Is the world running out of balance sheets?
With banks “done”, investors terrified and corporates struggling to raise cash to keep business as usual, there was only one balance sheet left to (try to) resurrect the financial system: The government’s.
And so it went. Governments across the developed world stepped in with a joint $2 trillion-plus “rescue” package, while their respective central banks also injected hundreds of billions, determined to re-liquefy the system.
But now the crisis has entered a new Act: “Spillover to Emerging Markets”. Who’s gonna bail out those?
Enter the International Monetary Fund. The world’s designated financial firefighter, which, up till recently, was shunned as irrelevant by market participants swimming in an ocean of cheap credit. An institution vilified by many an erstwhile borrower for its stringent lending “conditionalities” and its perceived allegiance to west-style capitalism. A lender of truly-last resort; so truly-last that its acronym (“IMF”) was at times associated with the exclamation “I’M Finished!” (or the less eloquent “I’M F***ed!”).
No more. Countries from Iceland to Pakistan are lining up to negotiate their own rescue package, as the crisis spreads ferociously into their territory.
What has changed?
First, the Fund itself. Destitute and demoralized after years of inaction, the IMF is keen on putting its idle money to work and its army of economics PhDs on a business-class ticket to Reykjavik. So keen that it’s considering sidestepping its (admittedly arteriosclerotic) lending guidelines in favor of more nimble packages—basically more (much more) money and fewer (if any) conditions.
Second, the stigma of IMF borrowing is arguably less of an issue than in years past. Why? Because, for once, emerging-market leaders can “market” their predicament as collateral damage from a major screw-up in the advanced world, rather than an obvious policy error at home.
While dubious under probing, the headlines are in their favor: Emerging Markets: Victims of a triple whammy of sharp declines in commodity prices (a key export for many); slowing world demand; and, crucially, a massive pull-out of foreign capital.
Now, emerging markets are special: The tools employed by advanced economies to deal with the crisis are not available to the likes of Hungary or Brazil.
For example, large government bailouts are not an option—emerging markets cannot borrow their way out of the crisis. Instead, the more they borrow, the bigger the fear they will default, and the larger the capital pull-out. Clearly, that’s not the case for advanced economies, not least America, whose debt (amazingly!) continues to be viewed as a safe haven by investors.
Unfair? Perhaps. But gets worse. As American or European banks cut their credit lines, emerging markets are left without money. Now this is not any money—it’s not their own Russian rubles or Hungarian forints their central banks can supply in unlimited amounts. It’s “hard” currencies they are short of—“hard” as in “respectable”, “sound”, “convertible” and “hard to find when foreigners are pulling out!” Dollars, euros, pounds, yen.
Once again, “rich” countries have an advantage: Their funding problems are (by and large) in their own currencies and, therefore, their central banks can be employed to provide the needed liquidity.
Gets even worse. While the Fed has established currency swap arrangements with its peers in the developed world, it does not (yet) have any such arrangements with central banks in the emerging universe. So if British banks, for example, are short of dollars, Bank of England can get dollars from the Fed to lend them on to its banks. Not so for the central banks of Brazil or Turkey, who will have to tap their own dollar reserves—reserves that, as we know, are depletable.
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So the IMF is back. But what can it do? I mean, its (much advertised) $200 billion-“strong” balance sheet is puny. Sure, it could provide some temporary help to the Latvias and Belaruses of this world, but what if Brazil or Russia were to go under? We’re not talking remote, idiosyncratic crises here, but a global disruption in liquidity. Mini-injections will hardly be of help.
What we need at this point is a global provider of liquidity… in hard currencies. A global version of the Fed. An institution that can “recycle” hard currencies from the cash-rich to the cash-strapped, until the bubble deflates, deleveraging subsides and investors come to their senses. The IMF could be that. Let me explain.
First, look at what the Fed is currently doing: Effectively, it has taken over financial intermediation in America: At a time when banks are reluctant to lend, hoarding cash instead, the Fed attracts this cash onto its balance sheet and lends it on to those who need it.
The Fund could play a similar role at a global level: Attract funds from the cash hoarders and lend it on to the cash-strapped. But who would give money to the Fund? Well, the Fed, the ECB, Bank of England, etc would be obvious providers of hard currency.
But here is another: China. As much as it enjoyed (and, indeed, fuelled) the global credit party while it lasted, China has been a silent observer of the demise of the global financial system. It’s about time it put a good chunk of it’s near $2 trillion of foreign exchange reserves into action.
So, were the IMF to garner the required funds, the question becomes: Who should it lend to? And under what conditions?
The “Who?” should not be difficult: Lend to countries that are illiquid, not insolvent. In fact, lend to insolvent too, provided they enter a program to restructure their debt. Let me say this is the IMF’s bread-and-butter expertise (the unfortunate instance of the 2003 program to Argentina notwithstanding!) so it shouldn’t be hard to dust off those crisis-resolution folders.
As to the conditions: Despair for action should not translate into an “anything you want” approach. Large-scale? Yes. Flexible? Absolutely. Nimble? Of course. But the programs should still aim at ensuring borrowers will be able to repay; and that IF(!) there was, indeed, some home-made screw-up, they use the opportunity to fix it.
Finally, let’s face it. The IMF is not the Fed. It can’t print its own money, nor can it rely on America’s taxpayers to cover up the hole. Moreover, unlike the Fed, there is no obvious collateral it could receive to make its lending more secure (Belarusian bonds? Russian vodka? Turkish kilims?) But then, who would bail out the Fund, if any of its borrowers were to default?
Ultimately, the IMF’s membership should stand ready to back up its balance sheet in the event it’s threatened. And they should unanimously reiterate the Fund’s preferred-creditor status, in letter and in spirit (no more Argentinas please!)
And if you think this is an ambitious, if not loony, idea, so be it. Just get ready to have another quarter like the one we’ve just had!
Originally published at Models & Agents blog and reproduced here with the author’s permission.