Over the years, the IMF and the World Bank have earned resentment due to the misguided conditions they impose to exercise their mandates. Lack of legitimacy is reinforced by their image as organisations that carry out the mean western policy.
The main cause of this crisis of legitimacy is the emerging country's little influence on how the development agencies meant to serve it are run. Countries that can avoid the assistance of the IMF do so by accumulating vast foreign exchange reserves, as a form of insurance against financial crisis. Those who cannot, often regard it as detrimental to the economy because it leads to a devaluation of the currency and reduction of foreign direct investment. For example, in March 2010, all 16 eurozone countries agreed to back a France - German plan to offer Greece loans in conjunction with the IMF. In a cross-linked system, mistakes by one of the eurozone members, such as one big bank (i.e. market share) with financial difficulties, can cause dangerous imbalances for every member. France and Germany have decided to collaborate with the IMF because the IMF has a better experience and authority in enforcing bailout plans than the EU. Yet, there are growing concerns. "An IMF- led solution... is hugely damaging for the euro's prestige as an alternative global currency," Jan Randolph, head of sovereign risk analysis at IHS Global Insight, wrote in a research note. "Why can't the eurozone solve its own problems and have to tap into the global fund, the IMF that should be reserved for much weaker and poorer countries?"(6)
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The recommendations to the G-20 on International Financial Institution Reform (7) are positive step towards international cooperation. And it highlights one of the most important issues under Bretton Woods - countries' vote share. If the IMF and World Bank adhere to these recommendations, then it could be the first step in facilitating the agreements between various countries. Some of the recommendations are as follows:
Adopt a new revised IMF quota formula that is both based on economic realities and gives developing and emerging-market countries a more appropriate share of the voting power.
Ensure that the IMF fully implements its mandate for multilateral surveillance with respect to exchange rates and other macroeconomic policies.
It is evident, with the recent crisis that the negotiators in Bretton Woods have failed once again. So, let us consider the potential obstacles of the re-introduction of Bretton Woods. The first is the inability to control the policies of U.S. and other countries that run large current account export led economies and surpluses generated by Germany, Japan, China and oil producing countries.
There is growing concern about China's currency. In an interview with Larry Summers, director of Barack Obama's National Economic Council, responds to the question. Is China a "currency manipulation"? "We think countries with large surpluses need to be focused on shifting the pattern of demand towards reliance on domestic demand"(8). Exchange rates are the relative price of foreign and domestic goods, and an important aspect of large surpluses. We can conclusively state that China is a Currency manipulator because it has intervened on a large scale to keep its exchange rate down. Between January 2000 and December 2009, China's foreign currency reserves rose by $2,240bn. China has purchased this foreign currency to keep exchange rates down and to preserve export competitiveness.
In March 2010, the World Bank raised its growth forecast for China to 9.5% (9) but he warned that a stronger currency is needed to prevent bubbles and to curb inflationary pressures. Chinese premier, Wen Jiabao, insisted that the currency was not undervalued and warned that, pressing China on its currency policy amounted to protectionism. On one hand, the US administration believes that China's refusal to let its currency appreciate is hindering the US economic recovery and hurting US competitiveness. On the other, the US is pressing China on its currency policy for the purpose of increasing exports. This is protectionism. The rapid rate of China's reserve accumulation is evidence that the renminbi is undervalued. China will be reluctant to allow its currency to appreciate substantially. Over time, we are likely to see a gradual appreciation of the renminbi, but the likelihood of witnessing a one-off revaluation is very low.
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The renminbi is undervalued and this could hinder the global recovery. Rebalancing is necessary for a sustainable recovery and the appreciation of renminbi is crucial for changes in competitiveness.
On April 15, 2010, the statistics bureau highlighted two important factors that are particularly important in the fight against rising costs i.e. imported inflation and labour cost. A stronger currency and renminbi will address those factors. The settings imposed when the renminbi was pegged to the dollar two years ago, were emergency settings. And on the basis of todays figures (11.9% first quarter), the emergencies are a long way away.
The second is that of countries which are experiencing a reduction in capital inflows (borrowing) from banks and other foreign currency lenders. Many countries made costly efforts to reduce vulnerability by accumulating currency reserves. By August 2008, the total foreign currency reserves of emerging countries had reached $5,500bn, whereas only $260bn (4) was available to the IMF. To restore stability, we need to reinstate and co-ordinate capital controls across borders. This can be carried out through the IMF, although it is not an entirely new idea. Members of the G20 should reflect on a central mandate of the IMF, as outlined in Article 6, Section 3: "Members may exercise such controls as are necessary to regulate international capital movements."
The third is that of making the financial system less vulnerable to huge shifts in risk appetite.
Reallocation of country quotas (capital share that determine voting rights) is crucial in restoring legitimacy to the Bretton Woods. The IMF and World Bank are dominated by western countries. In the case of the IMF, the U.S. had 17.9% of the quotes, the European Union account for 32.4%, While China had just 3.72% and India 1.91% .The group of 20 countries seems too large and Robert Zoellick, World Bank president, suggests a G14 which would include Brazil, India, China, Mexico, Russia, Saudi Arabia and South Africa. Yet, it would be more difficult to reach an agreement because there would be more voices and equality between members at the Bretton Woods. Although Mr Zoellick has a valid point, but reverting to a G14 would be discriminatory towards countries with a very low quotas. Therefore a good start to a new Bretton Woods, is to give a real say to those it serves today, not just those it served in 2007 (under the G8).
When central banks start implementing strategies to headoff the financial crisis, there is the potential to cause a range of currency change, particularly in relation to the issue of the dollar carry trade. "To me, the big risk this year is the dollar carry trade," confesses Zhu Min, deputy governor of the People's Bank of China. "It is a massive issue - estimates are that it is $1,500bn - which is much bigger than Japan's carry trade." .