At last, Japan and China have an important issue on which they can agree. Together with South Korea, they took the occasion of the annual meeting of the Asian Development Bank in early May to voice their frustration at the under-representation of themselves and other non-western and emerging economies in the International Monetary Fund.
The ADB was meeting as far from east Asia as can be – Istanbul, a city which is geographically in Europe but surpassed by no city as a cross roads. Turkey also happens to be a country significantly under-represented in global institutions but is literally and figuratively the bridge between Asia and Europe and between developed and developing worlds.
Like all institutions created after World War II, the IMF voting power and management largely reflects the world as it was 60 years ago. Although changes have taken place since that time, the developed western world still accounts for nearly half the IMF votes.
There have also been grumblings of non-western dissatisfaction at the appointment of former US deputy defense secretary, Paul Wolfowitz, ideologue and Iraq war advocate, to head the World Bank. Presumably for some yet to be revealed quid pro quo, the Europeans went along with the US nomination, distasteful though many found it. They failed to make common cause with Asian and other countries which also viewed the nomination with concern.
Inadequate Asian influence in these institutions is now a serious matter. There are very strong economic arguments for currency realignments which would reflect the strength of east Asian (and some southeast Asian) economies and payments situations. Given its own role, the IMF has a right and duty to point out where fiscal and exchange rate policies in member countries are creating international imbalances which threaten the long term stability of the global financial system.
However, the intellectual and policy force of the IMF is clearly very weak. Thus far China and others have largely ignored its (mildly worded) comments on exchange rates and systems, and the Fund's complaints about US fiscal and interest rate policies have been so muted as to be inaudible – especially in Washington.
The IMF's lack of clout is partly because its resources are too small. It was created for a world of mostly fixed exchange rates and of capital controls. Its resources can barely cope with one-off crises like Argentina, let alone bigger disasters.
In Asia, its reputation suffered from atrocious advice to at least two countries during the 1997-98 crisis. But at least as important in east Asian eyes is the western dominance of the fund's voting system and management. Too often it is perceived as a tool of western foreign and economic policies or the prisoner of the so-called (if actually illusory) "Washington consensus" on market economics.
The need for a better balance of global institutional power is underscored by the fact that most of the world's excess savings is to be found in east Asia. Thus any improvement in global balances must involve a two things: firstly, the encouragement of these economies to higher levels of consumption, and secondly, the re-direction of their surpluses from the old rich consumers (essentially the US, UK and Australia) towards those regions which badly need more assured supply of long term capital – south Asia, parts of southeast Asian and most of Africa and the (non-oil) Middle East.
Unfortunately the current global system is working to reinforce existing imbalances. Thus China (like Japan and Korea) continues to acquire dollar surpluses which are invested primarily in US debt instruments including treasuries and mortgage securities. The US needs China to keep buying these to sustain consumption growth which feeds China's factories. The purchases help China keeps its exchange rate stable against the dollar.
However, if one assumes – as one must – that the exchange rate does not reflect the relative strengths of the economies and that current US dollar interest rates are being held at artificial, historically very low levels, the foreign holders of this debt stand to face enormous losses on the exchange rate and probably additional ones on the value of bonds when real interest rates return to more normal levels.
It seems highly likely there are better investment returns available in developing countries, whether directly into infrastructure and industry or indirectly though purchase of local currency bonds and shares. In turn, such investment would spur exports from east Asia to compensate for any reduction in US demand caused by fewer purchases of US debt.
But the mechanisms are quite insufficient. Borrower and lender alike are stuck with the dominance of the dollar (and to a lesser extent the euro) in the international financial system.
Asia's central banks have lacked the imagination, and the western investment banks the commercial inducements, to make possible far more local currency deals. It is now almost eight years since the Asian currency crisis hit, but the region has barely begun to learn one its main lessons – the advantages of local currency borrowing for borrower and lender alike.
We are seeing some small improvements in capital flows. China has been buying into resource developments in many developing countries. China and Japan have been increasing aid flows, partly offsetting the decline in net money flows from the west and the multilateral lending agencies. Most recently the ADB itself has begun to borrow in some local currencies, proving avenues for foreigners to acquire India, Malaysian rupee and ringgit debt. The ADB deserves considerable credit for its attempts to develop local bonds markets and make them accessible to foreign investors. It now has an excellent website to link investors to available bond issues and markets.
Nonetheless, progress towards Asian financial cooperation has been very slow. Reserve swap arrangements to help avoid future exchange crises have been put in place but these have generally addressed yesterday's problem rather than today's problem of directing Asian surpluses to more productive investment than US mortgages.
Clearly, China-Japan mutual suspicions have been a factor. So too has been the anomalous position of the third largest reserve holder – Taiwan. But it is increasingly clear that greater Asian cooperation is badly needed if the region is to be able to handle the sharp adjustment that must come soon in the US trade imbalance. Lack of progress in giving Asia the share it deserves in the IMF ought to be spurring regional alternatives.
There are two areas where much could be done very quickly.
Firstly on exchange rates: A uniform system, let alone a single currency, is still at least decades away, but that does not preclude informal understandings among the major players – which southeast Asia will follow implicitly – that permanently fixed rates and beggarthy- neighbor exchange policies are dangerous.
Secondly, more effort has to be made to open up domestic bond markets, encourage pension and insurance funds to diversify within Asia, and create tax-free ways for central banks to buy the sovereign debt of Asian neighbours in the same way they can buy US sovereign and quasi sovereign debt.
In short, complaints about the IMF are justified but should be no excuse for not doing more to develop regional financial cooperation as a substitute in the same way as regional free trade deals are the response to the slow progress of liberalization under the WTO.