Who Gave the IMF So Much Power?

As the price of Asia’s bailout skyrockets, the International Monetary Fund, a shadowy, World War II-era relic headed by a diminutive French banker almost no one knows, makes daily headlines.

Is it qualified for the job?

The answer raises troubling concerns about America’s readiness for the light-speed economic challenges that so suddenly devastated once-thriving Asia.

The IMF was born in 1944, for reasons that no longer exist. Petrified that 1930s-style depression and hyperinflation might again provoke war, the major Western nations met in Bretton Woods, N.H., and created a fixed-currency exchange rate system. The 44 countries at the meeting invented the IMF to police the new rules.

Funded by exactions from members, for the next 30 years the IMF pursued its limited mandate. It could make loans for up to a year to buttress a temporarily discomfited country’s gold or other reserves if fixed exchange rates were threatened. In return, borrowers agreed to certain conditions--reduced public spending, for example--to replenish national accounts and stabilize currencies.

In 1973, the Bretton Woods system was scrapped in favor of freely floating currency exchange rates. Its mission gone, the fund could have faded away. Instead, it rode the 1970s and ‘80s oil-shock and debt crises to a vastly expanded role.

By the late 1970s, as energy prices shot up, and countries such as Mexico, Brazil and Argentina suffered from out-of-control inflation and punishing debt, the IMF boosted its funds to more than $70 billion. It began making bigger loans of greater duration, especially to developing nations. Though these new efforts resembled Bretton Woods-era stabilization policies, in scores of cases, the fund was actually attempting far more complex, risky coordination of entire national economies.

Almost always acting in secret, the IMF would first “assist” a loan applicant by establishing detailed national account parameters--projections of what a country could “earn” and what it would have to “spend” to create a surplus. Acting like supra-national consultants, fund staffers estimated how much a country could produce and sell on world markets--its revenue sources--and how much it had to pay for raw materials or necessities like food or energy to achieve its goals and provide at least some comfort for its citizens. Loan conditions were then tailored to control how recipients could behave in ways IMF economists thought would realize national income goals.

However well intentioned this ambitious agenda may have been, there’s striking evidence it didn’t work. According to the Heritage Foundation, a vocal IMF critic, 81 of the 137 countries that received IMF loans in 1965-1995 actually increased, not decreased, their dependence on the fund over time. Of the 89 less-developed countries that borrowed from the IMF in the same period, 48 are no better off, and 32 are now actually poorer, than before the fund intervened.

In the early 1980s, this disappointing record, combined with the conservative Reagan-Thatcher resurgence in Britain and the United States, the fund’s two largest donors, might have doomed the IMF. Instead, the U.S. savings-and-loan crisis, the second oil shock and the Latin American debt crisis gave it new life.

Michel Camdessus, formerly director of the elite French Treasury, was appointed in 1987 to head the fund with Reagan administration support--an ironic turn given his reputed French Socialist ties and suspected sympathy for Japanese and French state-led economies (policies he now blames for Asia’s woes). By 1990, the IMF had 181 member countries and a war chest of $183 billion.

Mexico’s 1995 debt crisis was a watershed for the fund. Working closely with U.S. Treasury Secretary Robert E. Rubin, who faced sharp congressional criticism, the IMF helped broker what was then history’s largest national bailout and debt-relief deal. When Mexico paid back America’s part of the loan before it was due, Camdessus and his Clinton administration allies scored a huge victory.

Can the IMF repeat this in Asia?

One troubling sign is that, despite its vaunted surveillance and planning skills, the IMF utterly failed to anticipate the crisis. Its 1997 annual report lauds Korea’s “enviable fiscal record” and Thailand’s “sound macroeconomic policies.” A few months later, Camdessus was flying secret missions to these same countries, warning of impending catastrophe.

Asia’s problems also differ from past challenges the IMF has faced. Unlike 1980s Latin America, the Asian economies had few current account deficits and low inflation. Their recent nightmares stem instead from monetary and borrowing strategies that made them vulnerable to speculative currency attacks.

To attract foreign capital, countries like Korea and Thailand exchanged their currencies at fixed rates for dollars or other “hard” currencies. This assured investors and lenders they could easily exit the country, and symbolized national confidence.

But exchange rate “pegs” have hidden risks. Much like stock markets that suddenly sink when a single influential firm’s earnings fall, news of short-term trade deficits or exchange-rate fluctuations can induce region-wide, panic selling of local currencies.

That’s what happened in Asia. Spooked by falling dollar reserves in Thailand and Indonesia, and then by a rash of speculative currency sales, mainstream investors demanded money at the fixed exchange rates. Panicked global lenders, who wanted to be paid back in dollars or yen, began calling short-term loans they normally rolled over. Like an old-fashioned run on the bank, high-flying Asian nations simply ran out of hard currencies to exchange.

In response, the U.S. and other influential countries could have proposed policies, as Nobel economist James Tobin and Harvard development specialist Jeffrey Sachs suggest, that would moderate unjustified panic selling and currency speculation worldwide. For this is more than Asia’s problem: If Asian debt levels could provoke rapid deflation, under similar criteria America, a country no one thinks threatened, looks even worse.

U.S. leaders such as Rubin, however, chose to view the crisis as just another malady requiring IMF medicine, though there’s no consensus about a cure, and the fund itself, recently touted Asia as among the world’s healthiest economic regions.

Why would the U.S. endorse this?

* Expediency. The Mexican crisis taught the Clinton administration it could bypass a hostile Congress with the help of multilateral organizations like the IMF.

* Trade Concessions. The U.S. could revive its dismally failing Asian trade agenda by making its “market opening” goals part of the IMF’s bailout conditions.

* Politics. Shielding big investors from Asian financial fallout pacified Wall Street--a strong Clinton supporter--and reassured an increasingly uneasy middle class with a lot of money riding on the stock market.

* Issue Avoidance. Dismissing Asia as another IMF basket case diverted attention from the specter of worldwide capital market volatility--a problem no one knows how to solve--and avoided discussion of America’s own potential for debt-driven, speculative economic meltdown.

The IMF thus became the key Asian crisis manager by default more than preference. Even so, it’s possible the fund can crib together a package that will be credited with calming worried investors and relaunching Asian growth.

But if, like Mexico, Asia’s troubles eventually move from the front pages, finding solutions for today’s economic concerns, not the 1940s, still is imperative. If the Asian crisis suggests a deeper lesson, it’s that in a world of unfettered capital movement shaped by often capricious motives, even model economies can, without warning, be forced under the heel of a former French bureaucrat. And that, as much as free-falling currencies and overnight asset devaluation, ought to strike fear in every American.