Discombobulated

Back in 1945, the Australian parliament debated the wisdom of joining the Bretton Woods agreement that involved the creation of five international financial institutions.

Led by the World Bank and International Monetary Fund (IMF), the Bretton Woods institutions would regulate and supervise the international banking system.

Put simply, these institutions were to make sure we would never again experience a financial crisis like the Great Depression of the 1930s.

Eddie Ward, the long-serving Labor member for East Sydney, opposed the Articles of Agreement arguing that: ‘Bretton Woods would enthrone a World Dictatorship of private finance, more complete and terrible than any Hitlerite dream’; destroy Australian democracy; pervert and paganise Christian ideals and endanger world peace’.

Last weekend the IMF released its World Economic Outlook.

Eddie Ward was wrong. Again

The changing face of the IMF

Far from being the ogre institution predicted by Ward, the IMF that emerged from the pages of its latest Outlook was lost and confused. Discombobulated.

The IMF’s role has changed since the days when international financiers were regarded by the Eddie Ward’s of the world as being part of a global conspiracy responsible for the Great Depression.

Back then, its most important role was supervising the foreign exchange system to ensure that currencies traded in a fixed relationship to other members of the IMF’s universe.

Should a currency be under market pressure to devalue, the IMF stood ready to ensure it remained in fundamental equilibrium. It did so by prescribing the appropriate fiscal policy.

If need be, funds would be advanced.

That role came to an end in the early 1970s when US President, Richard Nixon, simply closed the gold window—refusing to sell France US dollars at the fixed rate of $35 per ounce.

With the world’s currency exchange system floating, the IMF had to find itself a new job.

The petrodollar problem

An opportunity opened up almost immediately when the oil producers of the Middle East created a cartel that quadrupled the price of crude.

Global markets were soon awash with petrodollars looking for safe havens and steady interest returns.

While the private banks competed for the petrodollar business, the IMF faced little competition as a last-resort lender on the buy-side of the oil market.

All this liquidity created inflationary pressures around the globe with consequential impact on exchange rates.

In 1979, oil prices trebled to create a flood of petrodollars—many of which found their way, with the particular help of Citibank, to Latin America.

Citibank was run by a Will Rogers style banker called Walter Wriston who explained his bold Latin American lending with the statement, ‘Countries don’t go out of business.... And that’s very different from a company.’

But they can default.

Between 1970 and 1980 Latin American debt levels rose over 1000%.

They went to the IMF to bail them out. Funds were conditional on the imposition of economic reforms.

Austerity and capitalist–style reforms proved successful in restoring the Latin American countries to economic health.

However, the IMF lost badly on the political front as it was seen as an outsider imposing pain and suffering.

Most developing economies suffered a recession in the 1980s, but Latin America was the hardest hit. This was, in large part, due to the generally protectionist policies that had been implemented over several decades as an import substitution and employment-creating strategy. This made it impossible to expand exports rapidly to finance oil costs and higher interest charges on loans.

Not surprisingly, the IMF focused on the successful features of their Latin American recovery exercise. The fact that it reflected the political philosophy of Ronald Reagan and Margaret Thatcher was a powerful attraction. 

The Washington Consensus

Much to the chagrin of the British economist, John Williamson, this Thatcherite market-based neoliberal approach became known as the Washington Consensus.

Williamson had actually minted the expression to describe a much narrower, less-ideological approach to what might be called the ‘standard’ Washington approach to reform packages.

The Washington Consensus label was actually appropriated by its critics as a rhetorical way of conveying it as a sinister conspiracy.

Harvard professor and critic, Dani Rodrik, said that under the Washington Consensus:

‘‘Stabilize, privatise, and liberalise” became the mantra of a generation of technocrats who cut their teeth in the developing world and of the political leaders they counseled.’

The GFC killed the Washington Consensus stone dead.

In the years before 2008, it had acquired a reputation of being increasingly ideological and of advocating neoliberal fundamentalism as the one true way.

To survive, it needed to deliver success. 

By any measure the GFC, especially when it came to deregulated financial probity, was a monumental market failure.

As Dani Rodrik said, ‘While the lessons drawn by proponents and sceptics differ, it is fair to say that nobody believes in the Washington Consensus anymore. The question now is not whether the Washington Consensus is dead or alive, it is what will replace it.’ 

That question is particularly pertinent to the IMF. 

What is the future for the IMF?

The GFC has actually extended the writ of the IMF, which now finds itself a major player in the economic plight of the Eurozone.

At the same time, its previously normal neoliberal modus operandi has been rendered inoperable.

The institution’s professional operation has been severely dented by the IMF’s failure to forecast critical global and country growth figures over the last four years.

These provide the footings on which fiscal and monetary policy is built.

Compounding the managerial challenges ahead is the fact that the global economy is caught in a low-growth trap with ageing populations, high debts and miserable productivity growth.

There is a real risk of secular stagnation where demand is insufficient to attract investors unless interest rates fall below zero. In addition, there are the unknown responses of financial markets when the US soon takes its first steps back to normalising monetary policy.

We do know that the IMF has moved to address its failure to deliver more accurate figures for growth forecasts.

The Outlook report revealed that potential output figures would be derived via a New Keynesian macroeconomic framework. The key difference between that and the former method is that the New Keynesian model takes into account the stickiness of wages and prices. 

And while Keynes’ name was not mentioned, his influence is there in a six-point working paper on measures that the IMF suggests others could adopt to improve economic performance.

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Max Walsh

Contributor

Max Walsh was for many years one of Australia’s top economic and political commentators, highly regarded as a journalist, author and broadcaster. Throughout his career, Max was involved in all dimensions of the media industry, which has encompassed positions with two of Australia’s largest publishing companies and television networks.

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