Unsettling to a Cozy Status Quo

Uh-oh. It looks like the IMF might actually try to do something about the combination of growing trade imbalances and inflexible exchange rates. Like the Democrats about to take control of Congress they should tread carefully.

If there's one thing that everyone can learn from Alan Greenspan, it is this:

'Tis much better to swoop in after the catastrophe has struck and be viewed as the hero, than to act preemptively and get blamed for causing it.

According to this report, the new year will bring new efforts by the International Monetary Fund to address trade imbalances between exporters and importers. In recent years, these imbalances have not been permitted to correct themselves via currency exchange rates because so many exporting countries peg their currency to the currency of the world's largest importer, the U.S.

This system has been and, until someone sets out to fix it, will continue to be vendor financing on the grandest scale. Like Cisco lending money to their customers to buy routers that were piling up in company warehouses in 2000, Middle Eastern and Asian countries continue to lend money to Americans so that the oil and manufactured goods can continue to flow to the West.

Some call this process "attracting capital" as a result of a "savings glut", while others call it "vendor financing" - it all depends on your perspective. Whatever you call it, after a while it all seems routine for both importer and exporter - a cozy status quo.

The International Monetary Fund is to host a multilateral meeting of the US, EU, Japan, China and Saudi Arabia to discuss global financial imbalances early next year. Officials told a press conference at the Dubai International Financial Centre that both currency revaluation and measures to stimulate economic growth in the GCC will be on the agenda.

'There are two ways to tackle global imbalances,' said IMF Deputy Managing Director, Takatoshi Kato: 'Increasing the rate of growth in the surplus countries, or a revaluation of exchange rates. This sort of multilateral consultation is new for the IMF.'

Uh-oh. That Mr. Kato is 'gonna break something for sure with talk like that. Is he new? Maybe they ought to hire our retired Fed chairman to help handle this situation. His efforts would likely be directed at getting ready to "mop up" the place after things run their course, rather than "multilateral consultation".

Multilateral consultation could actually lead to someone doing something, triggering a cascading sequence of untoward events for which the organizer of the original meeting will be blamed. Mr. Kato's fingerprints would be all over this.

Representatives from both China and Saudi Arabia will be at the meeting, but if the recent trip to China by Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke is any indication, they'll be attentive listeners and little more. The Saudis? They'll probably nod their heads a lot.

Currency revaluation speculation is normally focused on the Chinese Yuan but the Saudi Riyal is also increasingly under scrutiny these days. Indeed, the $200 billion US trade deficit with China is smaller than its $250 billion trade deficit with the Middle East oil producers.
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But for countries whose exchange rate has been pegged firmly to the US dollar for more than two decades even the mention of the word 'revaluation' is unsettling to a cozy status quo. It could have serious implications for liquidity flows.

On the one hand, a stronger Riyal or UAE Dirham would make Euro-priced products cheaper, dampening consumer price inflation. There would also be a one-off currency gain for the owners of local real estate. But on the other hand, the region would become more expensive for some tourists and the inflow of foreign money might falter as assets would be more expensive.

Even putting revaluation on the agenda will be enough to make many potential investors sit up and think. For if you know a currency stands a good chance of being revalued then investing before that valuation change is a sure-fire hit, and worth leveraging.

Yes, there are a myriad of possibilities that could arise after another Plaza Accord style currency policy. It all gets rather complicated when you set out to fix something that has gone so wrong for so long while at the same time benefiting so many.

As for the alternative to currency revaluation - stimulating internal demand in countries with trade surpluses to offset exports - there is little hope of that being a feasible remedy since both the Middle East and Asia are increasingly subject to boom-bust cycles that could probably do without any additional stimulus.

In fact, if the Middle East stock market crashes earlier this year are any indication, additional stimulus there may have the reverse effect, ultimately causing increased demand for "much safer" dollar denominated investments.

Ultimately, there will likely be large currency blocks - one in Asia, another in the Middle East, maybe one for North America - so that individual countries do not have to bear the heavy burden of righting what is wrong in a world where an astronomical supply of fiat money sloshes around the globe searching for yield.

Until these systems can be established, probably the best thing that the IMF could do is buy more mops.