New Risks and Uncertainties Threaten an Evolving Global Financial Safety Net

Since the 2008/2009 financial crisis, the nature of how the world protects itself from financial and economic risk has changed due to the rise of a new player: Regional Financial Arrangements (RFAs). As a result, in recent years the Global Financial Safety Net (GFSN), or the series of interconnected financial arrangements that provide financial support in a crisis, has expanded and fragmented. Now, the GFSN may be at risk for even further change.

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According to the IMF’s April 2017 Global Financial Stability report there has been a rise in political and policy uncertainty, particularly in the United States and Europe. This uncertainty is caused by the rising tide of populism and anti-globalization; and it could trigger further fragmentation and regionalization of the GFSN as countries try to mitigate this policy risk. By analyzing the past rise of RFAs, we can predict what might happen to the GFSN in response to this recent increase in global uncertainty.

Traditionally, the GFSN has relied on two main sources of financial stability: the IMF, which acts as the lender of last resort for countries in need of assistance, and the U.S. Federal Reserve, which uses central bank swap lines to assist many governments with solvency problems. RFAs are regional emergency financial reserves and provide direct competition to the U.S. Federal Reserve and the IMF. Two notable examples are the Chiang Mai Initiative Multilateralization (CMIM), which was established 2010 by a conglomerate of Asian countries, and the BRICS Contingent Reserve Arrangement (CRA), established in 2015 by Brazil, Russia, India, China, and South Africa. The nine largest RFAs have a total of $1,172.3 billion in resources, more than the IMF.

One of the major motivations for the establishment of RFAs has been U.S. dominance in the GFSN. The U.S. Federal Reserve’s traditional role as the largest provider of central bank swap lines leads to unpredictable access for many countries. The United States can, and does, establish credit lines only with countries it chooses, often giving preference to western and developed economies. Furthermore, the United Sates’ large voting share in the IMF gives it the ability to exert great influence over the organization: Congress was able to delay the new IMF quotas proposed in 2010 for 5 years. By establishing RFAs, emerging economies such as China, India, and Brazil can have predictable and reliable access to assistance and can minimize U.S. influence over their ability to access financial reserves.

Now, the Trump Administration is using its economic influence to pursue its protectionist policy. At the IMF and World Bank Spring Meetings in DC on April 20th U.S. Treasury Secretary Steven Mnuchin stated that the United States would pursue reciprocal tariffs. Soon after, the Trump administration also persuaded the IMF to drop its anti-protectionist trade pledge. As the United States continues to use its influence over the IMF to pursue anti-globalization goals, emerging economies are likely to continue to consolidate resources regionally through RFAs.

Another major motivation for the rise in RFAs has been dissatisfaction with the IMF. The European Stability Mechanism (ESM) is the world’s largest RFA with a lending capacity of EUR 500 billion. The ESM, established by Eurozone countries in 2012 in response to dissatisfaction with how the Greek debt crisis was handled, helped to solve many of the governance and quality issues that faced the IMF, ECB, and European Commission; and it consolidated Eurozone resources to provide independent financial emergency reserves.

The Brexit vote and the rise of populist parties in various European elections recently demonstrates a rise in the opposition towards political and economic integration of the European Union, including the ESM. But despite this growing opposition, there have been high level talks among top E.U. policymakers about whether the ESM could be further regionalized and consolidated into a fully-fledged European Monetary Fund (EMF). As past dissatisfaction with the IMF led to the ESM, it is possible that current dissatisfaction with the European Union could lead to a breakdown of the ESM. With such polarized opinions on either side, however, it is uncertain whether the ESM will increase or reduce its influence.

While we can use past causes of RFAs to anticipate that the GFSN might continue to regionalize, we cannot predict how the net will handle the risks it faces. In March of last year, the IMF released a paper assessing the GFSN’s health. It asserts that the system has become too fragmented, costly, provides uneven coverage, and could lead to a dilution of IMF lending standards. Fortunately, there is some evidence of cooperation between the regional and the global to mitigate these risks. Some RFAs have embedded IMF links, which strengthen cooperation between the two entities. For example, the CMIM and the IMF must co-develop economic plans, as the CMIM requires an IMF linked arrangement for withdrawals of more than 30% of a country’s contributions. In addition, both the Trump administration and other populist leaders, although forceful in speech, have maintained working relationships with the IMF.

Until the system is tested in a crisis, we can only theorize whether this cooperation will be enough to mitigate the risks that regionalism and today’s political and economic climate pose to a fragmented and continually changing GFSN. It is imperative that all players–the IMF, U.S. Government, and RFAs–work to create a financial safety net with cohesive, fair, and accessible coverage.

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