A V Rajwade: Overselling neoliberalism

Income inequality and reduced growth apart, it leads to volatile exchange rate, which hampers trade and therefore growth

In this column, a couple of weeks back (“Time to upend convention”, August 18), I had discussed an article by three economists in the International Monetary Fund (IMF). It had argued that, in recent decades, “neoliberalism” has been oversold in terms of the economic benefits it is supposed to lead to. One of the items on the neoliberal agenda the article discussed was the issue of capital account liberalisation. While the article argued that such liberalisation leads to income inequalities and this, in turn, reduces growth, it did not refer to another fallout: volatile exchange rates and their impact on trade and, therefore, growth. Lest we forget, the foreign exchange market was born to help cross-border trade in goods and services; arguably, the improvement in living standards over millennia has come through ever increasing production of goods and services for exchange, rather than for consumption by the producer himself. This was facilitated by the use of money as a means of exchange, rather than as a speculative asset class.

Since capital account liberalisation, there has been an explosive growth in currency market volumes: As of now, the global currency market trades something like $5 trillion every day (or, say, $1,250 trillion per annum). In comparison, the global trade in goods and services was of the order of $16 trillion in 2015. Even if you add to the latter the flow of cross-border direct investment and long-term loans, it is evident that such genuine and beneficial economic activity comprises barely 1.5 per cent of the currency exchange. Much of the rest is speculative buying and selling of currencies by banks’ trading desks, as also hedge funds and others who make billions of dollars of profits from such trading. Do they make a corresponding contribution to the global economy through increased growth and job creation?

It is sometimes argued that speculative profits of one party are balanced by losses of other speculators and that, therefore, it is a zero-sum game. This logic does not go to the heart of the problem. Speculative trading by banks, hedge funds and others requires volatile exchange rates, which often lead to exchange rates moving significantly away from their fundamental values. To be sure, the efficient market theory argues otherwise: On the other hand, the reality is that the two most successful trading strategies adopted by players in the global market are trend following and carry trades; neither would work if markets were truly efficient and led to prices reflecting all fundamentals as the theory is.

While volatile exchange rates are essential to create an opportunity for currency trading/speculation, they are simultaneously a threat to the real economy, which produces goods and services and creates jobs. Arguably, the speculative profit of the financial economy is “earned” at the cost of the real economy. The neoliberal agenda of the IMF has created a situation where financial markets have become masters of the real economy, not its servants. It is worth recalling that, in terms of Article 1 of its Articles of Agreement, the IMF is supposed to “facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy”. Is this objective served by capital account liberalisation and its corollary, volatile exchange rates moving to levels far different from what is dictated by economic fundamentals like a reasonable balance in exports and imports, and in external assets and liabilities? One reason for ignoring the issue could well be the academic background of most IMF economists: “In a number doctoral programmes (in the US) a student can specialise in macroeconomics without knowing what an exchange rate is, much less an emerging market economy” (Olivier Blanchard, IMF’s economic counsellor and head of its research department, in Finance and Development, September 2014).

To come back to capital account liberalisation, the IMF is supposed to have modified its “institutional view” on the subject in 2012. While that view accepts the need for capital controls (to be sure, with a lot of ifs and buts and conditionalities), it is mostly silent on the issue of exchange rates. Recently, the IMF decided to include the Chinese yuan in the special drawing rights basket of currencies, despite it being a managed currency. Does this signal a change of the institutional view on the benefits of managed exchange rates?

The author is chairman, A V Rajwade & Co Pvt Ltd; avrajwade@gmail.com