The revival of the IMF

A few years ago a course on financial institutions would mention the IMF as a matter almost of politeness. An organisation that was created in 1944 for a role which ceased to make sense after 1971 seemed to be surviving, zombie-like, into a world where it had no purpose. And yet now the IMF is at the heart of the debate about the reform of the global financial system, is seen as the only credible source of support for the Greek (and increasingly European) financial crisis and is widely regarded as an experienced and wise counsel. In fact the IMF has unexpectedly become the only obvious beneficiary of the recent financial crisis (aside from a few hedge funds that is). How did this all happen?

The IMF was set up to provide balance of payments support for countries struggling to pay their import bills under the fixed exchange rate system known as Bretton Woods, after the town in New Hampshire where the agreement was signed by the soon-to-be victorious powers in World War 2. The system was designed by the USA with a degree of influence from the British and French and it depended on US economic leadership. By lending to countries in “temporary” financial disequilibrium to avoid devaluing their currency, the IMF was meant to stabilise the international financial system. But it only applied to countries in deficit, not surplus, and this introduced a deflationary bias to the system, as warned by the British economist John Maynard Keynes.

That system collapsed in 1971 when the dollar stopped being convertible into gold (at the official level, not for ordinary people) because France was asking for its dollar holdings to be converted into gold. All exchange rates pretty soon became floating and the grand era of liberalisation began. Although the IMF had lost its official role, it quickly established a new one as provider of finance to excessively indebted less developing countries, which later became known as emerging economies. This was the period of “IMF riots”. In various countries, but particularly in Latin American ones, governments that had over-spent blamed the IMF for the public spending cuts they had to do to get emergency financing from the Fund.

The IMF, together with the World Bank and the US Treasury, became part of the much-hated Washington Consensus – a view that all countries should aim to copy the US in financial liberalisation, free movements of capital and laisser faire government. From the early 1980s onwards this combination of policies has generated increasing instability in global finance. Debt crises arose in Latin America, Asia, Russia and eventually the US itself. That Consensus is badly wounded although not completely dead.

But the IMF has managed to achieve a new role as slightly more cuddly lender to governments in trouble and has been given a lot more money to do it. The fact that it is the G-20 rather than G-7/8 which is officially mandating it has helped enormously with its global public relations. Last year the head of the Chinese central bank suggested that a possible new global currency could be the previously obscure Special Drawing Rights (SDR) issued by the IMF. SDRs were created in the 1960s when there was a fear that global reserves were too scarce and there might be a lack of liquidity that constrained global trade. A few years of massive US deficits and then international capital liberalisation soon made SDRs rather redundant but they still exist.

And at a time when we are all searching for a new anchor for the financial system which is also vaguely democratically legitimate, there is nothing much else to start with except the IMF. Obviously at some point the absurdly out of date shareholding structure needs to be changed to represent the new economic realities. And most painfully for the French, the convention that the head of the IMF is a European needs to be scrapped. It would be a symbolically big step forward if the next head of the IMF were a Chinese or an Indian rather than, as seems likely, soon-to-be-former UK prime minister Gordon Brown.

The IMF’s research department was always pretty good but is now seen as excellent. Partly this is owing to the spirit of self criticism that means genuinely learning from earlier mistakes (such as the flawed emphasis on liberalised capital flows in Asia and the failure to abandon the Argentinian fixed exchange rate scheme until too late). Two of the most interesting and intelligent economists commenting on current financial affairs, Ken Rogoff and Simon Johnson, are former chief economists at the IMF. Of course getting involved with the euro disaster may yet be another mistake but since the current head of the IMF is widely believed to want to be the next French president, there is little doubt about the IMF’s involvement.

Three years ago, if the IMF didn’t exist nobody would have sought to invent it. Now it seems indispensible. This shows the resilience of institutions and is a warning for governments trying to cut back on public spending by shrinking the role of the state. By some luck and some judgement, the IMF has found a new role. Let’s hope they do a good job with it.

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