The Prime Minister is back home and let us hope recuperating nicely. He now has some leisure to think and plan ahead I hope. Most urgent of his tasks is not the forthcoming Budget nor the elections. It is the April meeting of the G20. This is a chance in a lifetime for him to play a crucial role as an architect of the reformed international financial system.
Over this week Wen Jiabao has been at Davos and touring Europe. Slowly and inscrutably the Chinese are revealing their plans as to how they see the global situation. The Chinese play the global diplomacy game keeping a low profile and punch below their true weight. At present, they are the strongest creditor country having sunk billions of their forex reserves into the US Treasury Bills. All the plans Obama has for recapitalising the banks (still thirsty for capital despite what has been given to them) depend crucially upon the ability of the US government to borrow hundreds of billions of dollars on the market. Whether the Chinese buy the US debt or not will determine how high the interest rate goes. Of course given the deflationary situation, the Fed could always buy the T Bills and create money.
Ideally the world should not be in such a situation. The Chinese or any surplus nation should have a choice of where to park their money. The US should not have unfair seigniorage gains merely because its T Bill market has enormous depth.
This is why it is crucial to reform the international financial system. IMF has not had a decent task to perform since the collapse of the Bretton Woods fixed exchange rate system. It has found itself a new task of giving bad advice to developing countries and battened down on the poorest. It failed to warn about the petrodollar debt problem in the Seventies. It has failed to warn the world about the financial meltdown. Yet it is sorely needed right now to bail out rich sovereign countries like Iceland, Hungary and Ukraine. But its governing structure is outdated with the voting power in hands of the developed countries and it has so far resisted reform. Its Managing Director is always a European and not necessarily the best person available.
Now is the time for Asian countries especially China and India to propose far reaching reforms which will bring IMF into the 21st century. This time the developing countries can do this from a position of strength not just on grounds of equity. The surplus countries are in Asia by and large and the previously powerful countries are debtors begging for funds to repair their economies.
So what can be done? First priority is to make IMF into a proper central bank . It is not just that the poor countries need more SDRs. It is that IMF needs a larger capital base. I believe the world needs an asset which the IMF can create in which the surplus reserves of China and Japan and other Asian countries can be parked. This asset should be across currencies and even across commodities which would help diversify risks and reduce the seigniorage gains to the US. Similar proposals have been mooted in the past by Nicholas Kaldor among others. Once IMF has an asset in which countries put their reserves then lending out a portion of the income will make a lot of sense.
This is not an easy task and it will require both diplomacy and some economic cunning to put it past the US. No country likes its huge seigniorage advantage taken away. But the world needs to transit to a multipolar arrangement. The reform will take more than a day or two in April. Bretton Woods took two years to finalise and even then Keynes did not get his way. Patience and a willingness to take half a loaf are crucial. But even so this chance is a rare one. I believe India should outline a proposal whereby a Committee of Experts is entrusted with the task of filling out a preliminary scheme. This will give the task importance and some urgency if the Committee is kept to a tight deadline. The Committee can then also undertake the reform of governance and the expert capacity of IMF so that it is more appreciative of the needs of the poorest. Now that we have seen the richest come to their knees it is no longer a sign of bad economic policy or philosophy to have to rush to the IMF for help. So the bullying can stop.
This will also be helped by the head of IMF being chosen from anywhere around the world. Debtor countries cannot be left in charge of the IMF. Their long reign is over, thanks to their own economic mess. It is time to move them on but in the nicest possible way. Dr Manmohan Singh is probably the best person to do this. India and China have worked well together in the WTO negotiations along with Brazil. It is now time to build on that experience. There is real panic in the US and EU about the depth of the crisis. This is a time for bold initiatives. India has the intellectual capacity to do this in Team Manmohan. Let the PM conjure up the scheme while he is recuperating.
?The author is a prominent economist and Labour peer