the IMF relies to make its lending
possible, and to preserving the centrality of the IMF in the global
financial system.
Beginning in October 2004, Secretary Snow has emphasized that
change is needed to address the growing disparity between the IMF's
governance structure and the realities of the world economy. In April,
he took a further step when he asserted that it is time to examine
these issues now--and that progress should not, and indeed need not, be
linked to an increase in the IMF's quota resources, which is not
necessary given the current strength of the IMF's financial position.
In particular, he has suggested that shifting quotas within the
existing total could yield substantial progress. This could allow for
quota shares to reflect the advent of monetary union in Europe and the
increasing role of fast-growing emerging markets, especially in Asia.
Change will not come quickly or easily. The issues are complex, and
extensive dialogue and cooperation will be needed to find a way
forward. Yet we believe the effort is worthwhile--and indeed essential
to the long-term effectiveness of the institution. An IMF for the
future must be an IMF in which all have a stake.
Argentina
One of the important tasks that has faced the IMF over the last 4
years has been dealing with the situation in Argentina, so let me say a
few words about Argentina's economy and engagement with the IMF.
The Argentine economy continues to recover from the sharp
contraction that accompanied the 2001-2002 financial crisis. Real GDP
grew 9 percent in 2004, following growth of 8.8 percent in 2003.
Inflation ended 2004 at 6 percent after spiking to 41 percent at the
end of 2002. The exchange rate has been roughly stable since mid-2003
and reserves have grown $11.5 billion since the end of 2002.
These positive results have been underpinned by better
macroeconomic policy since the crisis. The Federal Government increased
its primary surplus to nearly 4 percent of GDP in 2004 from a zero
balance in 2001. Monetary policy succeeded in limiting the growth of
the money supply to prevent an upward inflationary spiral.
The United States has supported IMF engagement with Argentina
through the transitional program launched in January 2003 and the 3-
year program launched in September 2003. The purpose of these programs
was to lock in macroeconomic stability and attack impediments to
growth. Essential reforms include addressing Argentina's chronic fiscal
problems related to Federal-provincial fiscal relations and weak tax
administration, restoring the health of the banking sector, and
improving the investment climate. The IMF program helped establish a
basis for facilitating the normalization of Argentina's relations with
its external creditors.
Argentina's performance under the 3-year program has been mixed.
Argentina has continued to perform strongly on its macroeconomic
targets. However, we still have concerns regarding the implementation
of its structural policy commitments under its IMF program. The IMF has
not made any disbursements to Argentina since March 2004.
With respect to the debt restructuring, in January 2005 Argentina
launched a debt exchange offer to restructure its $82 billion in
principal claims of defaulted debt. Over 76 percent of creditors
accepted Argentina's offer, while 24 percent (representing $20 billion
in principal claims) did not.
With the recent settlement of the debt exchange, Argentina is now
returning its focus to negotiating a new arrangement with the IMF. A
key issue will be the development of an Argentine strategy to resolve
the rest of the defaulted debt. There are a number of possible ways
Argentina could do this, but it is important for Argentina to be clear
about how it will proceed.
In addition to completing its debt restructuring, Argentina also
needs an economic program that supports sustained growth so that it can
continue to raise living standards and meet its financial obligations.
Sustained growth requires improving the investment climate in order to
attract private capital. Resolving the situation in the utilities
sector will be an especially important signal to investors in this
regard. Growth also requires locking-in fiscal improvements by fixing
Federal-provincial fiscal relations to prevent the provincial
overborrowing that contributed to the 2001 financial crisis. Finally,
continued strengthening of the banking sector will be important for
providing the credit Argentina needs to grow. Key reforms in the
banking sector include completing bank compensation, which Argentina
has made further progress on in the past month, defining the role of
public banks in the banking sector, and continuing with the defined
path of regulatory reforms.
Conclusion
I appreciate the opportunity to reflect on the path of IMF reform
and lay out for you the Administration's priorities as we continue to
press change in this vital institution. I believe that important
progress has been made. Yet there is more to be done to ensure that the
IMF operates effectively in the 21st century. I hope my remarks today
make clear our commitment to maintain the momentum of reform.
I welcome your questions.
----------
PREPARED STATEMENT OF ALLAN H. MELTZER
The Allan H. Meltzer University,
Professor of Political Economy, Carnegie Mellon University and
Visiting Scholar, American Enterprise Institute
June 7, 2005
Mr. Chairman and Members of the Committee: It is a privilege to
have this opportunity to review progress on reform of the International
Monetary Fund (IMF). I commend the Chairman and the Members for their
continued interest.
I am pleased to report that there has been progress on central
issues. On other important issues, much is unfinished, and in some
cases, unstarted. From the comprehensive list of topics proposed by
your staff, I have chosen to discuss progress toward the adoption of
recommendations of the Meltzer Commission, but I touch on other
questions that the staff raised.
In the view of the Meltzer Commission, the IMF has two main tasks.
Its most important activity is to increase the stability of financial
markets or, if crises cannot be prevented, to localize problems or
crises and keep them from spreading to countries or markets that would
be unaffected. A related but distinct activity is to reduce market risk
by improving the quality and increasing the quantity of information
available to lenders and creditors.
The IMF has made a sustained effort to improve the quantity and
quality of information on member countries. More is desirable.
Especially needed are reductions in the time before information becomes
generally available.
A remarkable change came to fruition this year. Argentina settled
its defaulted debt with about 75 percent of its bondholders. This was
the largest default ever, and it involved tens of thousands of
individual debt holders and many separate debt issues. Coordination did
not, at first, seem promising, but it was achieved without outside
intervention.
Unlike earlier practice, the IMF was not a party to the
negotiations. It did not make additional loans to Argentina to assist
in the settlement and bailout the lenders. The settlement was based on
decisions between the Argentine Government and representatives of the
bondholders. I am confident that in time, Argentina can settle with the
remaining bondholders without IMF intervention. I consider this a big
step forward because risks and returns were related. Lenders who
received high interest rates on risky loans had to bear the risk when
it came. This improves the functioning of markets and spares taxpayers
from paying for lenders' errors of judgment.
Also Argentina's financial problems were mainly confined to
Argentina. When they threatened to spread to its neighbor, Uruguay, the
IMF arranged a large loan. This is keeping with its principal
function--preventing the spread of crises.
In its response to Argentina and Uruguay, the IMF followed the
spirit and often the letter of the Meltzer Commission recommendations.
It was not always so. The Meltzer Commission made two unanimous
recommendations. The first called for writing off ``all claims against
heavily indebted poor countries (HIPC's) that implement an effective
economic and social development strategy.'' The second called on the
IMF to limit its lending to short-term loans leaving long-term loans
for poverty reduction to others. Instead, the IMF created the Poverty
Reduction and Growth Facility (PRGF). The IMF had no special expertise
in economic development and poverty reduction. These problems should be
left to the World Bank. While I agree with those who say that the
development banks are ineffective, unfocussed, and should be thoroughly
reorganized, duplication of their work at the IMF is not the right
solution. The PRGF should be closed.
The IMF, the World Bank, and the G-7 countries have not agreed on
rules for debt relief for several of the heavily indebted poor
countries (HIPC). Some agreements have been made, and countries have
agreed to use the resources released thereby for education and health.
Great Britain is pressing for new agreements at the 2005 summit in
Scotland.
Part of the discussion of debt relief is misleading. The HIPC
countries do not actually service most of their debt. To prevent
default, the IMF lends the country enough to make payments, increasing
the countries' indebtedness. A HIPC country receives credit for payment
but little or no new money. Debt relief, as usually discussed, is
actually a way of increasing HIPC country borrowing. It would increase
the countries' available resources, since debtors would receive the
same payment but would not have it offset by a debt service payment of
similar size to the IMF. The net transfer would increase.
The main issues in current discussions are how the transfer should
be financed and how the increased net transfer should be used to
improve social and economic conditions. Gold sales by the IMF are one
option that has been proposed. As you know, the Congress wisely
disallowed the sale of the U.S. gold deposit at the IMF without its
consent. The gold should be returned to the members and revalued by
them. Part of the profit could be used to reduce HIPC debt.
One of the Meltzer Commission's main recommendations called for
replacement of conditional loans with loans based on a limited number
of preconditions accepted in advance by the troubled country. The
purpose of this proposal includes reducing risk, increased incentives
for reform, and giving the borrowing country a large part in the choice
of policies. To its credit, the IMF has reduced substantially the
number of conditions attached to its loans. It considered, but did not
adopt, preconditions. As part of the comprehensive review of its
strategy that is now underway, it proposes that future lending should
be ``anchored in strong country ownership.'' (IMF Survey, 34, number 7,
April 25, 2005, 105)
This is a good step away from the command and control of the 1990's
based on the so-called Washington consensus. ``Ownership'' means that
the country has a major role in the choice of policies. Much evidence
suggest that reform is made more likely when political leaders in the
country choose it, support it, and decide to implement it. The Fund's
own research suggests that much of the time countries did not implement
the conditions to which they agreed to get a loan.
Preconditions reduce risk in other ways. Countries that avoid
pegged but adjustable exchange rates, improvident fiscal and
inflationary monetary policies, and weak financial systems are more
prone to crisis. Reducing or removing these sources of instability
reduces the chance of a crisis. Further, negotiated preconditions
accepted in exchange for a commitment to assist in a crisis reduce the
long delay that often occurs before assistance is given.
A critical part of this proposal is that countries would have
greatly increased incentives to reform. If they did not agree to
preconditions, they would not be eligible for assistance. This, alone,
increases the incentive for reform. But this incentive increases
because lenders would distinguish between countries that adopted
reforms and those that did not.
The international private capital market is the principal supplier
of loans. It offers 5 to 10 times the volume offered by international
financial institutions. The private market would offer more loans at
lower interest rates to countries that adopt preconditions. Reformers
in the countries could replace arguments claiming the IMF requires
reform with citation of the benefits to the country, more capital at
lower interest rates.
The IMF faces many possible challenges. Will other countries follow
Argentina by defaulting and renegotiating debt? Will recognition of
increased risk reduce the amount of lending? Does the large
accumulation of reserves by Asian countries, and other recent changes,
signal a decision by these countries to manage future crises without
the IMF? Have the Asian countries taken a further step toward
development of a regional financial bloc? If the IMF no longer bails
out private lenders, will the private lenders object to the IMF's
preferred creditor status?
The IMF's loans are heavily concentrated in the debts of a small
number of countries. Will one or more of these countries default on the
IMF?
We should recall that the IMF's original purpose included
monitoring and maintaining a fixed exchange rate system. The IMF should
take more responsibility for the exchange rate system to adjust under
or overvalued exchange rates. It is well-known that if more countries
allowed their exchange rates to adjust, there would be fewer crises.
Many observers claim that undervalued Asian exchange rates and the
large U.S. current account deficit will end with a major financial
crisis. They use the word ``unsustainable'' when they discuss the U.S.
current account deficit. I am far from certain, even skeptical, about
these claims. But we should recognize that there is a risk that will
not be removed and may be increased, by an appreciation of China's
exchange rate. In keeping with its original purpose, the IMF should try
to implement a cooperative solution that revalues the yuan and reduces
the U.S. deficit.
Finally, corruption is a major problem in some developing (and
developed) countries. No one can rid the world of bribery and
corruption, but the IMF could do more than it now does to limit
corruption.
PREPARED STATEMENT OF C. FRED BERGSTEN
Director, Institute for International Economics
June 7, 2005
It is a pleasure to testify before the Committee again concerning
your ongoing oversight of the International Monetary Fund. The topic
remains of great importance and our Institute for International
Economics will in fact be holding a major conference on IMF reform on
September 23 to address a number of specific proposals for
strengthening and enforcing the rules of the monetary system, improving
the governance of the Fund itself, reforming its lending programs, and
reassessing the ways in which it might be financed in the future. All
Members of the Subcommittee and staff are cordially invited to
participate in our event!
Exchange Rates in China and East Asia
The most important and urgent issue facing the international
monetary system and the IMF at the present time is the huge imbalance
in major national economies and exchange rates. The global current
account deficit of the United States is very large (nearing an annual
rate of $800 billion, almost 7 percent of our GDP) and growing rapidly.
The global current account surplus of China is very large (over $100
billion this year, about 6 percent of its GDP) and also growing very
rapidly. A number of other Asian countries--most notably Japan but also
Korea, Taiwan, Hong Kong, Singapore, and Malaysia--are also running
substantial global surpluses that are the counterparts of the U.S.
global deficits.
We in the United States must lead the correction of these
imbalances by raising our rate of national saving so that we will not
be so reliant on inflows of foreign capital--which we must now borrow
at the rate of $5 billion every working day--and thus condemned to run
the counterpart current account deficits, which generate enormous
pressures for trade protection (which are now being rapidly realized,
especially against China) as well as huge international financial
risks. This requires a combination of restoring the budget surpluses
that we were running just a few years ago, to reduce public dissaving,
and increasing our pitifully low rate of private saving.
One essential element of the global correction will be a further
large decline in the exchange rate of the dollar, probably by at least
20 percent on a trade-weighted average against the currencies of our
major trading partners. The dollar has already declined substantially
against the currencies that float freely in the exchange markets:
Notably the euro, pound, Swiss franc, Canadian dollar and Australian
dollar. The next phase of the dollar's decline needs to take place
against the currencies of the East Asian countries that are running the
world's largest surpluses and have the world's fastest growth rates--
but have intervened massively in the exchange markets to block any
appreciation of their currencies at all (China, Malaysia) or to limit
that appreciation far below what market forces would have produced.
China is the key country. Its surplus is now the largest among the
major Asian economies as a share of its economy. It has been increasing
its competitiveness by riding the dollar down against most other
currencies, thus achieving a trade-weighted depreciation of about 10
percent over the past 3 years. Moreover, the other Asian countries
(from Japan to India) are terrified of losing competitive position
against China so will resist the rise of their currencies against the
dollar as long as doing so also means rising against the renminbi. The
need for appreciation of the Asian currencies is particularly acute
from a U.S. standpoint now that the euro, which had risen 65 percent
against the dollar from its lows of late 2000 to its peak earlier year,
is under downward pressure as a result of the apparent rejection of the
proposed constitution for the European Union.
It is the responsibility of the International Monetary Fund to take
the lead in promoting correction of such huge, costly, and potentially
destabilizing imbalances in the world economy. The Fund's Articles of
Agreement in fact enjoin member countries to ``avoid manipulating
exchange rates or the international monetary system in order to prevent
effective balance-of-payments adjustment or to gain unfair competitive
advantage over other member countries'' (Article IV, Section 1,
paragraph iii). In 1977, early in the era of floating exchange rates,
the Fund laid out principles for its surveillance over members'
currency policies that identified ``protracted, large-scale
intervention in one direction in the exchange markets'' as indicating a
need for Fund discussion with the offending country.\1\
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\1\ A complete analysis of this issue can be found in Morris
Goldstein, ``The International Financial Architecture,'' in C. Fred
Bergsten and the Institute for International Economics, The United
States and the World Economy: Foreign Economic Policy for the Next
Decade (Institute for International Economics, 2005.) Goldstein also
suggests a number of other important IMF reforms that should be pursued
in the near future.
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China clearly meets these criteria. (So does Malaysia and so would
have Japan until it ceased its massive intervention a little over a
year ago.) Our own Treasury indicated as much in its latest semiannual
report to the Congress, after whitewashing China's behavior for several
years and still inexplicably failing to label it explicitly as a
``currency manipulator'' as called for under the relevant statute of
U.S. law.
The International Monetary Fund, however, appears to have limited
its activity on this issue to quiet efforts to persuade China to reform
its currency regime (as opposed to raising upward its exchange rate.)
It apparently was unwilling to endorse the critique of China's policy
in the latest Treasury report, incomplete as that was.
The Fund is of course a creature of its major member countries,
especially the United States and the rest of the G-7, so the
responsibility lies with those governments at least as much as with the
institution itself. Part of the problem is that the U.S. Treasury and
the rest of the G-7 have, at least until very recently, been proposing
the wrong thing: They have been asking the Chinese to float their
exchange rate, which is neither desirable (because it might float down,
worsening the current account imbalances) nor feasible (because the
Chinese banking system is far too fragile to support anything
resembling a true float, especially with a sharp reduction in China's
capital controls), rather than for the sizable one-shot revaluation of
perhaps 25 percent that is essential to make a substantial contribution
to reduction of the global imbalances.\2\
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\2\ Our estimate at the Institute for International Economics is
that a Chinese revaluation of 25 percent and upward appreciations of
one half that much by the other East Asian countries would reduce the
U.S. current account deficit by about $60 billion after the full
effects phased in over two to 3 years. The U.S. gain would be at least
$100 billion if the exchange rates of the other Asian countries rose by
the full amount of the Chinese move.
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The Fund, with its systemic and global responsibilities, should
nevertheless have been making a much more forceful and much more
pragmatic effort to bring the global imbalances back under control. To
its credit, it has been vocally pushing the United States to initiate
(especially budget) actions that would reduce its external deficits. It
has likewise been urging the Europeans to implement structural reforms
to accelerate the growth of domestic demand in their economies, to
offset the adverse impact they will experience from the declines in
their trade surpluses that are an essential counterpart of reduction in
the U.S. deficits. Without much stronger support from the G-7
countries, however, notably including the United States itself, there
is little that the Fund can do to achieve realization of such policy
alterations--including with respect to the Chinese and other East Asian
exchange rates.
Argentina
Another key question facing the IMF at present is its relationship
with Argentina as that country emerges from its traumatic depression
and debt crisis. The Fund badly mishandled Argentina virtually
throughout the run-up to that crisis. It endorsed the country's rigid
currency peg, even as it was becoming increasingly overwhelmed, and
failed to insist on fiscal tightening during the boom period of the
middle 1990's, setting the stage for the escalation of budget deficits
and debt that brought on the biggest default in modern history when
things turned sour. It then prolonged and deepened the agony by lending
large amounts that enabled the Argentine authorities to further
postpone the policy changes whose necessity had become blindingly
obvious.\3\
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\3\ The full story is in Michael Mussa, Argentina and the Fund:
From Triumph to Tragedy (Institute for International Economics, 2002.)
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At the same time, the lessons of the Argentine crisis for the
international monetary system and the IMF are not yet clear. Argentina
itself is recovering briskly. It is now receiving so much foreign
investment that its currency is rising and it has recently adopted
restraints on capital inflows. The global financial system suffered
little contagion from the Argentine episode, despite the country's
being both the largest borrower among emerging market economies and
engineering the largest sovereign default in modern history. Emerging
market economies are receiving near-record capital inflows so no
significant ``chilling effect'' can be discerned at least for now. The
apparent ``success'' of the Argentine default strategy does not seem to
have tempted other countries to pursue a similar strategy and Brazil
next door has in fact been a model of rectitude even under the Lula
Government.
All these results will of course need to be stress tested during
the next global economic downturn and sharp rise in world interest
rates before firm systemic conclusions can be drawn. One close observer
of the process concludes that ``Argentina's crisis has done little so
far to validate or discredit the idea of statutory sovereign
bankruptcy'' but adds that ``It achieved impressive debt relief in a
reasonably short timeframe without either CAC's (collective action
clauses) or bankruptcy.'' \4\
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\4\ Anna Gelpern, ``What Bond Markets Can Learn from Argentina,''
International Financial Law Review, April 2005.
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Debt Relief and IMF Gold Sales
Another operational issue confronting the Fund is whether to
relieve some of its poorest member countries of their debt to the Fund
itself (now about $6 billion for the forty or so countries identified
as Heavily Indebted Poor Countries, or HIPC's) and, if so, how to
finance the resulting impact on the Fund's balance sheet. The most
promising candidate is use of the Fund's own gold reserves, which are
worth more than $40 billion. A limited version of this idea, which
enabled the Fund to mobilize profits on its gold holdings without
actually selling any of them into the market, was actually implemented
in 1999 and yielded about $2 billion for debt relief.
There is considerable debate over the desirability of debt relief
as a mechanism for providing assistance to poor countries. Whatever the
economics of the issue, however, it is clear that this particular
channel attracts more political support than most other methods of
providing foreign aid. In addition, our own careful study of the issue
suggests that debt relief has a number of advantages over more
traditional forms of aid: Increasing ownership of their development
program by poor countries because of their greater autonomy in using
the funds, reduced transaction costs, increased fungibility and hence
utility of the resources, elimination of tying, and freeing donor
countries of the need to extend new aid to the debtor countries simply
to finance repayments of existing debt. We advocate several important
changes in existing debt relief techniques but support the basic
strategy, including through mobilization of another portion of the
IMF's sterile gold stockpile.\5\
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\5\ The full analysis is in Nancy Birdsall and John Williamson,
Delivering on Debt Relief: From IMF Gold to a New Aid Architecture
(Center for Global Development and Institute for International
Economics, 2002.)
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A related issue is whether the IMF should continue to lend to the
world's poorest countries through its Poverty Reduction and Growth
Facility (PRGF). This is one of the few issues, along with the
desirability of comprehensive debt relief itself, on which there was
unanimous agreement among the members of the Meltzer Commission: that
the IMF should get out of the business of making poverty reduction
loans. My own proposal, however, is not to eliminate the PRGF but
rather to transfer it to the World Bank, whose primary mission is
poverty reduction in poor countries. This would inter alia clear the
decks for the IMF to extend debt relief to those poor countries without
placing itself in the self-contradictory position of then extending new
loans to the very same countries that had just been judged incapable of
paying their existing debts.
Meltzer Commission Report
These were among the very few issues, however, on which there was
agreement on the Meltzer Commission. I have testified to this
Subcommittee or the full Banking Committee on these differences on a
number of occasions including in March 2000 upon the release of the
Commission's report, in April 2000 and most recently in May 2004. As
the author of the dissenting minority report, I am pleased that the
U.S. Treasury and the G-7 Finance Ministers rejected the main proposals
of the majority almost immediately and that those proposals mercifully
enjoyed a very brief period of serious consideration.
Suffice it to note today that the majority's proposals look even
worse in retrospect, if that is possible, than they did when issued.
They would clearly not have precluded the mistaken program for
Argentina described above because Argentina, which was (mistakenly) the
Fund's ``poster child'' for much of the 1990's, would almost certainly
have been deemed to meet the majority's requirements for
prequalification for Fund assistance. Former IMF Chief Economist
Michael Mussa notes that ``On the criterion of having a sound banking
system, with widespread participation of foreign banks, Argentina was
clearly outstanding . . .and it was particularly praised in this regard
by one of the members of the Meltzer Commission majority. Presumably,
on those grounds (my note: Which were the majority's chief criteria),
under the Commission's proposals, Argentina would have qualified for a
very large package of precommitted support.'' \6\
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\6\ Mussa, Argentina and the Fund, p. 73.
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On the other hand, the Meltzer Commission majority's requirement
would almost certainly have precluded the very successful Fund program
for Brazil (and the program for Turkey, whose ultimate outcome is less
clear but which has succeeded to date). Their proposals to shut down
several major sources of funding for poor countries, including the
regular lending program of the World Bank, fly in the face of the
revealed preferences of virtually every rich country in the world
(including our own, in both the Administration and the Congress) to
sharply increase the flow of resources to counter poverty and
underdevelopment. I hope we can focus today's discussion on issues of
current and future relevance rather than rehashing stale debates that
were closed out for all practical purposes half a decade ago.