Global Policy Forum

by Philip Bowring

The Argentine currency and debt saga has dragged on for so long that it is easy to think of it as a one-country crisis. But it may be just the tip of the iceberg of an alarming imbalance in liquidity between developed and developing countries. At a time when the world needs a demand boost from countries in the best position to grow - the developing world - capital is moving in the wrong direction.

A liquidity shortage is being exacerbated by the volatility of capital flows, forcing developing countries to maintain higher foreign exchange reserves than previously deemed necessary.

According to the latest IMF data, 2001 will be the second year in a row when there has been a net outflow of capital from the developing countries to support consumption in the West. Overall, they are expected to have a current account surplus of $20 billion after $60 billion in 2000.

The IMF has suggested that private capital flows to the developing world could fall further in the next few months. The Bank for International Settlements likewise has just reported a sharp fall in lending to developing countries. Net debt of all developing countries has fallen to $1.45 trillion. That compares with U.S. net foreign debt, according to the Federal Reserve's quarterly data published on Dec. 7, of $2.6 trillion. U.S. foreign debt per capita is now almost three times that of Argentina.

Overall, international liquidity has increased rapidly in the last three years mainly due to the U.S. trade deficit. Total foreign reserves rose by 11 percent to $1.53 trillion, and the portion in dollars climbed to 68 percent. However, most of this increase has been accounted for by other industrial countries plus China. Even developing countries which have seen their reserves grow remain nervous. Those which, of their own volition or after IMF persuasion, allow free capital flows fret over whether their reserves are big enough to withstand sudden changes in market sentiment. For them, seeking protection in larger reserves has become a habit restraining them from the stimulus that their economies need.

Such caution is evident throughout Asia except in South Korea, where a huge rise in reserves and OECD status have revived self-confidence in the currency's stability. The rise in the dollar proportion of global reserves has also increased other countries' sensitivity to the dollar's value. The strength of the dollar has had a negative impact on most of the developing world, not just economies with dollar-pegged currencies such as Argentina.

Developing countries worry about the U.S. recession. And there is increasing resentment at an international financial architecture which imposes so many constraints on them but allows America to use the position of the dollar to avoid reasonable monetary and balance of payments discipline.

Broad money supply has grown by 13 percent in the United States in the past year - double the European Central Bank's upper limit. The past six months have seen the Federal Reserve create huge amounts of money by increasing its holdings of U.S. government securities by $25 billion.

Japan and Europe are also being urged to push higher money growth.

In Asia, currency concerns have been a major cause of very low money growth and hence of feeble domestic demand despite continued strong trade balances.

Easy money in America may ensure that the recession is a shallow one. But the ability to print money at will is coming under scrutiny and must lead to pressure from developing countries for a boost to their international liquidity via a new issue by the IMF of special drawing rights.

That will, as in the past, be opposed by the West on the grounds that it is both inflationary and an unjustified, unilateral transfer of resources to the developing world. But with inflation allegedly dead, and with global demand everywhere looking weak, a dose of global monetary stimulus for the non-OECD world looks like a good idea for everyone.

U.S. debt levels, the dismal demographics of Japan and Europe, the volatility of free capital flows, the overweighting of the dollar in international reserves, the unfair advantage that reserve currency status gives to the three rich blocs all point to the need for a formal boost to international liquidity in a way that spurs demand in the developing world.

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