Don’t blame the IMF for the next global economic crisis

When the next global economic and financial market crisis occurs, fingers should not be pointed at the IMF for having been asleep at the wheel while the conditions for that crisis were building. To its credit, the IMF seems to have learned from its negligence in the run up to the 2008-2009 Great Economic Recession. This time around, it has been exercising a very useful multilateral surveillance role of its member countries’ policies by pointing to warning signs that the world is becoming increasingly vulnerable to another 2008-2009 style crisis.

One instance of the IMF sounding the alarm was in its recent Global Financial Stability Report in which it pointed to a dangerous build up in debt among the Group of 20 (G-20) countries. In particular, it drew attention to the fact that G-20 debt levels today have risen to 235 percent of GDP, which was significantly above the corresponding 210 percent of GDP level on the eve of the 2008-2009 global financial crisis. The IMF also highlighted that debt leverage ratios had now risen to new records in the household, corporate, and government sectors of those G-20 economies.

More recently, the IMF has been warning that there now appears to be an excessive use of exotic derivative instruments that contributed so greatly to the severity of the last global economic and financial market crisis. In particular, the IMF is warning that the increasing use of exotic financial products tied to equity volatility by investors, such as pension funds, is creating unknown risks that could result in a severe shock to financial markets. According to IMF estimates, assets invested in volatility targeting strategies have risen to about $500bn, with this amount increasing by more than half over the past three years.

While this time around, the IMF may not be asleep at the wheel, the same may not be said of the world’s major central banks. As recently as the end of June 2017, in a statement that is bound to come to haunt her, Federal Reserve Chair Janet Yellen blithely assured us that she does not believe there will be another financial market crisis for as long as she lives. She based her belief on the reforms that had been made to the banking system since the 2008-09 crash.

Yellen seems to be unfazed by the record global debt levels and the increased resort to exotic derivative products to which the IMF is pointing. She also seems to be relaxed about Alan Greenspan’s warning that the world is experiencing a major government bond market bubble at the same time that the world’s equity markets are currently at lofty valuations that have only been experienced three times over the past one hundred years. And she seems to be choosing to ignore the fact that most of today’s credit risk resides not in the banks, but in the very lightly regulated shadow banks, which now constitute the largest part of the US financial system.

Sadly, it is not the IMF’s Christine Lagarde, but rather it is the Fed’s Janet Yellen and the European Central Bank’s Mario Draghi who are so important in the formulation of the world’s monetary policy. It is especially to be regretted that these key monetary policymakers show little sign of recognizing the acute vulnerability to another global financial crisis that they have wrought by many years of their ultra-easy monetary policies.

Should we indeed have another global financial market crisis in the next year or two, it is to the world’s main central banks that the fingers of blame should be pointing, and not to the IMF.

Desmond Lachman is a resident fellow at the American Enterprise Institute.