22 April 2009

Rear Vision on the IMF

Reporter: The G20 Summit in London has ended with a regulatory blueprint designed to derail the worst financial crisis since the Great Depression.

Central to the plan is agreement to triple the resources available to the International Monetary Fund which in turn will help troubled economies.

Barack Obama: In a world that's more and more interconnected, we all have responsibilities to work together to solve common challenges and, although it will take time, I am confident that we will rebuild global prosperity if we act with a common sense of purpose and the optimism that the moment demands.

Keri Phillips: At the recent G20 meeting in London, world leaders agreed to put the International Monetary Fund centre stage in the battle to restore global economic health. Today on Rear Vision, we'll look at the history of the IMF, an organisation with a chequered past that has moved far beyond its original role.

David Vines is Professor of Economics, Balliol College, Oxford.

David Vines: Towards the end of the Second World War, the US and the UK and their allies were inspired by the possibility offered by John Maynard Keynes in his general theory of managing economies to avoid disaster. They had in their memory the end of the First World War which had seen a catastrophic collapse, followed ten years later by the Great Depression, and they were determined that countries should be able to manage their economies to keep full employment, and they saw that doing this might lead to balance of payments difficulties. And they wanted a world where this shadow didn't hang over them any longer.

Keri Phillips: Even as World War II continued, allied leaders were looking beyond the conflict in a belief that cooperation between nations would allow for future economic stability and growth for all. The International Monetary Fund, along with the World Bank specifically to help developing nations, was created even before the war ended. James M Boughton is the historian of the IMF.

James M. Boughton: Now then, the founding of the IMF is quite an interesting story because it was founded during World War II at a time when it was very difficult, and even dangerous for government officials to try to get together and meet in one place. But they all came together in 1944 at the what is now the very famous Bretton Woods conference in Bretton Woods, New Hampshire, up in the north-east part of the United States. And what they were trying to do, these were all finance officials from all the allied countries fighting against the axis in World War II, and what they were trying to do was to avoid the kind of conflicting policies and really destructive policies that countries had followed in the period between World War I and World War II, and that had led to the Great Depression; it had led to all kinds of policies where countries tried to get an advantage over their neighbours.

The term that was popular in the 1930s was 'Beggar thy neighbour policies', and what this meant was countries would devalue their currencies; they would cheapen their currencies relative to others, and that would make their products cheaper in foreign trade, and so that they, in the hope that they could sell more goods. And they would set up tariffs against, or other barriers, against imports from other countries. And what that led to was a lot of currency instability and it led to a drastic reduction in international trade, and that reduction in trade then led to a great increase in unemployment, reductions in output, and ultimately it was a contributing factor at least in leading to a Second World War, because the poverty and the despair that came out of the Depression led to an increase in dictatorships and other disastrous political decisions.

Keri Phillips: The primary role of the IMF would be to oversee a system of fixed exchange rates. The ultimate goal was to help countries maintain an equilibrium between imports and exports, without having to resort to devaluing their currencies to keep what they produced cheap and their workers employed.

This kind of economic discipline was difficult for the many democracies which emerged throughout the late 19th and early 20th centuries, according to James Raymond Vreeland, Associate Professor of International Relations in the Edmund A Walsh School of Foreign Service, Georgetown University.

James Raymond Vreeland: Under democracy, a government survives by keeping the population happy, and if the population recognises that they can't buy as much as they used to, consumption goes down, then they find that government not to be very popular. And so the government actually finds it very difficult to impose discipline on its population. When I've talked about discipline, I'm talking precisely about people earning less and sometimes just not having jobs. And if you have an authoritarian form of government you might be able to manage that, but under democracy, the government's going to be voted out of office and so either they should pursue populist policies or they'll be voted out, and a new populist government will come to power. And that populist government may be willing to actually burn the currency in order to maintain employment, but that's not sustainable over a long run with a fixed exchange rate. And the idea of having an IMF was to deal with temporary problems, loans to countries for 6 to 18 months and that basically as I said before, softened the blow of that adjustment period.

Keri Phillips: So the idea was that instead of devaluing their currencies, members would borrow from the IMF while they made the adjustments necessary to get a balance back between imports and exports. But almost from the very beginning, governments found it politically impossible to stick to the fixed rates.

Ben Chifley: Good morning, listeners. The Australian government has carefully considered the implications for Australian and the movement in the sterling-dollar rate. The government has decided that the rate of 125 pounds Australian to 100 pounds sterling, shall remain unchanged. Accordingly, the Australian pound will be devalued as against the United States dollar in the same proportion as sterling. The International Monetary Fund has been consulted and has agreed.

Keri Phillips: Australian prime minister Ben Chifley, announcing Australia's response to Britain's devaluing of its currency by almost a third in September, 1949. IMF members would struggle with the fixed exchange rate arrangements until they were finally abandoned in the 1970s when the US got into trouble. But there were other features of the fledgling fund that would distort its operation as well. Professor Ngaire Woods is director of the Global Economic Governance Program, University College, Oxford.

Ngaire Woods: One of the elements that they built into the IMF was that each country would be assigned a quota and that quota would reflect their weight in the global economy. So it's a very complicated formula that ostensibly represents their share of global trade and so forth, and on the basis of that quota they would be assigned certain voting rights and also a figure of how much they would have to lodge with the organisation. What's rather fun is that when you look at the formula you think it's all terribly scientific, but in fact Raymond Mikesell, the author of the formula, reveals in his memoirs that he was actually simply told by the United States and Britain, to go off into a corner and come up with whatever formula it took to ensure that the United States had a certain share of votes and that Britain had a certain smaller share of votes, and then to sort the rest.

Right from the start, the IMF had an executive board created, which would sit permanently and the executive board is five countries who had their own representative on the board, and so those representatives are not particularly independent. If the United States or Britain isn't very happy about what their executive director is doing, they can actually recall and replace them instantly. But all the other countries in the IMF are represented in groups, called constituencies and those constituencies elect a director. And why I'm going into that detail is because once they elect a director, they can't touch that director for two years. So in fact, those directors are very independent, they can do whatever they like.

The negotiations for creating the IMF took place at Bretton Woods in the United States, and the countries came up with an agreement, and for example, within that agreement was an agreement that gold would be the reserve currency, and that there would not be conditionality attached to IMF loans. But very quickly after that conference, in subsequent actions, the dollar very quickly became the reserve currency. The United States produced something it called their interpretation of the Articles of Agreement, and in their interpretation, they laid out that there would be conditionality. Right at the outset it was agreed by all countries that the IMF should safeguard its resources, it shouldn't just be wanton and profligate with its resources. What the United States then leapt upon which this definition of what it meant to safeguard the resources, and it's that that then they expanded, and has expanded further and further through the decades to imply a huge program of conditionality, so that by the 1990s countries were being asked to do 120 different very specific policy measures in return for their IMF loan. So both through formal politics, the United States ensured that in the Charter it had a veto, that the organisation would be in Washington DC, that it would have a controlling voice on senior management and staffing.

But also through this informal means of simply announcing what they understood the Articles of Agreement to mean afterwards, the United States quite quickly asserted its dominance.

Keri Phillips: You're listening to ABC Radio National. I'm Keri Phillips. Today's Rear Vision looks at the history of the International Monetary Fund, the agency designed to foster global economic co-operation and prevent global economic catastrophe.

John Maynard Keynes, the British economist behind the Bretton Woods system, had proposed an IMF of a size equal to one-half of the world's imports, enabling it to exercise a major influence on the global monetary system. But the US was not prepared to give that much power to a division of the United Nations.

Nonetheless, many countries, including Australia, did make use of this global credit union.

James Raymond Vreeland: There was this stigma attached to turning to the IMF and taking on IMF austerity conditions. These austerity conditions were supposed to get countries to follow the good policies, the policies deemed by the IMF to be the proper ones to address balance of payments problems, and the loan was supposed to soften the blow while they adjusted. So you did see from time to time, developed countries borrowing from the IMF. Australia borrowed from the IMF in 1961; around that time, so did the United States and Japan. The United Kingdom and France also borrowed from the IMF in the 1970s but those agreements already started to have much more austerity attached to them, and in the case of the British, it became quite a politically distasteful thing to do.

So developed countries started to steer away from the IMF and really cut down on borrowing from the IMF in the late 1970s, such that only Spain and Portugal, which probably we wouldn't really consider developed countries at that time, but they were the last Western European countries to borrow from the IMF in the 1980s.

Now one thing that's kind of interesting is that a lot of people are aware of the fact that the IMF shifted its operations in the 1970s, the early 1970s, when the US went off the gold standard, right? So between 1971 and 1973, you see the world shift away from the gold standard, and the IMF ceases to, over that decade, ceases to lend to the developed world.

In the meantime, however, they had already been loaning to the developing world. You have countries like South Korea that borrowed from the IMF throughout the 1960s, straight, they actually borrowed for 12 years straight; you have a country like Panama that borrowed in the 1970s and 1980s for 20 years straight; a country like Zaire, now the Democratic Republic of Congo, they borrowed for about 14 years straight. Now it's no accident that I just threw out South Korea, Panama and Zaire; these were all Cold War allies of the United States, and so there is some correlation between who borrows from the IMF and who's favoured by the United States, who is the largest shareholder of the IMF.

So what you see is sometimes the IMF is used for political purposes to prop up governments and maybe the loans go towards helping those governments survive in power, as opposed to helping soften the blow as they adjust. If they just adjusted, maybe their program would last 6 months to 18 months, but because they don't adjust, they keep needing more loans and because they're favoured or important to the United States, they keep getting those loans.

Richard Nixon: We must protect the position of the American dollar as a pillar of monetary stability around the world. In recent weeks the speculators have been waging an all-out war on the American dollar. Accordingly, I have directed the Secretary of the Treasury, to take the action necessary to defend the dollar against the speculators. I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.

Ngaire Woods: The real pivot point for the IMF came in 1969 when President Nixon announced America's first step away from the Gold Standard, which finally in 1971 he abandoned entirely. Now what that meant was the whole system the IMF had been created to oversee was smashed in one blow. It would no longer be a rule-based exchange system. By announcing that it would no longer back dollars with gold, smashed the fixed exchange rate system, floating the dollar and then all the other major currencies floated in the wake of the dollar. And that created a problem which is still with us today, which is that there is no rule-based exchange rate system, and so countries accuse each other of cheating on their exchange rates.

The reason why you could have fixed exchange rates in the 1950s and '60s, is because countries used capital control. That means they kept the windows and doors closed to foreign capital coming in and out of their systems. Investors couldn't speculate on the value of exchange rates. That's what changed in the '60s and '70s.

Keri Phillips: Once countries, especially industrialised countries, decided that market driven floating exchange rates were a more appealing alternative to the Bretton Woods system, the original raison d'etre of the IMF was gone.

Ngaire Woods: In the 1970s the IMF just seems to be an institution with no purpose, and no role; it looked completely marginal. It was no longer overseeing a fixed exchange rate system, countries weren't particularly in need of its loans, in fact in the 1970s there weren't in need of its loans because the oil price increase of '73 had created vast amounts of wealth which was in search of investment opportunities, and commercial banks took up that money and very quickly started lending it to developing countries. So in the 1970s you saw this fiesta of private lending. And because inflation was high, the real interest rate on the loans that these commercial banks were making to developing country governments, like Mexico and Argentina, were negative.

In other words, banks were going to governments and saying, 'We'll lend you money, and we'll pay you to take it', because the interest rate didn't cover the rate of inflation. Needless to say all those governments did not resist the temptation. They took out millions and millions of dollars in these loans. And the IMF was simply put into a cupboard with the door closed, and it wasn't till that great party of lending crashed and came to a halt after 1979 that the IMF was pulled out of the cupboard and pushed into centre stage.

John Arden: Tremendous efforts have been made to narrow the gap between exports and incomes. In the first six months of this year alone, Brazil had a visible trade surplus of $6 billion, but the interest payments on massive loans wiped out the benefit.

The government failed to impose austerity measures demanded of it for fear of social unrest. Two riotous days in the industrial city of Sao Paolo last April were evidence of that. But convinced that the IMF could get tough, the government has now gone ahead with new measures, and they include reducing the indexation of wages to inflation.

In the '70s, the so-called Brazil Economic Miracle saw growth rates of 10% with inflation rates of only 20% to 30%. Now growth rates are negligible and inflation is running at 127% a year. The foreign debt is $90 billion.

Ngaire Woods: In 1979, the United States Federal Reserve decided dramatically to increase its interest rate, to try to stem inflation. And that very quickly affected these massive loans that had been made to developing countries. You can picture your own mortgage: if you thought you had a mortgage which you paid no interest on and then suddenly overnight you were told that you were going to start paying 13% interest on it, which is what happened, you'd either go bankrupt or start looking distinctly unstable financially. And that's what happened to these countries.

Now that might not have been a problem for the United States and Europe if it weren't for the fact that it was their banks that were hugely over-exposed in their loans to those countries, and so it became very quickly apparent that there would be an international financial crisis unless you found a way to ensure that countries like Mexico and Venezuela and Brazil and Argentina repaid the banks their loans to stop the banks from going bust. If they had all collectively defaulted it would have brought down the international financial system.

So the IMF was wheeled out and sent in to provide loans to these countries and to require these countries to adjust. And that was the deal. On the one hand, some financing, and on the other hand some adjustment. The financing was modest, it was just enough money to ensure that for example, Mexico repaid its loans to the banks. The problem of course from the Mexican point of view was that this IMF loan came with a high interest rate of its own, in fact it wasn't bailing out the countries, it was bailing out the banks through the countries, because the loans it was making to these countries had high interest rates, and these countries became more and more indebted through the 1980s. You saw riots and social unrest immediately in these countries, because the places that governments could most easily cut back were things like food subsidies, education for the poor, health for the poor, different kinds of welfare activities, and these were the places that governments first cut back.

What's interesting about the 1980s Latin American debt crisis is that the IMF was sent into a crisis, which it actually didn't have the toolkit to deal with. The approach was premised on the idea that by taking these quite draconian adjustment policies, countries would begin to grow, but by the mid-'80s, it was clear that none of the governments that were undertaking these policies were growing, and that made their debt burden more and more unsustainable.

Keri Phillips: This is Rear Vision on ABC Radio National. I'm Keri Phillips, here with a history of the agency designed to foster global economic cooperation and prevent global economic catastrophe, the International Monetary Fund.

In the decades since the Latin American debt crisis the IMF has found itself at the centre of a continuing series of economic crises.

Ginny Stein: Thailand's financial woes started a domino reaction across South East Asia. It led to Thailand seeking a US$17.2 billion rescue package from the International Monetary Fund. In accepting the bail-out package, Thailand agreed to a number of conditions, including bringing in a budget surplus in 1998, keeping its current account deficit in check, and restructuring its financial sector.

Tarrin Nimmanahaeminda (Thai Finance Minister, 1997): We will work very closely with the IMF. We will try to make our policies, our plans, which will be transparent, concise and implementable, and hopefully creditable.

James Raymond Vreeland: Now with the East Asian financial crisis, there was a major turning point, because a lot of the policies that they imposed in the late 1990s, during the East Asia financial crisis, turned out to be the wrong ones, and exacerbated the crisis, and so many emerging market countries decided to stop borrowing from the IMF. That coupled with reasonably good economic conditions, led to very little borrowing from the IMF and the IMF actually found itself tightening its own belt. And in the early 2000s, it was the IMF going through their own austerity and trimming their own budget. A major problem for the IMF is that it actually generates its own revenue through the loans that it provides. Now because it does charge some interest on the loans, and it's the interest that actually goes towards the operations, make funding the operations of the IMF.

Now with this new financial crisis, there's going to be a new round of lending and the IMF is going to be flush once again with loan repayments, and interest repayments that will help finance them. But this leads to this strange kind of a, what you'd call a perverse incentive, that the IMF does better when there are economic crises, and yet the IMF's job is supposed to be in part to prevent these crises.

Keri Phillips: After the debacle of the Asian crisis and before the current global financial crisis the IMF appeared to be sliding into irrelevance. Although the GFC may have thrust it into the spotlight once more, world leaders will have to commit more money to keep it there.

James M. Boughton: Well the IMF has a very limited amount of money to lend, and part of the discussion that's taking place among major countries now is trying to determine the best way to make sure that the IMF does have enough money to lend. We're not like a central bank that can just create money at will; our members keep the IMF on a pretty tight leash, but by the same token, they want to make sure that the IMF does have enough resources to do its job properly.

James Raymond Vreeland: The first thing that I would point out is that the IMF is still a relatively small organisation in terms of how much money it has to lend. Now on the one hand, they have, depending on the value of the dollar on any given day, they have say roughly $250 billion that they can loan out. That's sizeable, but when you consider the size of the stimulus packages that are being put together in the developed world where we're in the magnitude of trillions of dollars, you can see that the IMF certainly isn't large enough to address any of the crises in the developed world. It's really not even big enough to address crises in the emerging market countries.

Keri Phillips: As everyone keeps telling us, we're travelling through unchartered economic waters, but whatever lies ahead, one thing is certain, the current trade imbalances are unsustainable.

David Vines: What we are seeing now is a transition in the world economy from a world led by the US to a world which will be a really multi-polar world of the US, Europe, and crucially China, India, East Asia and Latin America. And we need a financial system which is stable during the period that this transformation happens and the fund is crucial to make that possible.

Let me just explain to you: a really big circumstance in the world at the minute has been the huge growth in China through very rapid export-led growth. 10% of China's GDP is exported and less than half of China's output is consumed. It's a very extraordinary growth process.

The other side of the coin has been borrowing from the rest of the world, the US, UK, Australia too, the counterparty to the Chinese selling a lot and others borrowing in order to buy it. This can't go on forever, and a stable international system in which these international imbalances are unwound, is absolutely crucial and the Fund's maintaining that stable system is central to us not degenerating into the kind of chaos we've had the last year and the kind of problem that many of us believe will continue to apply until this adjustment of international imbalance has happened. There's a real danger of competitive scrambles for devaluation in a floating rate world, by countries in debt when they get into crisis, and the Fund and the managed international system is necessary now just like it was after the Second World War to stop such a scramble.

Ngaire Woods: I think the key problem for the IMF began first when the rule-based exchange rate system collapsed because what the United States and its partners didn't do was work out what was going to replace the old rule-based system, and they didn't use the IMF as a forum to do that. And I think that's what they're going to be having to sit down to do now.

The other crucial element for the IMF was being forced in the 1980s to become this rather draconian debt collector, rather than a forum of international co-operation, and that gave the institution habits, habits of imposing conditions on countries, rather than really listening to them. So if we look at the world economy today, it's clear that the world very much needs a forum for international monetary cooperation and that it should be a role that the IMF plays. But the play that role, the IMF has to be seen by all of its members as a neutral forum for those conversations, and as an impartial arbiter and enforcer of the rules. And that's a lot of ground that it's going to have to catch up. And the very first steps it's going to have to make to do that are going to be on the representation of countries. The world is no longer a world in which America is the largest creditor. America is now the world's largest debtor. China is the world's largest creditor, and China is going to need not just a seat at the table, but a very important seat at the table.

Keri Phillips: Ngaire Woods, Director of the Global Economic Governance Program at Oxford University.

We also heard from James Raymond Vreeland, Associate Professor of International Relations at Georgetown University; David Vines, Professor of Economics, Balliol College, Oxford, and the historian of the IMF, James M. Boughton.


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