The dollar has long been the globally dominant currency and will remain so for the foreseeable future. The International Monetary Fund is the lynchpin of the international monetary system. These two statements are regarded as quasi-axiomatic. But how do they hang together?
The global landscape is comprised of nation states. There are significant economic and financial interdependencies among countries. The Fund serves as one ‘universal’ institution. While many analysts focus on the dollar’s reserve currency status, its role in greasing the wheels of international finance is of greater significance and more entrenched.
The Federal Reserve has a domestic mandate. While the Fed monitors and is sensitive to the global spillovers of its policies – and these are undeniably critical – it takes into greater account whether foreign developments have spillback effects on the optimal functioning of the US economy. Given how large and closed the US economy is, spillbacks are limited in normal times.
But during the 2008 financial crisis, disruptions in dollar markets were enormous and the worldwide financial system quaked. That was true also during the pandemic, though to a lesser extent. Economic activity in the US and other economies faced deep peril. To steady the international financial system, the Fed stepped up as the de facto global lender of last resort, offering swaps and other facilities to major advanced economy and emerging market central banks that are key for systemic stability.
Should the IMF take on a greater lender-of-last-resort role?
The IMF is another key financier for the global economic and financial system. As Brent Neiman, US Treasury assistant secretary for international finance, said in a discussion with OMFIF, it has a key role as a balance-of-payments lender for troubled economies. The Fund especially played this role in 2008 and during the pandemic.
The IMF offers various precautionary lending instruments, including its flexible credit line and a short-term liquidity line. While the FCL has racked up some successes, the history and record of the IMF as a precautionary or insurance lender has been mixed. For better or worse, there has been little interest in IMF liquidity swaps. Large-scale liquidity support could be suited for strong-performing countries facing problems, a principle well recognised in the design of the Fund’s FCL and swap line facility. Some strong performers would argue, though, that there is a stigma associated with going to the IMF or that they simply don’t believe they need such backing given robust buffers and policies.
But many other Fund members face entrenched balance-of-payments adjustment needs and the line between illiquidity and insolvency for them is often blurred. In such cases, the Fund acts as a conditional lender. It does not secure collateral as a bank might. The Fund imposes surcharges on large-scale use, but there is now a campaign to reduce them.
Some might argue that it should be the Fund’s role to offer short-term swaps, not the Fed’s, and the Fund should assume a greater global lender-of-last-resort role. But its resources are constrained by its member countries. Some analysts suggest this might be overcome through frequent allocations of special drawing rights, but the Fund’s members have historically been reluctant to allocate SDRs in normal times. The unconditional use of SDRs can perhaps hurt more than help and add to debt woes. Members certainly do not back SDRs – as provided for in the IMF’s Articles – becoming the principal reserve asset of the international monetary system.
In short, the Fund faces constraints in its ability to act as Walter Bagehot would recommend – lending early and freely to solvent banks (countries in this case) with good collateral at penalty rates.
Global financial safety net
While it may not be a global lender of last resort akin to the domestic role that a central bank plays, the Fund is a critical player in the global financial safety net. The first lines of defence in the GFSN are strong country policies and buffers – such as foreign exchange reserves. Further, countries may seek IMF support, both precautionary and conditional.
Given the Fund’s catalytic role, countries’ external financing is also augmented by bilateral official support or private market borrowing. Some bilateral support takes the form of co-financing for the Fund’s programmes. Regional financing arrangements – such as the multilateralisation Chiang Mai Initiative – can play a role. Bilateral country swaps are another facet of the GFSN – including swaps from China’s central bank – though these are often opaque and may represent trade finance, rather than short-term liquidity support.
In short, the GFSN is a hodgepodge. Some might say more euphemistically that it is ‘multi-layered’.
The Fed is a reluctant crisis lender of last resort for the global dollar-dominated system. The IMF is a central player in the GFSN. Together, it’s messy, flawed and reflects the untidy gaps in a worldwide ‘architecture’ dominated by interdependent nations in which international institutions play a supporting role. One can decry that messiness and argue for more universalism and a greater lender-of-last-resort role for the IMF. But the realpolitik of nation states suggests that is not in the cards. The messiness is here to stay for now.
Mark Sobel is US Chair of OMFIF.
Thanks to Tamim Bayoumi for helpful comments.
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