Do We Really Need a Bigger IMF?
Wednesday, October 6, 2010
How the IMF increasingly exposes the global taxpayer to major sovereign debt risk.
A dangerous idea is making the rounds in Washington. It is International Monetary Fund (IMF) Managing Director Dominique Strauss-Kahn's proposal to increase the IMF's war chest by US$250 billion. If past experience is any guide, such a proposal is all too likely to only prolong the euro zone's sovereign debt crisis. And it will do so in a manner that in the end will cost the global taxpayer dearly.
Barely a year after the G-20 London Summit agreed to triple the IMF's resources to $750 billion, the IMF is now coming back for more money. Purportedly the increased resources it is requesting would be used to insulate well-managed countries from future financial crises.
The IMF's bold request for additional resources comes on the heels of its unprecedentedly large commitments to help bail out the euro zone's very troubled peripheral economies. In May 2010, the IMF granted Greece a $40 billion stand-by arrangement—a sum that, in relation to the country's economic size, exceeded by a factor of two and a half any previous IMF stand-by arrangement. A few weeks later, as part of a European financial support program, the IMF pre-committed itself to lend as much as $320 billion to Greece, Spain, Portugal, and Ireland.
Greece will pay dearly for the IMF's misguided intervention in its economy.
Before acceding to the IMF's request for more resources, the global community should be asking two hard questions of the IMF. Is the IMF playing a constructive role in the present euro-zone crisis? Or is the IMF simply helping the Europeans to kick the can forward by providing large amounts of financing to forestall the inevitable restructuring of the euro-zone periphery's sovereign debt?
In addressing those questions it is well to take a close look at the IMF's involvement in Greece, since the Greek case all too likely offers a prototype of how the IMF will respond as the sovereign debt crisis intensifies in the more important and complicated case of Spain, as well as in Ireland and Portugal.
Not wishing to countenance the idea of either debt restructuring or Greece dropping the euro, the IMF is prescribing draconian fiscal retrenchment as a cure-all to Greece's economic ills. Indeed, it is requiring Greece to implement tax hikes and public spending cuts that total as much as 10 full percentage points of GDP in 2010 alone. At the same time, the IMF is urging Greece to restore the 20 percent that it has lost in international competitiveness over the past decade through price and wage deflation.
Is the IMF simply helping the Europeans to kick the can forward?
By now, one would have thought that the IMF would have learnt from its Argentine and Latvian experiences that undertaking a Herculean-sized budget adjustment, without the benefit of a currency depreciation to boost exports, will plunge the Greek economy into a major economic recession. This will be particularly the case at a time when Greece's borrowing costs have soared, its banks are losing deposits, and labor disturbances have become the order of the day.
The basic flaw in the IMF's Greece program is that if successfully implemented it will have the unwanted effect of substantially increasing Greece's public-debt-to-GDP ratio. Since, if Greece's nominal GDP were to decline over the next few years by 20 percent, as a result of a deep recession and price deflation, Greece's public-debt-to-GDP ratio would rise towards 175 percent. It is calculations of this sort that are inducing markets to assign a 75 percent probability to a Greek sovereign restructuring within five years despite the massive IMF–European Union Greek bailout package.
The basic flaw in the IMF's Greece program is that if successfully implemented it will have the unwanted effect of substantially increasing Greece's public-debt-to-GDP ratio.
Greece will pay dearly for the IMF's misguided intervention in its economy. Over the next few years, its economy will be put through the severest of wringers while the country will be saddled with a mountain of official debt that will be difficult to restructure. Yet, in the end, it is all too probable that the country will be forced to default on its debt and to exit the euro if it is to have any chance of extricating itself from the deepest of recessions.
With the Greek example in front of us, we should now be asking whether the global taxpayer really can afford to have an even more abundantly endowed IMF repeating the same egregious mistakes it is now making in Greece in countries like Spain, Portugal, and Ireland. For it hardly seems a wise use of taxpayers' money to have the IMF use those resources to delay the necessary write down of these countries' onerous debt burdens. This would seem to be all the more the case if in the process the IMF puts these countries through unnecessary hardship by delaying the necessary restructuring of their debt, and if it increasingly exposes the global taxpayer to major sovereign debt risk.
Desmond Lachman is a resident fellow at the American Enterprise Institute.
FURTHER READING: Lachman announces “The Emerging Market’s Century,” warns that the “Greek Tragedy Could Have Multiple Acts,” and anticipates “Dipping and Deflating” in the U.S. economy. Lachman also wrote “Greek’s Threat to the Euro” and concedes that “Maybe Milton Was Right about the Euro.”
Image by Rob Green | Bergman Group.