The Progressive Response - IMF Bailouts

[Robert Weissman <rob@essential.org>]

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The Progressive Response   3 April 1998   Vol. 2, No. 10
Editor: Tom Barry
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I Updates and Out-Takes

*** IMF BAILOUTS AND GLOBAL FINANCIAL FLOWS ***

The Clinton administration’s funding request for the IMF has come under
criticism from a handful of congressional liberals, a coalition of DC
progressive advocacy groups—including Public Citizen—who insist on
attaching labor and environmental provisions to IMF lending, free-market
conservatives, and populist Republicans who rail at machinations of the
“East Coast foreign policy establishment.” Its approval by the House has
also faced a campaign by social conservatives who want to attach an
anti-abortion measure to the foreign aid bill. The administration, however,
has managed to build strong bipartisan support for IMF funding around a
traditional liberal internationalist agenda that calls for continuing U.S.
support for financial institutions that spread and enforce the global
capitalist order.

In the new FPIF policy brief IMF Bailouts and Global Financial Flows, David
Felix of Washington University in St. Louis calls for policymakers and
citizen groups to broaden the debate to consideration of substantial
reforms in IMF policy along with other measures designed to reduce foreign
exchange turnover.
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The International Monetary Fund (IMF) is the central agency for enforcing
the Bretton Woods Articles of Agreement, whose terms serve as its charter.
The objective of the agreement, which was reached by the major capitalist
powers toward the end of World War II, was to establish a postwar economic
order in which international trade and investment as well as stable,
convertible exchange rates would not conflict with high employment,
progressive taxation, and other components of welfare capitalism.
Controlling international capital flows was judged essential for this
entire set of goals to be mutually attainable. Hence, Article VI requires
the IMF to deny emergency credits if used “to meet a large or sustained
outflow of capital,” authorizes members “to exercise such controls as are
necessary to regulate international capital movements,” and mandates the
IMF to ask for such controls.

In practice, the IMF has neither requested such controls nor suspended
credits when they were used to finance capital flight. During the first
three post-war decades, however, its importance as an emergency lender was
subordinated to cold war-motivated official grants and credits in the 1950s
and 1960s, and (as “foreign aid fatigue” set in) to commercial bank lending
to assorted third world countries in the 1970s. Since then, the U.S. has
found the IMF increasingly useful for handling third world debt crises and
for opening third world commodity and asset markets to foreign capital.
>From minor lender of last resort, the IMF has become the enforcer of
foreign debt service and a promoter of integrating developing countries
into the G-7 financial markets. 

In pursuing these functions, the IMF has made capital controls a major
target of attack, moving from neglect to active violation of Article VI.
This pursuit has augmented the policy changes that the IMF routinely
demands of countries seeking its credits. Prior to the 1980s the IMF’s
primary intent was to relieve foreign exchange crises at moderate
socioeconomic cost to the supplicant economies. As such, the fund insisted
on combinations of monetary-fiscal tightening and devaluation but left
capital controls largely untouched. After 1980, however, the goal became to
resolve these crises by attracting private capital. Thus, measures that cut
deeply into the structures of the supplicant economies and increased their
adjustment costs were added to the IMF’s policy demands. 

Supplicant countries are now forced to ease capital controls and rely
instead on higher interest rates to halt capital outflows and attract
inflows. Often these moves have generated massive bankruptcies, a systemic
banking crisis, and a credit crunch that has depressed domestic output and
employment. To attract equity investment, supplicants are expected to
privatize state assets, reduce social expenditures, and repeal laws
protecting employment or privileging domestic over foreign firms. One
component of the operational crisis enveloping the IMF is an increasing
resistance to the augmented hardships the fund imposes and to IMF meddling
in politically sensitive areas. 

Debt relief has also hardened. When official loans constituted most of
third world debt, the IMF could ease debt servicing by persuading official
creditors to stretch out repayments. But leaning similarly on private
lenders deters new lending, undermining the goal of advancing global
financial integration. Protecting debt service has thus become de rigeur
for the IMF, and to pacify panicky creditors the fund has even required
supplicant governments to sign retroactive rewrites of private debt
contracts. During its 1995 crisis, for example, Mexico was forced to
transform tesebonos (government notes payable in pesos at a price indexed
to the peso/dollar exchange rate) into U.S. dollar payments. 

In compensation for its hard-line policy on debt servicing, the IMF has
been expanding its emergency credits. But as currency-cum-banking crises
have become more frequent, a second component of the IMF’s operational
crisis has emerged—legislative resistance in creditor countries to the
rising fiscal burden of replenishing IMF coffers and providing supplemental
loans. The Mexican bailout, for example, dwarfed previous bailouts, and the
Asian bailouts are nearly triple the Mexican totals.

A third component of the IMF’s operational crisis is a growing awareness
that the fund lacks workable remedies. Typically, third world debt crises
catch the IMF unaware. It then reacts with assessments that demand drastic
measures only of the stricken countries, not of the lenders or of the
international financial markets governing their behavior. The remedies
notwithstanding, new crises erupt, followed by revised one-sided
assessments and corrective measures, and then more crises.

Problems With Current U.S. Policy

The IMF’s operational crisis reflects a major flaw in its basic policy
line. But since the U.S. sets the essential policy line of the Bretton
Woods institutions and cuts them little slack, the IMF’s crisis is a U.S.
policy crisis. 

The IMF’s current policy line stands the original Bretton Woods position on
its head, contending that free international capital mobility advances
(rather than undermines) the basic Bretton Woods goals. The claim is that
by globally integrating financial markets, capital flows reduce the cost of
capital and bring about both an international converging of real interest
rates and a more accurate pricing of capital assets. This should raise the
global rate of investment and improve its efficient allocation. By
rewarding “sound” policies with capital inflows and punishing “unsound”
ones with capital outflows, the globalized financial markets should also
improve domestic policymaking. All this should raise productivity and
global output—most dramatically in the capital-short, technology-dependent
third world, where the return on investment should be highest. Thus, the
increased socioeconomic costs to debtor nations of IMF stipulations merely
prescribe short-term pain for greater long-term gain.

But this claim is an assertion with negligible support from economic theory
and is refuted by the actual trends since the 1970s. Removing capital
controls has opened the gates to an accelerating volume of financial flows.
This has been paralleled, however, by slackened growth of investment,
savings, output, trade volume, and productivity in both the third world and
the OECD countries, with the main exceptions—the East Asian “ miracle”
economies—now joining the pack.

The explosive growth of cross-currency financial flows has also been
paralleled by increasing volatility of both nominal and real exchange rates
and by sharply rising real interest rates. This identifies one of the
causal links between increased capital mobility and its attendant growth
slowdown. Higher volatility raises the risks of investing long-term, while
higher real interest rates boost the cost of capital. Each deters long-term
investment. Thus, private investment has been tilted toward projects with
short-term payoffs, which contribute less to productivity growth than did
the long-term investments dominating the less-volatile Bretton Woods
decades. An extreme example is the upsurge since the 1980s of investments
in mergers, acquisitions, and exchange and interest rate speculation, none
of which adds to productive capacity. 

The surging financial flows have been predominately short-term. Over 80% of
global foreign exchange (Forex) turnover—which exceeded $300 trillion in
1995 compared to only $4.6 trillion in 1977—involves round trips of a week
or less. About 5% of Forex turnover is used to finance trade in commodities
and nonfinancial services, compared to around 30% in the 1970s. Most of the
rest reflects purely financial transactions: to exploit discrepancies
between intercountry interest rate differences and corresponding exchange
rate differences, to capitalize on movements of bonds and equities in
different markets, and to speculate on exchange rate variations. The
short-term focus of these flows makes them highly skittish. Hence, as their
volume has increased, so have the frequency and disastrous effects of these
sudden capital inflows and outflows. Since 1980, one-fourth of the IMF
member countries have suffered major currency-cum-banking crises, usually
with adverse economic repercussions on other members. 

The architects of the Bretton Woods Agreement had contended that the
dynamics of unregulated international financial markets tend inexorably to
the dominance of short-term speculation and increasing financial
instability. They therefore built into the agreement controls on
international capital movements as well as a lender-of-last-resort
facility. By contrast, the present policy line views hot money surges as
the financial markets’ mode of purging countries of  “unsound” economic
policies and practices. In the midst of the current Asian crisis,
Washington and the IMF are still pressing for the replacement of Article VI
with the prescription that the IMF require its members to commit to the
complete elimination of capital controls. 

The increasing frequency and severity of the crises, however, and the
chronic failure of the IMF to identify “unsound” policies before these
crises hit—or to devise sets of “sound” policies that ensure against new
crises—are eroding the current Washington-IMF policy line of credibility
even in conservative circles. Reflecting on the current Asian collapse,
Alan Greenspan observed that “excessive leverage” and short-term bank
lending “may turn out to be the Achilles heel of an international financial
system that is subject to wide variations in financial confidence.” 

Further evidence of fragility is the rising share of GDP generated by
finance, insurance, and real estate (FIRE)—activities that facilitate asset
trading and the transfer of risk. Until the mid-1970s the rising FIRE/GDP
ratio in each G-7 country was accompanied by a faster output growth of
goods and nonfinancial services. Since then, however, the relationship
between rising FIRE/GDP ratios and economic growth has turned negative,
implying that the liberalized international financial system has been
crowding out the production of goods and nonfinancial services. 

Even more troubling is the rise of the real interest rate on G-7 high-grade
bonds to twice the real GDP growth rate of G-7 countries. Reinforced by
increased debt leveraging, the holders of financial assets—largely members
of the wealthiest 10% of G-7 households—have (since 1980) garnered a rising
share of national income. Over the past 115 years, only the two interwar
decades exhibited such a high real interest/GDP ratio, partly  because real
GDP collapsed in the deflationary 1930s.

Toward a New Foreign Policy

The Clinton administration’s request that Congress replenish IMF coffers
with another $18 billion is evoking criticism—most vehemently from free
market conservatives—that IMF interventions have catalyzed financial
instability. The IMF bailouts, they charge, have primarily aided
international bankers and speculators, who are thereby encouraged to engage
in still riskier forays. The 1995 Mexican bailout sowed the seeds of the
current Asian crises. Without IMF interventions, these critics say,
financial markets self-adjust more smoothly, while still effectively
disciplining national policies. Rather than granting the IMF more funds,
Congress should vote to abolish it. 

There is merit to their criticism of the bailouts, though not to their
solution. Forcing speculators (and the institutions that bankroll them) to
absorb more of the losses when crises hit would lower the speculative
fever. But replacing the IMF with a free-marketer’s pipe dream—a fully
self-adjusting global financial market—is a sure recipe for recreating
1930s-style chaos. The IMF needs substantial reforming, not elimination. 

Congressional liberals, on the other hand, condition their support for the
$18 billion measure on the inclusion of language requiring the IMF to
protect labor rights and environmental integrity in the borrower nations.
Such a sop is no more likely to advance such worthy goals than have similar
provisions in the NAFTA treaty. Instead, IMF critics should parlay their
current opportunity, created by the Asian and IMF crises, into an effective
effort to curb the power of the international financial system to disrupt
trade and production and (by quick capital flight) to torpedo full
employment and social welfare programs with their more delayed payoff
periods. 

For over a decade, the G-7 has been trying unsuccessfully to curb
exchange-rate volatility and misalignments by setting upper and lower
bounds to exchange-rate movements, and by buying and selling foreign
exchange to keep the rates within those bounds. These efforts have failed
because the globalized financial markets can overwhelm the official Forex
reserves that central banks stockpile in order to contain market movements.
Global official reserves in 1977 totaled nearly 17 days of global Forex
turnover. Yet despite a quadrupling of global official reserves in the
interim, they totaled less than one day of Forex global turnover by 1995.
Limiting exchange-rate variance requires curtailing Forex turnover, which
requires curbing the short-term speculative flows that largely account for
its rapid expansion. Stabilizing exchange rates would advance a
full-employment objective, and curbing hot money flows would undermine the
power that financial markets wield to impede egalitarian reforms. 

Nobel Laureate James Tobin’s proposal to impose a small, globally uniform
tax on all Forex transactions offers a relatively efficient, market
friendly way of advancing both objectives. The tax would reduce Forex
turnover by squeezing the net profits from large-volume, rapid-turnover
activities (such as exploiting interest rate differences across currencies
and speculating in exchange rates) while leaving returns from long-term
capital infusion (such as foreign trade and direct investment) relatively
untouched. Exploratory estimates suggest that a global 0.25% tax could cut
Forex turnover by up to 50% while generating annual tax revenues of $200 to
$300 billion. Both developments would substantially strengthen the power of
the G-7 to confine exchange rate movements.

Such a tax would also reduce the power that financial markets wield (by
threatening capital flight) to coerce domestic policies. For example, a
0.25% tax rate would allow country A’s interest rate on 30-day notes to
diverge from B’s by an additional 6% before triggering arbitrage flows.
This leeway, plus the tax revenues generated, would augment the economic
feasibility of socioeconomic reforms, which yield mainly long-term payoffs. 

To date, the G-7 has avoided the Tobin proposal and discouraged public
debate over its merits. The U.S. suppressed an attempt in 1996 by the UN
Development Program to circulate a volume of expert papers on the Tobin
Tax, pursuing, instead, its campaign to abolish Article VI of the Bretton
Woods Agreement. Policymakers and concerned citizen groups should insist on
the following conditions for supporting any new IMF funding: (1) Article VI
should be preserved and enforced, (2) future IMF bailouts should equally
penalize both lenders and borrowers, and (3) the Tobin Tax should be placed
on the G-7 agenda.

Sources for More Information

Friends of the Earth
Email: foe@foe.org
Website: http://www.foe.org

50 Years is Enough: U.S. Network for Global Economic Justice
Email: 50years@igc.apc.org

New School for Social Research, Center for Economic Policy Analysis
Email: cepa@newschool.edu
Website: http://www.newschool.edu/cepa

Center of Concern: Rethinking Bretton Woods Project
Email: coc@igc.apc.org
Website: http://www.coc.org/coc

Public Citizen 
Email: public_citizen@citizen.org
Website: http://www.citizen.org/pctrade/tradehome.html

Halifax Initiative
(for information on Tobin Tax)
Email: rjr@web.net
Website: www.sierra.ca.national.halifax

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