The Wall Street Journal March 2, 1998
A Necessary Institution
The IMF acts as the strong arm of the marketplace
Remember the Trilateral Commission?Back in the 'Eighties, the international talkathon for big shots was demonized into an international conspiracy against the proper order of things. Like the Third International, the Masonic Order and the Illuminati, the Trilateral Commission served for some as the grand explanation for everything that seemed to be going wrong in the world.
Fortunately, the commission has gone out of paranoid fashion and returned to the unobtrusive status it always deserved. Unfortunately, the next bugaboo is turning out to be the International Monetary Fund. This could be more serious: Although flawed, the IMF actually is an important institution. Also, its flaws are diminishing while its importance is growing.
Fear of the fund goes back many years. As part of the Bretton Woods agreement that set up the new world financial order after World War II, the International Monetary Fund was established as a global lender of last resort. When a country and its financial institutions become so overextended that private institutions run away, the IMF runs in to dispense cash, but on severe terms. Who could like an agency like that? Does a wastrel student like the terms his parents impose for paying his debts?
The cash bothers some people: It's a bailout. Worse, it's a bailout of the international banks that lent unwisely, for projects that were unnecessary or worse. But these bailouts are no more than the international equivalent of bankruptcy. In the same way that bankruptcy is better than debtors' prison, even for lenders, so an IMF bailout is better for the taxpayers of the world than collapse in even a small profligate nation.
The IMF arrives early, when a debt crisis can be contained. In Britain and Italy in the 'Seventies, in the Latin American debt crisis of the 'Eighties, in the nations of the former Soviet Bloc, in the Asian countries of the current debt crisis, the IMF arrives when circumstance has forced governments to listen to its advice.
A Dose of Realism
It's the advice, however, that worries more and more people. The IMF usually prescribes devaluation, monetary contraction and fiscal discipline. These are the counter-agents to the overvalued currencies and other easy money policies that put its subject countries into trouble. In quick succession come high interest rates, economic contraction and high unemployment: General misery balances the former general elation.
The IMF's advice would not do for every country. Some, like the United States, are so favored by their natural and human resources, by good timing in their business cycle and by their stable political institutions that they ought to have strong currencies and low taxes. From this truth, it is easy to imagine that the IMF's advice need not be followed anywhere. It is a little more difficult to imagine that the IMF deliberately dispenses bad advice. It is harder still to imagine that international bureaucrats are deliberately impeding economic growth to make poor people suffer.
Yet such imaginings are becoming ever more popular. The notion that IMF officials advise devaluation only in order to protect their advisory jobs even finds its way onto the editorial pages of great newspapers. So does the equally loopy idea that the IMF exists to hold down wages and pollute air and water in poor countries for the benefit of rich "transnational" companies.
Starting with the Mexican crisis of 1994-95 and even more strongly in the current Asian crisis, otherwise sensible people are claiming that the cure is worse than the disease -- that devaluation, tight money and strict fiscal policies replace little problems with bigger problems.
Jack Kemp, for example, offers this: "The IMF is giving bad advice. In every instance, they say 'soften your currency, devalue it, raise taxes,' and the combination of soft money and high taxes is the problem in every country the IMF has visited. I think it [should give] the opposite advice and that Congress should not give a dollar of replenishment to the International Monetary Fund until they start giving good advice."
In fact, the typical IMF prescription is simple realism: A country in trouble must accept the consequences of its mistakes. An overvalued currency must float to its market value; the government must either stop creating money faster than the market wants it or stop hiding the dirty secret of a bulging money supply; it must stop borrowing faster than it can tax to pay debt service. This is not bad advice, this is the facts of life. If the IMF did not advise this discipline, the market would impose it in a much more painful way.
Once a crisis has reached the point where national leaders must put their old policies behind them, the IMF makes suggestions for economic reforms. Here, the organization is much improved. Where once it espoused the capital controls and nationalist socialism inspired by the British Labour Party, the IMF now pushes open markets and capital mobility with an intensity that could put many Americans to shame.
Providing Courage
In America, two symbolic issues currently dominate discussion of the International Monetary Fund. The more abstract is the IMF's opposition to a currency board in Indonesia; the more tangible is the Clinton Administration's request to Congress for an $18 billion capital contribution to the fund.
A currency board system backs every unit of suspect local money with a unit of trusted foreign currency. In Argentina, for example, every peso in circulation is matched by a dollar in the central bank. Individuals know the government can maintain that exchange to the last peso or the last dollar.
The IMF doesn't want a currency board in Indonesia. It says it believes the Indonesian government must retain monetary flexibility or see its banks collapse. But that's wrong. The Indonesian government shouldn't print money to shore up its banks; it should inspire confidence in its money and its institutions so the IMF and private investors will lend them more capital. Whether it does that with a currency board or some other mechanism ought not to be the issue.
Whatever will be believed will work. In Hong Kong, a currency board carried the credibility needed to protect the local dollar despite the general crisis and the specific uncertainty of the former colony's relationship with China. In Taiwan, solid prosperity and a heap of foreign exchange reserves were equally credible.
A currency board is just another word for courage. Or, considered another way, it is another form of the promise to peg exchange rates. Either way, a country better known for borrowing than for paying back promises to spend every last dollar of its foreign-exchange reserves defending its currency.
There's nothing wrong with courage, and there's nothing wrong with keeping promises. But money is just paper. Just as the country that promises to defend its exchange rate can abandon that promise, the country that creates a currency board can dismantle it.
Either way, markets judge each country's promises and test the resolve of any mechanisms that declare value. All currencies, even those protected by secrecy or lies, even those backed by gold, float against each other, against gold, against other commodities. An Indonesian currency board will not be more credible than any other promise extended by the Suharto family-government. IMF funding for Indonesia's bankruptcy should focus on the country's credibility, not on whether it creates a currency board.
Investing for Profit
If the IMF didn't exist, it would be necessary to invent it. Everybody wants a free lunch. Governments have a natural tendency to profligacy. Banks have a natural urge to lend and borrow and lend again, even to governments. Bust and bankruptcy follow boom and hyper-investment. The world's financial institutions cannot prevent such mishaps, but the IMF can contain them, limit the damage, teach the lessons that should be learned and move on to the next cycle.
If the world had to invent the International Monetary Fund now, it would probably be a private institution, drawing on capital invested by banks around the world and paying a nice return on investment. We would prefer a world in which it did raise private capital and gain strength from the power of markets. But while it's an instrument of governments, the U.S. should be an investor.
An odd coalition of labor, protectionists, gold bugs and environmentalists opposes more U.S. funds for the IMF, but they don't serve their country's interests.
The most important capitalist country, which is also the world's largest trading nation, should realize that the wealth of its citizens depends in large part on a world system that punishes bad policies and forces incompetent governments to improve.
Thomas G. Donlan receives E-mail at tg.donlan@news.barrons.com
Copyright © 1998 Dow Jones & Company, Inc. All Rights Reserved.
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