Balancing Act

So, having, like Britain after the war, lost an empire and failed to find a role, the International Monetary Fund is going to sort out the imbalances in the world economy.

It will do this by practising "multilateral surveillance" of economic policies and banging countries' heads together. Or not, as the case may be.

Journalists were so excited that something happened, or nearly happened, at the spring meetings of the IMF and Group of Seven finance ministers that they painted a very exciting picture of events and implications. In this they may have been encouraged by officials, such as the managing director of the IMF, Roderigo Rato, and others, who have been calling for a more "relevant" role for the Fund.

Why, the spirit of John Maynard Keynes, in the 60th anniversary year of his death was even conjured up to justify the historic significance of what is supposed to be going on.

Before examining the prospects further, however, we ought just to note some of the rewriting of history that accompanied these reports.

First, it should be noted that, unless you count the United Kingdon as a developing country, the IMF did not suddenly turn into a lender of last resort for developing nations when the Bretton Woods fixed exchange rate system broke up in 1971-73.

The IMF was still playing its traditional role of tiding over advanced industrial countries with temporary balance of payments difficulties as late as 1976, when the Labour government under James Callaghan resorted in humiliating circumstances to the Fund.

The IMF's role in assisting developing countries came to the fore in the 1980s, after the fashionable 1970s policy of "recycling petrodollars" to what were then known as LDCs ( less developed countries) led to a huge, and prolonged, international debt crisis - the big theme of the annual meeting of the IMF in Toronto in 1982.

But it is true that the UK was the last major industrial country to borrow from the IMF, and that for some three decades now the IMF has not been exercising its traditional role of policing the international payments system.

Like many another institution - for example, the Bank for International Settlements, set up to handle German reparations between the wars - the IMF bureaucracy gradually adapted to a new role.

More recently, however, with private capital flows dwarfing its own funds, and not even a handful of serious borrowers, the IMF has reduced people such as the Bank of England governor, Mervyn King, to ask : "What is the IMF for?". It is not as if there is not a problem for it to address. When the world moved from a system of fixed ( but adjustable) exchange rates to a floating regime, the extreme free market brigade seriously argued that, because the markets knew best, exchange rates would find their own level. They most certainly did. But it was not necessarily an appropriate level, as the current controversy over the Chinese exchange rate regime signifies. The gyrations of major exchange rates in recent years have been out of proportion to what can conceivably be justified by what economists and politicians like to describe as "economic fundamentals".

So, the thinking behind the plans - or hopes - for a beefed up IMF is fine. The payments imbalances around the world are enormous, and potentially dangerous should the markets suddenly overreact. For example, a truly dramatic drop in the dollar, driving the euro sky high, could cause immense damage to a eurozone whose "recovery prospects" are far from assured.

The idea that the IMF should advise countries on sound economic policies is fine. But the IMF has been conducting surveillance and proferring advice for years. Such advice tends to be steadfastly ignored, even contradicted - by no less a figure than the chancellor, Gordon Brown, who happens to be chairman of the IMF's key policymaking committee ( the international monetary and financial committee).

Getting countries to change their policies for the benefit of the greater good is going to be an uphill struggle. I wish the reformers well. But I wish the reform effort had begun 20 years ago. The imbalances are so enormous that it is difficult to see how even an IMF with real clout can, if one may change the metaphor, avoid a very hard landing. · William Keegan is the Observer's senior economics commentator