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G20 task force loses confidence in IMF

By Lawrence Gash

Advisory report voices growing concern about looming liquidity crisis

In an advisory report for the International Monetary Fund (IMF), an expert G20 task force has observed that: “The risk of an unexpected and unplanned reversal of abundant global liquidity hangs over the world economy.”

The report by the Robert Triffin International forum published in December and first published by the Telegraph, doubted the IMF’s potential to battle such a crisis. It stated: “The IMF is not in a position to function as an international LOLR [lender-of-last-resort],” later adding: “Without granting the IMF sufficient resources or a capacity akin to the one of an international LOLR, the stability of the system will continue to be fragile.”

Whereas the IMF was able to act somewhat competently during the global financial crisis of 2008/09, a period of historically low interest rates coupled with vast levels of quantitative easing (QE) and a sharp rise in offshore dollar lending has made the IMF less effective.

The report also observed that “private liquidity is now considerably larger than official liquidity”. Whereas the IMF, the eurozone’s bailout fund (ESM) and the central bank swap lines total around $3trn (£2.3trn, €2.7trn), private liquidity, or foreign currency credit to non-banks, has ballooned to $12trn. Furthermore, while the IMF’s resources accounted for 4 per cent of global external liabilities 40 years ago, they now account for only 1 per cent.

With dollar funding of non-US banks rising to around $18trn, the scale of the Global Dollar system’s fragility will only become clear in the event of a worldwide liquidity crunch. Such an event “would force foreign banks to scramble for dollars” to pay back bonds and loans in a hurry.

The task force commented: “The need to address the risk of a new dollar liquidity crunch is urgent,” observing later on that: “Banks outside the United States currently have dollar debts which exceed the total liabilities of banks operating within the United States. Their dollar funding is vulnerable to any dollar liquidity shock.”

Such a crunch would further haemorrhage an international financial system that is already suffering from a global economic slowdown. Chinese hopes for a post-trade war boom have been hampered by the coronavirus epidemic while the eurozone repeatedly reports subpar growth.

Indeed, the two largest economies on Earth have both experienced liquidity crises of a more domestic nature in recent months. The Federal Reserve Bank of New York has injected hundreds of billions of liquidity into the repo market in the past six months to avoid a liquidity crunch and to ensure that between $2trn and $4trn of debt continues to be financed every day.

Meanwhile the People’s Bank of China (PBOC) freed up $115bn in liquidity with cuts in Chinese banks’ required reserve ratio (RRR) in the run up to the lunar new year. A month later the PBoC injected a further $174bn in a single day in a vainglorious effort to stem the losses incurred by the coronavirus epidemic.

Such liquidity crises would pale in significance to what the potential crunch feared in the report. The authors, who include former officials at the Bank of International Settlements (BIS) and the World Bank, urged: “Failure to counter promptly a dollar liquidity squeeze in the next downturn (and offset the associated shortage of safe assets) could aggravate recession and leave the financial system weaker.”

FURTHER READING: PBOC 1.2tr yuan injection fails to stop losses

FURTHER READING: Hedge funds exacerbated the recent repo crisis

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