A Necessary Institution

[Dennis L. Fiddle]

[wsj.com]
March 2, 1998
A Necessary Institution [Image]
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The IMF acts as the strong arm of the marketplace
[Image]
Remember the Trilateral Commission? Back in the
'Eighties, the international talkathon for big
shots was demonized into an international
conspiracy against the proper order of things. Like
the Third International, the Masonic Order and the
Illuminati, the Trilateral Commission served for
some as the grand explanation for everything that
seemed to be going wrong in the world.

Fortunately, the commission has gone out of
paranoid fashion and returned to the unobtrusive
status it always deserved. Unfortunately, the next
bugaboo is turning out to be the International
Monetary Fund. This could be more serious: Although
flawed, the IMF actually is an important
institution. Also, its flaws are diminishing while
its importance is growing.

Fear of the fund goes back many years. As part of
the Bretton Woods agreement that set up the new
world financial order after World War II, the
International Monetary Fund was established as a
global lender of last resort. When a country and
its financial institutions become so overextended
that private institutions run away, the IMF runs in
to dispense cash, but on severe terms. Who could
like an agency like that? Does a wastrel student
like the terms his parents impose for paying his
debts?

The cash bothers some people: It's a bailout.
Worse, it's a bailout of the international banks
that lent unwisely, for projects that were
unnecessary or worse. But these bailouts are no
more than the international equivalent of
bankruptcy. In the same way that bankruptcy is
better than debtors' prison, even for lenders, so
an IMF bailout is better for the taxpayers of the
world than collapse in even a small profligate
nation.

The IMF arrives early, when a debt crisis can be
contained. In Britain and Italy in the 'Seventies,
in the Latin American debt crisis of the 'Eighties,
in the nations of the former Soviet Bloc, in the
Asian countries of the current debt crisis, the IMF
arrives when circumstance has forced governments to
listen to its advice.

A Dose of Realism

It's the advice, however, that worries more and
more people. The IMF usually prescribes
devaluation, monetary contraction and fiscal
discipline. These are the counter-agents to the
overvalued currencies and other easy money policies
that put its subject countries into trouble. In
quick succession come high interest rates, economic
contraction and high unemployment: General misery
balances the former general elation.

The IMF's advice would not do for every country.
Some, like the United States, are so favored by
their natural and human resources, by good timing
in their business cycle and by their stable
political institutions that they ought to have
strong currencies and low taxes. From this truth,
it is easy to imagine that the IMF's advice need
not be followed anywhere. It is a little more
difficult to imagine that the IMF deliberately
dispenses bad advice. It is harder still to imagine
that international bureaucrats are deliberately
impeding economic growth to make poor people
suffer.

Yet such imaginings are becoming ever more popular.
The notion that IMF officials advise devaluation
only in order to protect their advisory jobs even
finds its way onto the editorial pages of great
newspapers. So does the equally loopy idea that the
IMF exists to hold down wages and pollute air and
water in poor countries for the benefit of rich
"transnational" companies.

Starting with the Mexican crisis of 1994-95 and
even more strongly in the current Asian crisis,
otherwise sensible people are claiming that the
cure is worse than the disease -- that devaluation,
tight money and strict fiscal policies replace
little problems with bigger problems.

Jack Kemp, for example, offers this: "The IMF is
giving bad advice. In every instance, they say
'soften your currency, devalue it, raise taxes,'
and the combination of soft money and high taxes is
the problem in every country the IMF has visited. I
think it [should give] the opposite advice and that
Congress should not give a dollar of replenishment
to the International Monetary Fund until they start
giving good advice."

In fact, the typical IMF prescription is simple
realism: A country in trouble must accept the
consequences of its mistakes. An overvalued
currency must float to its market value; the
government must either stop creating money faster
than the market wants it or stop hiding the dirty
secret of a bulging money supply; it must stop
borrowing faster than it can tax to pay debt
service. This is not bad advice, this is the facts
of life. If the IMF did not advise this discipline,
the market would impose it in a much more painful
way.

Once a crisis has reached the point where national
leaders must put their old policies behind them,
the IMF makes suggestions for economic reforms.
Here, the organization is much improved. Where once
it espoused the capital controls and nationalist
socialism inspired by the British Labour Party, the
IMF now pushes open markets and capital mobility
with an intensity that could put many Americans to
shame.

Providing Courage

In America, two symbolic issues currently dominate
discussion of the International Monetary Fund. The
more abstract is the IMF's opposition to a currency
board in Indonesia; the more tangible is the
Clinton Administration's request to Congress for an
$18 billion capital contribution to the fund.

A currency board system backs every unit of suspect
local money with a unit of trusted foreign
currency. In Argentina, for example, every peso in
circulation is matched by a dollar in the central
bank. Individuals know the government can maintain
that exchange to the last peso or the last dollar.

The IMF doesn't want a currency board in Indonesia.
It says it believes the Indonesian government must
retain monetary flexibility or see its banks
collapse. But that's wrong. The Indonesian
government shouldn't print money to shore up its
banks; it should inspire confidence in its money
and its institutions so the IMF and private
investors will lend them more capital. Whether it
does that with a currency board or some other
mechanism ought not to be the issue.

Whatever will be believed will work. In Hong Kong,
a currency board carried the credibility needed to
protect the local dollar despite the general crisis
and the specific uncertainty of the former colony's
relationship with China. In Taiwan, solid
prosperity and a heap of foreign exchange reserves
were equally credible.

A currency board is just another word for courage.
Or, considered another way, it is another form of
the promise to peg exchange rates. Either way, a
country better known for borrowing than for paying
back promises to spend every last dollar of its
foreign-exchange reserves defending its currency.

There's nothing wrong with courage, and there's
nothing wrong with keeping promises. But money is
just paper. Just as the country that promises to
defend its exchange rate can abandon that promise,
the country that creates a currency board can
dismantle it.

Either way, markets judge each country's promises
and test the resolve of any mechanisms that declare
value. All currencies, even those protected by
secrecy or lies, even those backed by gold, float
against each other, against gold, against other
commodities. An Indonesian currency board will not
be more credible than any other promise extended by
the Suharto family-government. IMF funding for
Indonesia's bankruptcy should focus on the
country's credibility, not on whether it creates a
currency board.

Investing for Profit

If the IMF didn't exist, it would be necessary to
invent it. Everybody wants a free lunch.
Governments have a natural tendency to profligacy.
Banks have a natural urge to lend and borrow and
lend again, even to governments. Bust and
bankruptcy follow boom and hyper-investment. The
world's financial institutions cannot prevent such
mishaps, but the IMF can contain them, limit the
damage, teach the lessons that should be learned
and move on to the next cycle.

If the world had to invent the International
Monetary Fund now, it would probably be a private
institution, drawing on capital invested by banks
around the world and paying a nice return on
investment. We would prefer a world in which it did
raise private capital and gain strength from the
power of markets. But while it's an instrument of
governments, the U.S. should be an investor.

An odd coalition of labor, protectionists, gold
bugs and environmentalists opposes more U.S. funds
for the IMF, but they don't serve their country's
interests.

The most important capitalist country, which is
also the world's largest trading nation, should
realize that the wealth of its citizens depends in
large part on a world system that punishes bad
policies and forces incompetent governments to
improve.

Thomas G. Donlan receives E-mail at
tg.d...@news.barrons.com

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dfi...@mn.uswest.net (Dennis L. Fiddle)
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