Fixing the IMF
Calomiris, Charles W., Meltzer, Allan H., The National Interest
The future role of the International Monetary Fund (IMF) is today in doubt. Former Treasury Secretaries George Shultz and William Simon have urged that it be closed. President Clinton wants the IMF to devote more attention to preventing crises rather than responding to them. Even the IMF criticized its own recent operations in Asia for protecting foreign lenders at great cost to borrowing countries and their citizens. Protestors in the Asian countries and elsewhere complain that the IMF is a lackey of the United States, doing the U.S. government's bidding to the detriment of local populations.
Before agreeing to provide more money for the IMF as part of the 1998 budget agreement, Congress insisted on greater transparency in decision making and higher interest rates on IMF loans. These changes are first steps toward reform of international lending institutions. Still, more fundamental reforms are needed to reduce the risks of destabilizing crises that have become more frequent and more costly. Even the losses suffered by bank depositors during the Great Depression pale by comparison to recent losses in Mexico, South America and Asia.
Five factors go a long way toward explaining why there have been so many large financial and foreign exchange crises in developing countries during the current period of sustained growth and development in the world economy: weak banks; government interference and direction of lending (part of crony capitalism); a large volume of misdirected bank lending; domestic government and IMF bailouts to protect foreign lenders and domestic oligarchs; and fixed, unsustainable exchange rates.
The proposal for reforming the IMF that we shall make in this article seeks to restore international lending while avoiding the excessive risk-taking that leads to financial bailouts and severe depressions, as in Mexico, Thailand, Indonesia, Korea and Russia. The new IMF would avoid both the problem of excessive risk-taking, followed by collapse, and the risk of a protracted reduction in capital flows to developing countries. The challenge is to reduce the costs of the present system while retaining the benefits for economic development of international lending and capital movements.
A Record of Failure
The IMF and the World Bank were created at the end of World War II to foster long-term economic growth and stability in an environment of weak international capital markets. The World Bank's role was to boost capital flows to promote long-term growth. The IMF's role was to provide short-term assistance to facilitate the maintenance of fixed exchange rates. The presumptions underlying the creation of these Bretton Woods institutions were that, first, countries would maintain fixed exchange rates tied to gold and the dollar and, second, that private international capital flows would be rather modest.
Both presumptions proved to be wrong. The fixed exchange rate system ended in 1971, when President Nixon devalued the dollar and closed the gold window. All major currencies - the dollar, yen and deutschemark - soon began a managed float. And instead of a dearth of private lending, large-scale lending to developing countries has coincided with all of the major financial crises of the past twenty years.
Why have these institutions, intended to foster growth and promote stability, failed so badly in the Eighties and Nineties? Many reasons have been offered. Two aspects of private financial arrangements are of central importance: the form of international capital flows and the structure of domestic banking systems in emerging market economies.
Under current arrangements, corporations and bankers in the developing countries borrow from financial institutions and markets abroad. The loans are made at fixed exchange rates and denominated in dollars, marks or yen, so the lender is paid in his own currency and the borrower therefore bears the full risk of devaluation. …