The International Monetary Fund and the National Interests of the United States
Testimony before the Joint Economic Committee
United States Congress
The national interests of the United States are strongly supported by the International Monetary Fund, as we saw in the Mexican crisis in 1995 and are seeing again in the current Asian crisis. The IMF is in fact one of the best possible deals we could ever imagine: its programs cost us nothing yet it provides enormous benefits for our economy and our foreign policy. Hence I strongly support prompt Congressional approval of both the proposed $3.5 contribution to the New Arrangements to Borrow and $14.5 billion for our share of the internationally agreed increase in Fund quotes.
The Cost of the IMF
It is essential at the outset to clarify the cost side of the equation. Our contributions to the IMF have zero-repeat, zero-cost to the American taxpayer and economy. Every dollar we contribute produces an equal amount of US claims to draw yen, DM or other currencies from the Fund ourselves. Hence these contributions amount to an "exchange of assets," with no budget cost or requirement for appropriated funds (an arrangement which, incidentally, I worked out with the Congress in conformity with the new Budget Act of 1974 when serving as Assistant Secretary of the Treasury for International Affairs in 1977-81.
The ability of the United States to draw on the Fund itself is not a theoretical proposition. The United States has borrowed foreign currencies from the IMF on 28 different occasions, more than any other country. We drew about $3 billion of DM and yen in 1978 to help defend the dollar in the exchange markets. The IMF has always been a two-way street for the United States and the Administration's analogy with a credit union is apt.
In addition, the IMF enables the United States to effectively leverage its funding to induce other countries to support internationally agreed programs. Our share in the Fund is less than 20 percent so every $1 we contribute is matched by more than $4 from others. The IMF is thus an extremely useful tool to achieve our perennial goal of sharing the burden of international efforts with countries around the world.
Hence it would be impossible to oppose the proposed IMF contributions on budgetary or cost grounds. The meaningful debate is over whether the Fund effectively promotes US economic and foreign policy interests.
Does the IMF Need More Money?
A second point to clarify at the outset is that the IMF clearly needs more money. The Fund now has about $45 billion in "uncommitted loanable resources." However, $30-35 billion of that total is unconditionally available to member countries and thus could be withdrawn on demand. Only $10-15 billion is clearly available for additional country programs.
In addition, the Fund can borrow about $23 billion from the existing General Arrangements to Borrow (GAB). This credit line has been available to support IMF programs since the early 1960s. Its activation, however, requires unanimous agreement of the GAB member countries and, given differences of views within the group about individual country programs, might not be readily usable.
Hence the Fund has assured access to only about $10-15 billion of additional resources. It is quite possible that another major country, such as Brazil or Argentina or Turkey, could run into a payments crisis at literally any time-especially if the Asian crisis were to erupt again into an additional round of sharp currency declines, which is quite possible. It would then be impossible for the Fund to become involved and the risks of contagion to the rest of the world, and costs to the world economy including the United States, could be multiplied many times.
It is thus clear that the Fund needs additional resources-the quota increases as well as the NAB. Hence we again come solely to the central question: does the Fund effectively promote US economic and foreign policy interests?
US Interests in the World Economy
The United States has two central interests in the world economy. The first is the maintenance of maximum rates of economic growth and employment that are consistent with reasonable price stability. The second is the most widespread possible application of market-oriented policies rather than governmental controls and directives. These goals, incidentally, demonstrably serve our broader national security and foreign policy interests as well as our economic interests.
The IMF plays a crucial role in supporting both fundamental US objectives. When a member country asks the IMF for help to respond to a crisis, the Fund produces two things: financial assistance and policy requirements. Both are central to inducing and enabling the country to (1) adjust gradually to its crisis rather than precipitously and (2) adopt constructive, market-oriented policy measures rather than draconian dirigiste controls.
A country, whether Mexico in 1994-95 or Korea in 1997-98 (or, for that matter, the United Kingdom and Italy in 1992), experiences a financial crisis because it can no longer pay its foreign bills and/or faces a sharp fall in its exchange rate. It must enact new policies to put its house in order. But there are also two crucial choices:
- 1. Must it enact measures, however draconian, that take effect immediately or can it phase in the adjustment over a period of time?
- 2. Closely related, must it clamp on trade and capital controls or can it alter the market environment in a way that will produce adjustment of a much more economically sound, and thus sustainable, nature?
The IMF plays a critical role in the answers to both questions. An IMF program brings external financing that tides the crisis country over an intermediate period that permits gradual rather than abrupt phasein of the adjustment measures. The conditions attached to that program require the country to employ sound, market-oriented measures rather than "quick fix" controls. In essence, the IMF is an international lender of last resort in the same way that the Federal Reserve is a lender of last resort in our domestic financial crises.
The United States has a huge interest in these IMF contributions. It is far better for us that a crisis country adjusts gradually and constantly--via sound budget and monetary policies, trade and investment liberalization, and needed structural reforms as are required now in Asian financial and corporate governance systems--rather than by instituting import controls, even sharper depreciations of currencies, and even deeper economic turndowns. Our economic and foreign policy interests would be imperiled if major countries, such as Mexico and Korea, were forced to go the latter route because there was no IMF to point them in constructive directions.
One might of course suggest that the United States itself, or somebody else, could provided the needed external funding and policy advice instead of the IMF. We would hardly want to pick up the entire financial costs of significant support programs, however. Moreover, it is likely that any unilateral US attempt to impose adjustment conditions would either fail and/or worsen rather than improve our relations with the crisis country. A multilateral institution, of which the crisis country itself is a member, is the optimal--indeed, probably the only effective--means for carrying out such programs at this point in history. It is literally true that we would have to create the IMF it did not exist.
Some observers who share my assessment of US goals nevertheless oppose the IMF because they believe that, contrary to my arguments, it does not promote those goals effectively. Some even believe that the IMF has counterproductive efforts. We must therefore turn to those critiques.
Criticisms of the IMF
First, some believe the world would be better off without the IMF or any similar institution. They would let the market take care of all crises on its own.
As noted, the IMF promotes market-oriented solutions and the United States strongly supports that approach. The problem, however, is that markets occasionally go haywire and far overshoot the rational bounds of underlying economic conditions. The results can be catastrophic for both the countries involved and the world economy as a whole.
For example, huge amounts of private capital continued to pour into Mexico and the Asian countries until literally the eve of their crises-despite impending signs of trouble and frequent warnings from many quarters. Then the private capital flow totally reversed and drove the countries' currencies down much further than can be justified by any objective analysis. This "roller coaster effect" of the private capital markets was already seen in the runup to, and aftermath of, the Third World debt crisis of the 1970s. It demonstrates why we cannot rely wholly and solely on market forces.
The United States knows about these problems from direct experience. As recently as early 1995, the foreign exchange markets drove the dollar to its all-time lows against the yen and most European currencies despite the stellar performance of our economy and relative stagnation in Japan and Europe. Our own Treasury, despite its strong preference for market solutions, felt compelled to intervene to drive the dollar back up. Since that time, the dollar has risen by 60 percent against the yen and 40 percent against the DM-demonstrating again the "roller coaster" or "bandwagon" effect, and revealing clearly that the dollar had fallen much too far only three years ago.
It would be enormously risky to rely solely on market forces to resolve currency and other financial crises.
As noted above, crisis countries would then be wholly on their own and would inevitably have to accept much sharper recessions, much sharper declines in their currencies, and/or draconian trade and capital controls. Such alternative adjustment paths would hardly support US economic or broader interests. The archtypical example was of course the competitive depreciations and trade warfare of the 1930s that helped bring on the Great Depression-and that induced the world to create the IMF after World War II in an effort to avoid ever repeating such a disaster.
A second criticism is that the IMF "doesn't work. Proponents of this view note the continued shakiness of Asian currencies and stock markets, and conclude that the IMF program has failed. No institution is perfect. Crisis management and recovery are extremely difficult. We should not expect a miraculous recovery in every IMF program country.
But patience is required. It took about six months for the markets to stabilize in Mexico in 1995, which is a dramatic success story whose economy has grown by an average of 7 percent in 1996-97 after suffering only one year of adjustment. Stabilization in Asia will almost certainly take longer because of the regional spread of the crisis and the structural nature of the needed reforms. Moreover, one can only expect success if countries faithfully implement the IMF programs. Both Thailand and Korea had to navigate political successions before they were able to start applying the needed remedies. Indonesia has not yet begun to do so. Once can hardly charge the IMF with failure until its prescriptions have been in place long enough to be fairly tested.
A third and more nuanced criticism is that IMF remedies are "too extreme" and/or "not tailored to the differing situations in different countries." These complaints are voiced particularly in the current Asian context, where the problems are mainly structural and financial rather than presenting the traditional problems of excessive budget deficits and monetary expansions.
The unique nature of the Asian problem has indeed meant that the IMF has had to "learn while doing." As it moved from Thailand to Indonesia to Korea and now back to Indonesia, and as time has passed, it has been modifying its programs and especially their priorities. Some of the earlier fiscal targets turned out to be too tight, in light of subsequent circumstances, and have been modified with little or no harm done. The overwhelming emphasis of the programs is now on financial restructuring and corporate governance, which is correct.
The most difficult dilemma resides with monetary policy. On the one hand, moderate interest rates are highly desirable to facilitate financial restructuring and to avoid unnecessary economic slowdown. On the other hand, high interest rates help defend the currency and avoid even further depreciations. The IMF strategy is to insist on sufficiently tight money to achieve the latter goal but to approve relaxation as soon as circumstances permit, as they are starting to do in Korea. Judgment calls have to be made on the spot but the basic strategy appears sound.
The most understandable criticism is that the IMF creates "moral hazard" by assuring private investors that they will be bailed out and hence encourages the destructive "roller coaster" efforts described above. Policymakers, including at the IMF, do indeed face an acute dilemma when confronting a country in crisis. Their immediate imperative is to stop capital outflow and restore capital inflows, to finance the (usually sizable) external deficit until it can be corrected, and then to permit gradual and constructive adjustment. This counsels avoidance of hits to existing investors that could scare them off and undermine the whole strategy. At the same time, however, this approach may create the "moral hazard."
The answer to this legitimate concern is to make sure that all IMF program require the relevant private investors to contribute equitably to the costs of the support operation. Equity investors already do so; foreign holders of Asian securities have taken enormous losses and some have been wiped out. Foreign lenders to Thailand did so as well; they were required to convert their short-term claims at market interest rates into longer term claims at 2 percent. Korea's foreign creditors had to stretch out their maturities considerably and accept modest interest rates. Indonesia's foreign creditors will understandably receive the same (or worse) treatment. Major US banks have in fact recently reported substantial losses from their Asian lending.
Nevertheless, the IMF needs to build this element systematically into all its support programs. The model should be the Brady bonds that characterized the second, and final, stage of the Third World debt workout of the 1970s. Under that approach, existing creditors were required to take equiproportional losses, as determined by the IMF and the creditor countries, for each debtor nation. The lender had several choices for how to absorb the loss: par bonds at low interest rates, discounted bonds with market rates, new lending, etc. But each had to accept its fair share of the overall workout. Such a model, suitably modified to reflect the more complex array of lending entities that are now involved, needs to be included in all future IMF programs.
A final criticism relates to the transparency of IMF operations. The IMF insists that its borrowers increase the transparency and accountability of their policies and processes. Hence it is eminently logical to ask whether the IMF is sufficiently transparent itself.
The IMF is in fact more transparent than most observers realize. Almost every IMF program is available in full detail, including on the internet. But the process of disclosure is random and unstructured, and much more order could be brought to it. The United States has in fact been pushing for more IMF openness for at least twenty years.
The greatest need, in my view, is publication of the analyses of country outlooks by the IMF staff. The data portions of the Fund's country consultations are already published. But the markets need to know when country problems are foreseen, both to limit or avert the continued influx of unsound loans and to help induce the country to take preventative policy steps.
It must be recognized, however, that the Fund faces a genuine dilemma in this area as well. Full public disclosure of Fund materials would deter some countries from providing full data to the institution. Sovereign nations, including our own and certainly many industrial as well as developing countries, will always want to preserve a degree of confidentiality for some of their most sensitive financial and economic data. The Fund would thus probably lose access to some of its most important inputs if it mandated full disclosure. I would still support increased disclosure, as noted above, but a judicious balance must be struck in answering this question.
I thus conclude that the various criticisms of the IMF are either unfounded or can be answered through readily available changes in Fund policy and programs. The Congress should certainly urge the Administration to pursue such changes.
It would be a grave mistake, however, for the Congress to withhold its approval for the two new funding requests or to condition that approval on the implementation of changes in Fund policies. The Fund's need for additional resources, to position it to implement programs that are vitally in the interests of the United States, is far too great to permit any such delays.
The United States has an enormous interest in an effective and fully funded IMF. The Asian crisis reinforces and underlines that interest. I urge the Committee, and the Congress, to approve the Administration's proposals fully and promptly.