GLOBAL ECONOMICS
David Husband
Drain the Fund? The IMF at a Crossroads
April 20, 2015
The International Monetary Fund is a sham – bailing out banks in creditor countries, such as Germany, at the expense of taxpayers in countries in trouble. The plight of Greece is ample evidence. The €246 billion lent to Greece since 2009 by the troika (the IMF, the European Central Bank and the European Commission) has been little more than a thinly disguised bailout of German and other European banks. They had loaded up on sovereign debt – including that of Greece – and could have experienced substantial losses if debtor countries had systematically begun to default on their repayment schedules. Citing this unsubstantiated possibility, the IMF made an emergency loan of a €30 billion to Greece and in doing so broke a 2003 agreement barring it from lending funds to countries with unsustainable debt obligations.
So as to put a stop to the bailout mentality that had so characterized the IMF durivng the financial crises of the 1990s, debtor countries and their creditors were to restructure and write down debt to a sustainable level before the IMF would give them any new loans. The initial €30 billion loan to Greece, followed by much more, side-stepped this rule. As concluded by Professor John Taylor of Stanford University, and former Under Secretary of the Treasury, the US Congress has been right not to endorse the IMF quota and voting revisions agreed upon in 2010 by the G-20 countries. Why agree to double IMF’s lending power when it so clearly has violated the governing rules and limits? Why increase the IMF’s financial resources if it uses these resources to make loans that “effectively bail out creditors, raise the debt burden on a country's citizens --- and increase risk-taking”. If saving banks in Germany and elsewhere in Europe was the real objective of the troika loans to Greece, it would have been more sensible to combine a substantial “haircut” for bond holders with direct support to the banks – as was done in the US during the financial crisis. Instead, the troika loans have facilitated a massive transfer of Greek debt from foreign banks to foreign governments and organizations (the EC, ECB and IMF), putting taxpayers in creditor countries at risk of ultimately having to pick up the tab.
In response, Chancellor Merkel and her finance team have been adamant – Greece, your government borrowed outrageously, pay up. And not only do so but reform yourselves following our model of fiscal discipline and competitiveness. The same message – basically – had been made to Ireland, Spain, Portugal and others, even though the fundamentals were very different. In a recent editorial in the New York Times, Germany’s unflinching Finance Minister, Wolfgang Schauble, glossed over the differences and summed up the euro crisis as a confidence issue – rooted in structural shortcomings. To rebuild trust in the debtor countries, Germany has “consistently advocated structural reforms and reducing public debt without throttling growth”. Contrary to the Finance Minister’s view that Germany has been an enlightened leader, the ‘medicine’ has been toxic. Most unfortunately, the IMF has been party to this folly, only belatedly admitting to serious errors in judging the economic consequences.
The IMF has failed to be the wise counsel in a tangled web of interlocking financial interests and serious errors in economic policy. Most fundamentally, it has failed to fairly arbitrate blame for the euro crisis among the creditor and debtor players. Surely the German and other banks that lent so much to Greece, Ireland, Spain, Portugal and other countries share responsibility for the euro crisis. After all, it was their lax lending practices that facilitated excessive borrowing by debtor countries. Why should the lenders be protected – in effect – by an international agency? IMF interventions following the 2008 financial crisis, ostensibly in support of Greece, Ireland, Portugal and other countries have in reality been rescue missions on behalf of the international financial community. The creditor banks and bond holders have been protected from the harsh rub of the market.
The €246 billion extended to Greece, some 175 billion of which is from the IMF, is not for government largess in Greece – as seems to be the perception in Northern Europe. While Greece has fallen short of the severe austerity measures and reforms dictated by the troika, it has slashed wages and pensions by some 25%. As a result of fiscal compression, Greece is now running a primary budget surplus (before interest payments). Rather than supporting the unsupportable, more than 85% of the money extended by the troika has channelled back to the banks that lent so imprudently to Greece. The risk to banks of buying sovereign-backed bonds of debtor countries, lured by the higher yields, has been offset by the IMF and other members of the troika. In the process, the IMF has contributed to a serious moral hazard problem; creditor banks and shadow banks are encouraged to take on more risk than market prudence would dictate.
Where was the IMF when the Greek government and the European banks were in effect running a giant self-destructive Ponzi scheme? The ECB apparently led the banks down the yellow-brick road by treating holdings of government bonds from anywhere in the euro zone as risk free assets for regulatory purposes. The credit agencies, in turn, overlooked the different risk factors and rated government debt almost equally, allowing Greece to borrow at rates not much different from those of Germany or other fiscally sound countries. But the IMF should have been knowledgeable enough to blow the whistle on this unsustainable practice.
And why would the IMF, supposedly the world’s foremost macroeconomic manager, impose – together with the other troika members – an unsustainable austerity program on Greece, resulting in a 27% loss in GDP and unemployment rates to match? Surely – contrary to views of Finance Minister Schauble – the dismal science of economics is not so dismal as to continue to preach severe austerity while the economy crashes and the debt to GDP ratio soars – a logical consequence when GDP drops so precipitously.
The IMF has a long history of messing up. The 1997-98 Asian financial crisis stemmed in large part from misguided pressure by the IMF and World Bank on Thailand and other countries in the region to open up their banking sectors to foreign financial markets. Overlooked was the need for strong regulatory oversight. When the Thai baht collapsed as a result of unsustainable US dollar denominated debt obligations, Thailand received a $17 billion loan from the IMF that promptly went to western banks and other holders of Thai debt instruments. Of course, this meant transferring ultimate repayment to Thai taxpayers. To add insult to injury, the Thai government was instructed by the IMF to run a budgetary surplus in the midst of a crashing economy.
The 1997-98 Asian financial crisis embroiled South Korea, Indonesia and other countries that had bowed to the IMF mantra of open capital markets. The scars have been long and deep, so much so that many Asian countries have vowed never again to be at the mercy of the IMF. This has exacerbated a global savings glut, with developing countries as net savers. As observed by Ben Bernanke, the former Federal Reserve Chairman, Asia’s massive savings and build-up of foreign exchange reserves has been at the expense of consumption. Rather than buying goods from developed countries, developing countries have been buying foreign securities, such as US Treasury bonds. According to Bernanke, the imbalance between consumption and savings in Asia is an important reason for high unemployment, low wages and slow growth in America and Europe.
In light of the experience to date, surely it is time to re-consider the role of the IMF. The Battle of Bretton Woods by Benn Steil provides a thorough account of the American agenda in 1944 in ramming through founding principles for the IMF – notably exchange rate stability and the US dollar as the international reserve currency and medium for international trade. The now disgraced chief architect, Harry Dexter White, Assistant Secretary of the US Treasury, saw the IMF as an instrument of US world economic dominance; debtor countries running short of foreign exchange reserves (i.e., US dollars) would, in order to qualify for bridge financing, be obliged to comply with the IMF’s (Washington’s) prescriptions for corrective fiscal and monetary policies. In this manner, debtor countries would be dissuaded from engaging in competitive exchange rate devaluations, which had been so disruptive of trade during the Great Depression.
In contrast to the US position, the legendary John Maynard Keynes proposed a Clearing Union, a new international reserve currency and penalties against countries that run consistent balance of payments surpluses – thereby amassing huge reserves as China has done and Germany is now doing. In short, Lord Keynes envisioned discipline on the part of both creditor and debtor countries. Despite the wisdom of Keynes’ proposals, the US outmanoeuvred objections to its self-serving position, holding, as it did at the time, massive gold reserves and economic mastery over its war-torn allies. The UK, in particular, was near bankruptcy and beholden to the US for continued credit support.
It didn’t take long before the IMF’s founding principles were openly violated by its member countries. Economic turmoil following the Second World War necessarily included major currency realignments, making a mockery of the IMF principle of stable exchange rates. In 1949, Britain gave the IMF only twenty-four hour notice of its 30% devaluation; another 23 countries followed shortly after. And even the much vaunted American dollar succumbed to sharp depreciation in 1973, when President Nixon abandoned the gold exchange standard.
Currency depreciation, indeed, continues to be very much in vogue, as a way of boosting exports and stimulating economic growth. The yen has depreciated 35% against the dollar since 2012 and the euro has depreciated 25% against the dollar since 2014. Even the staid Bank of Canada recently introduced an interest rate cut that sent the Canadian dollar to new lows. So much for exchange rate stability. As noted by Raghuran Rajan, the former IMF chief economist and now the Central Bank Governor of India, we are in the midst of a currency war.
Of course, the euro provides a stable exchange rate for trade and capital movements among the 18 EU member countries that have adopted it as their currency. While the IMF has been a strong advocate of the euro, it is increasingly obvious that monetary union for such a widely disparate set of economies is unworkable and undesirable. In effect, Germany benefits from an artificially low exchange rate (relative to what the deutschmark would have been), while Spain, Portugal, Italy and other countries see their less competitive positions further undermined by an artificially high exchange rate. This is disastrously so in the case of Greece; had it retained the drachma as its currency, deep depreciation would have spurred exports – including its all-important tourism industry.
Hence the temptation for “Grexit”, or Greek exit from the euro. This may be inevitable, given the troika’s – especially Germany’s – hard line on Greece sticking to the proscribed severe austerity, radical reforms and unrealistic repayment schedule. The Roger Bootie/Capital Economics exit plan may have to become operational – including writing-off a large portion of Greece’s external debt and dual use of the euro and reintroduction of the drachma. While the EU appears to have become sanguine about the possibility and likelihood of Grexit, the blow to unity could be serious. UBS economists have warned that real risk would come from bank runs in other highly indebted countries. The rise of Eurosceptic parties in the UK, Germany, and France is symbolic of disillusionment with the EU construct. And the overarching role of the IMF would appear to have contributed to the disillusionment.
Prior to the 2008 financial crisis, the IMF had shrunk in importance and some analysts saw the IMF as largely irrelevant; the developing countries were avoiding drawing on the Fund and developed countries paid little attention to IMF surveillance. The 2008 international financial crisis has given the IMF a new lease of life. Despite its chequered performance, including its failure to foresee either the 2008 international financial crisis or the euro crisis, the IMF portrays itself as the guardian of world financial and monetary conditions, helping member countries bridge balance of payments problems and providing technical assistance and advisory services. These roles sound constructive and no doubt there are many instances where IMF assistance has been critical. But a moral hazard problem hangs over the IMF. What lessons does the financial community draw from the IMF loans to Greece? Having broken the 2003 rule – no loans to countries with unsustainable debt – how many other debt-submerged countries might be supported in the name of avoiding “high risk of international systemic spillover”?
It could be argued that the IMF loans to Greece mark an exceptional case, at the behest of the EU which holds 30% of the voting power. However, some analysts see the recent IMF lending to European countries as evidence of systemic bias in favour of developed countries with strong political ties with the IMF’s largest shareholders. Further, developing countries with strong ties to the G-7 members appear to have easier access to IMF credit, and on more lenient terms. Not surprisingly, IMF governance is subject to political pressures. Leaving the equivalent of almost one trillion in US dollars to be allocated by the IMF, unchecked by the 2003 rule, is a moral hazard problem rite large.
The Financial Stability Board – an international body of financial regulators – has been deputized to reform the international financial system. The task is daunting. Huge capital flows around the world continue to be essentially unchecked, destabilizing an already unstable world economy. China, with its four trillion in US dollar reserves built up over three decades of mercantilist practices, is now side-stepping the IMF and World Bank. It is promoting competitive international financial agencies, notably the Asian Infrastructure Investment Bank, the New Development (BRICs) Bank and the Chiang Mai Initiative (a regional currency swap facility designed as a substitute to the IMF).
China should be applauded for its financial initiatives, not shunned as the US has unsuccessfully endeavoured to do. The US is blamed for the Chinese initiatives on the grounds that it has yet to endorse reforms of the IMF and World Bank leading to stronger voting rights for China and other emerging middle-income countries. As noted earlier, the US Congress is right to veto the reforms until the IMF is subject to tighter rules of governance. Whether the Financial Stability Board is the appropriate body to cast judgement on such issues is debatable. After all, that is simply asking the financial community to redesign itself. Given that the financial community is held in such low esteem, a more broadly representative assembly of community interests would seem warranted. Perhaps it is time for a sequel to the Bretton Woods Conference, possibly leading to a more decentralized, competitive system of international financial regulators and development banks.