Do We Really Need a Larger IMF?
Sunday, March 9, 2014
Several developments should cause the U.S. Treasury to reverse itself in favor of a smaller International Monetary Fund.
John Maynard Keynes famously observed, “when the facts change, I change my mind. What do you do, sir?” Evidently the same may not be said of the U.S. Treasury regarding the appropriate size of the International Monetary Fund. While the U.S. Treasury is all too ready to argue the case for a bigger IMF when circumstances appear to justify such a move, it has been reluctant to revise its assessment now that changed circumstances indicate a smaller IMF is preferable.
Immediately prior to the onset of the European sovereign debt crisis in early 2010, major IMF shareholders were considering whether the IMF’s role in the international financial system should be downsized. The IMF’s traditional clients appeared to be highly disinclined to again come under the IMF’s tutelage. Following the Asian crisis in 1998, most Asian countries moved to flexible exchange rate systems and built up substantial arsenals of international reserves with the express purpose of ensuring that they would never again be subject to the humiliating conditions that the IMF imposed on its Asian lending. Following the Latin American exchange rate crisis and the Russian crisis in the late 1990s, those countries too expressed strong antipathy to the IMF’s conditional lending. For the most part, those countries also moved to flexible exchange rate systems, built up international reserves, and mended their wayward fiscal ways. Those changes reduced the chances that they would need the IMF on anything like the scale they had previously had.
The onset of the 2010 European sovereign debt crisis took European policymakers and the IMF by surprise and encouraged them to reverse course. They again thought it imperative that the IMF should play a critical financing role in Europe to help keep the euro from unraveling and to avert a European banking crisis, especially considering that the European institutions were not in a position to lend on the scale needed to prevent the Greek debt crisis from cascading through the rest of the European economic periphery. Against that background, in December 2010, the U.S. Treasury and the world’s other ministries of finance agreed that it was desirable that the IMF’s resources available for lending be increased by an unprecedented 100 percent to around $720 billion. That proposed increase is yet to come into effect for want of U.S. congressional acquiescence to the Treasury’s proposal.
Even at the IMF, it is sinking in that massive IMF lending to countries like Greece was probably a big mistake.
Since December 2010, a number of new facts have arisen which the U.S. Treasury should take into account before continuing to push the idea that the IMF’s resources still need to be expanded. First, the Europeans have made fundamental institutional changes that make large-scale IMF financial support to Europe redundant. The Europeans have set up a permanent European Stability Mechanism (ESM) with a lending capacity of €500 billion and with the express purpose of financially assisting the adjustment effort of the troubled European economic periphery. More important still, the European Central Bank has started an Outright Monetary Transaction program under which the ECB has committed itself to buy unlimited amounts of a member country’s bonds with a maturity up to three years, subject to that country having negotiated an ESM economic adjustment program.
A second change that has occurred is that, much as was the case in Asia and Latin America before it, there has been a veritable political backlash in Europe against the harsh IMF conditions imposed on its lending. Those conditions are generally linked to the depressed state of the European economic periphery and the associated extraordinarily high European unemployment levels. This makes it politically unlikely that European countries will want to see a big future IMF role in their economies.
A third change is that, even at the IMF, it is sinking in that massive IMF lending to countries like Greece was probably a big mistake. Such lending forestalled the early restructuring of the country’s privately held public debt, which in effect put the European and international taxpayers on the hook for misguided private sector lending. It also saddled the affected countries in Europe’s periphery with a mountain of official sector debt that is difficult to restructure.
In short, we have now come full circle with respect to the need for increased IMF resources, and are back to where we were before the onset of the European sovereign debt crisis. If the European countries no longer need IMF resources on anything like the earlier scale, which part of the world does? It would seem highly doubtful that Asian or the Latin American countries will be rushing to raise their hands. Whether the U.S. Treasury will change its mind on the IMF resource question in line with the change of facts is quite another matter.
Desmond Lachman is a resident fellow at the American Enterprise Institute.
FURTHER READING: Lachman also writes "Yellen's Wishful Thinking,""The Fed Ignores Emerging Markets at its Peril," and "Europe's Outlook in 2014."
Image by Dianna Ingram / Bergman Group