LDCs to IMF: Shove Yer Capital Control Guidelines

Boys and girls, here's an interesting development as we rejoin the currency wars. Sometime ago, I discussed the Strauss-Kahn era IMF warming up to the idea of capital controls--at least in certain situations deemed unusual such as excess speculative inflows or too-rapid currency appreciation. Most likely, this warming up is attributable to IMF-organized research which finds that capital inflows are negatively associated with economic growth. According to Messrs Prasad, Rajan, and Subramanian:

Taken at face value, our results suggest that there is a growth premium associated with reduced reliance on foreign finance-—though we do not have strong evidence to suggest that this is a causal relationship. The reliance of nonindustrial countries solely on domestic savings to finance investment comes at a cost, however. There is less investment and consumption than there would be if these countries could draw in foreign capital on the same terms as industrial countries.

So, have we embarked on a new era where the IMF grants LDCs much-vaunted "policy space" in setting up capital controls when they believe they're warranted? Er, no. In fact, the IMF has been trying to get LDCs to agree to a set of guidelines which make capital controls a "last resort" after other avenues have been exhausted. At the recently held World Bank/IMF Spring Meetings, capital controls were among the main topics on the agenda of updating the IMF's global monitoring role. You may take the IMF's inability to get these LDCs to play along at the current time as another demonstration of America's inability to get its preferences across via international financial institutions. From the WSJ:

Representatives of emerging nations rebuffed an International Monetary Fund plan to guide them on managing huge flows of capital into their economies, viewing it as a way to constrain their actions rather than help. The IMF's policy-steering committee, at its spring meeting over the weekend, responded by effectively delaying the plan, which would influence the use of capital controls—tools such as taxes and restrictions on foreign investment. The committee agreed to study the issue more in coming months [translation: shelve it for now].

The IMF's recent endorsement of capital controls marked a reversal in its longstanding opposition to limits on the free flow of capital around the world. IMF officials had come to acknowledge emerging markets' need to curb surging inflows, which can fuel asset bubbles and inflation and hurt domestic exporters by driving currency values higher. The IMF's plan would have encouraged nations to treat capital controls as a last resort, after they had first tried use other tools, such as policies on interest rates, currency values and government budgets.

But ministers of developing economies resisted vehemently, viewing the proposal as an effort by advanced economies to hamstring their policies. Brazil, Turkey, South Korea and several other developing countries have adopted capital controls over the past year to limit surging inflows. "We oppose any guidelines, frameworks or 'codes of conduct' that attempt to constrain, directly or indirectly, policy responses of countries facing surges in volatile capital inflows," Brazil's finance minister, Guido Mantega [of international currency war fame], told the IMF's steering-committee meeting.

The fight over capital controls comes amid a continuing battle over who is to blame for the flood of capital flowing primarily from sluggish advanced economies into faster-growing developing countries. Developing countries blame the U.S. Federal Reserve, in particular, as a fountain of excess capital because it is holding short-term interest rates near zero and pumping money into the economy by buying government bonds. Developed countries trace the problems primarily to China's policy of tightly controlling its currency's value, and also to the tendency of investment capital to flow to the economies with the fastest growth.

The IMF committee directed the fund to study the issue with more focus on the sources of capital inflows. Mr. Mantega called capital controls "self-defense" measures. "Ironically, some of the countries that are responsible for the deepest crisis since the Great Depression, and have yet to solve their own problems, are eager to prescribe codes of conduct to the rest of the world, including to countries that are overburdened by the spillover effects of the policies adopted by them," he said in a statement to the policy committee.

That's one version of the story. Here's the American take:

U.S. Treasury Secretary Tim Geithner called the IMF proposal a "good start." He blamed the currency policies of countries such as China, saying they drive capital into economies with freer exchange rates. "A few emerging markets run tightly managed currency regimes, deploying extensive capital controls and accumulating excess reserves well beyond precautionary levels," he said. "This asymmetry magnifies capital flows into emerging markets with open capital accounts, heightening upward pressure on exchange rates that are flexible and fueling inflation in economies with managed, undervalued exchange rates."

The IMF had opposed capital controls for decades. Nations employing them risked criticism from the fund, spurring resentment from some members who feared a stigma from investors or other nations. But the IMF stance has shifted in recent years amid huge volumes of "hot money," or short-term flows, into many economies.

The LDCs have a valid point: if an orgy of liberalization, deregulation, and privatization did not bring America to the promised land--it look quite pitiful from where I stand--who's to say that others should follow its example? Indeed, America's recent return to deliberalization, reregulation, and nationalization--same with many other industrialized economies--contradicts its stance on what LDCs should adopt.

I'd say "shove yer capital control guidelines, white man" is an understandable response to this characteristically hypocritical American behaviour as its free-money policies cause LDCs misery through higher energy prices, food prices, etc. The US ain't got no street cred on these matters; I wonder why.