The IMF’s Existential Crisis
Wednesday, October 3, 2007
The global economy has changed. Can the International Monetary Fund?
In a widely anticipated move, the International Monetary Fund has announced that Dominique Strauss-Kahn, a former French finance minister and recent Socialist presidential candidate, will soon become its next managing director. But while Strauss-Kahn’s ascension may be clear, his agenda is not. Confronted by the challenges of an evolving international system, the IMF is facing an existential crisis.
Established in 1944 at the Bretton Woods Conference, the Fund was originally designed to promote international financial stability and free trade by guarding exchange rates and providing emergency loans to nation-states. It operated as an "international credit union" of sorts, in which member states contributed quotas that permitted them to borrow from the collective sum if they ran into financial trouble. If a country found itself low on foreign currencies, it could obtain a temporary loan. At a time of fixed exchange rates and a limited supply of private capital, this system seemed to make sense.
Half a century (and several financial crises) later, however, the global economy boasts well-functioning capital markets and most of the IMF’s erstwhile borrowers are in good fiscal shape. Demand has waned for the Fund’s large, heavily conditioned loans, leaving the “lender of last resort” in the unprecedented position of having too few borrowers. Critics from some of the IMF’s largest contributors, most notably the United States, have accused the Fund of neglecting its responsibility to guard exchange rates. Developing countries routinely lambaste the Fund’s “unrepresentative” leadership. And its poverty reduction initiative has come under sharp criticism as a “poorhouse program” that has done little to develop the developing world.
Borrowers have increasingly flocked to private-sector sources of liquidity, which are typically more flexible in their repayment schedules and conditionality.
So is the IMF still relevant? Experts debated that question at a recent conference hosted by the American Enterprise Institute. Over the past decade, noted AEI scholar Desmond Lachman, the Fund has very nearly run out of big borrowers. The major industrialized countries, which are able to tap the international financial markets at will, have not borrowed from the Fund since the 1980s. In recent years, most Asian countries have also steered clear of IMF loans, largely in reaction to the organization’s poor handling of the 1997 Asian financial crisis. Argentina and Brazil paid the entire $25 billion of their outstanding loans ahead of schedule in 2006, hoping to prevent the Fund from meddling in their internal affairs.
Within the developing world generally, borrowers have increasingly flocked to private-sector sources of liquidity, which are typically more flexible in their repayment schedules and conditionality. And while no one knows for certain whether a future crisis may demand some great public-sector bailout, the diversity and spread of private-sector outlets should make it unlikely.
On the surface, a lack of borrowers—especially for financial bailouts—might be considered a good thing. But the IMF’s financing model relies almost exclusively on income derived from its lending operations to meet administrative expenses, including surveillance and technical assistance. So if the Fund fails to attract more borrowers, it will eventually be unable to pay for its own operations. It currently has reserves worth about $8.8 billion, and insists it can comfortably finance budgetary shortfalls well into the next decade. But as Andrew Crockett, the president of JPMorgan Chase International and former head of the Crockett Commission (a group commissioned in 2006 to study the Fund’s revenues) pointed out, the Fund’s model is clearly unsustainable over the long haul, since member states rely increasingly on private capital flows.
There is no easy solution. If the IMF raised member quotas, that could “politicize” its work. If it invested more money on the open market, that would expose it to greater risk. It could always sell some of its gold reserves, but the U.S. Congress has refused to endorse that idea in the past. On top of these financing problems, the IMF also finds its very operations under scrutiny. Some question whether the organization possesses the legitimacy, technical expertise, and enforcement power to fulfill its original mandate—and whether it should exist at all.
It remains to be seen how an organization dependent on voluntary contributions from nation-states can guarantee compliance.
At its inception, the IMF was tasked with “promoting exchange stability” in order to “avoid competitive exchange depreciation.” But today, as Lachman noted, the Fund has remained notably silent even amidst “unprecedented global trade imbalances.” Currently, the U.S. is running a trade deficit of 6 percent of its GDP, matched by similar surpluses in several Asian nations, including China. And as U.S. Treasury Secretary Henry Paulson told Reuters in June, “Although there are plenty of currencies that aren’t market determined, there’s only one for a country that’s as big and as integrated into the global economy in terms of trade in goods and services and that’s China.”
But while critics have assailed the IMF’s failure to properly monitor international exchange rates, few have suggested a practical mechanism for enforcement. It remains to be seen how an organization dependent on voluntary contributions from nation-states can guarantee compliance, especially when it appears to be losing what was once its chief bargaining chip: the ability to offer its members emergency loans and guarantee international financial stability.
Faced with a new environment, a dysfunctional apparatus, and funding obstacles, should the IMF simply cease to exist? Experts from across the political spectrum tend to agree that despite its myriad troubles, the Fund still serves an important function. But what many believe to be a bloated bureaucracy desperately needs reform. Crockett believes it should be streamlined into a “secretariat” that provides authoritative, impartial information and a neutral forum for the facilitation (rather than the adjudication) of international financial disputes. Free markets should be allowed to sort out the rest.
Such a limited role could certainly help the IMF resolve its funding difficulties, noted Allan Meltzer, chairman of the International Financial Institution Advisory Commission. Small programs acquired over years of bureaucratic creep, including the Fund’s poverty reduction initiative, could be delegated to the World Bank, allowing the IMF to focus on its comparative advantage: providing financial information to help ensure the smooth functioning of markets.
But some critics argue that such a role may be too limited. According to Edwin Truman, a former assistant secretary at the U.S. Treasury, IMF reform should aim to make the organization a better regulator, rather than a “good friend” of its member states. The Fund must become more representative of the new global economy, said Truman, and then forcefully address those instances in which the free market has failed to function, such as the present spat over Chinese currency manipulation. But while few would oppose a more representative IMF, at least in the abstract, awkward questions remain over which country—and whose experts—would supervise the “correction” of market failures.
For while the need for IMF reform is obvious, the precise nature of that reform is not. Dominique Strauss-Kahn has his work cut out for him.
Karen Porter is a research assistant at the American Enterprise Institute and an editorial assistant at THE AMERICAN.
Image credit: photo by Eugene Salazar/IMF.
Image credit: photo by Eugene Salazar/IMF.