IMF failure redux

February 25, 1999 • Commentary

Yet another financial crisis has arrived, this time in Brazil. It wasn’t supposed to happen: last fall, Washington replenished the treasury of the International Monetary Fund, which then organized a $41.5 billion loan package to bolster the Brazilian economy. Brazil’s experience demonstrates yet again that the IMF is a problem, not a solution.

Economic chaos has become a common international occurrence. In 1997, it was East Asia, most notably Indonesia, South Korea and Thailand. Last year, Russia imploded spectacularly.

Now Brazil’s currency and stock market have collapsed. At least the implosion surprised virtually no one.

As Chase Manhattan’s chief economist, John Lipsky, put it, ”This is one of the more anticipated shocks of recent times.” Banks and hedge funds had reduced their exposure in Brazil accordingly.

By holding out the prospect of a bailout for any country that fails, … the IMF encouraged irresponsible behavior.

However, just as Thailand’s implosion heralded disaster elsewhere in East Asia, many analysts worry that Brazil may be a harbinger of greater problems in Latin America, particularly Argentina, Mexico, Peru and Venezuela.

The best means of dealing with the financial virus is quarantine. Rather than bailing themselves into the problems of sick economies, healthy nations should stay out.

Obviously, national disruptions cannot be completely isolated in an international economy. But IMF‐​organized bailouts create another transmission belt of economic crisis. Having placed their full faith and credit behind a succession of failed economies, the United States and other industrialized nations are now at increased risk if the contagion spreads.

Yet IMF programs have consistently failed. Until President Richard Nixon closed the so‐​called gold window in 1973, the Fund’s objective was to support the system of fixed exchange rates. Then the IMF jumped into the development business, providing loans to poor nations in the name of reforming their economies.

The Fund spent two decades supporting the worst collectivist and authoritarian regimes of Zaire and Yugoslavia, Romania and India, Argentina and dozens of others. The IMF’s loan conditions often hindered market‐​oriented reforms and, even when pro‐​growth, were rarely enforced.

Most borrowers became permanent IMF clients. Three nations, Egypt, India and Turkey, have relied on IMF aid for more than 40 years; 16 states have been on the Fund dole for 30 to 39 years. An incredible 67 have been using Fund credit for at least a decade.

In 1994, the Fund moved into the bailout business, with its assistance package to Mexico. By 1997, bailouts became a regular Fund activity. IMF Executive Director Michel Camdessus acknowledges that they ”represent a marked departure from the kind of programs we have traditionally supported.”

The IMF was no more successful in this occupation, however. Indonesia signed and violated successive Fund agreements; IMF Deputy Managing Director Stanley Fischer responded by proclaiming his organization’s willingness to ”show considerable flexibility.”

Russia collected more than $20 billion in IMF loans from 1992 to 1996. Rather than encouraging Russia to reform, this aid allowed the regime to pursue unsound statist policies. Yet the IMF extended another loan last year; promised Stanley Fischer, ”There is certainty that the IMF measures will be implemented in full.”

That was early August 1998. By late August, Moscow was retreating from economic reform: government controls were expanding, ruble printing presses were running, bank bailouts were proceeding and business subsidies were flowing. Moscow wasted the first loan installment of $4.8 billion to support the ruble, which nevertheless ignominiously crashed. Now Russia is threatening to default on its international debts.

By holding out the prospect of a bailout for any country that fails, the Fund created what is called a ”moral hazard,” that is, the IMF encouraged irresponsible behavior. Countries and investors take greater risks when they believe that they will be relieved of some or all of the cost of any mistakes.

Yet the Fund never learns. The disasters throughout East Asia and in Russia led the organization, backed by the Clinton administration, to suggest yet another role: preventive aid to forestall financial collapse, like last November’s deal for Brazil. Alas, Brazil retreated from serious economic reform and maintained its overvalued real after pocketing the money.

Now the IMF plan lies in ruins. ”It’s a breach of the firewall that we spent months building around Brazil,” acknowledges one administration official. ”It’s hard to overestimate the anger around here about how the Brazilians wasted time when they needed to deal with their problems.”

But never mind. The Fund has told Argentina and Mexico that help is available if they desire.

The most powerful incentive for reform is the pain of failure. Left to their own devices, Indonesia, Russia, Brazil and other countries in crisis would have to adopt all of the reforms necessary to recondition their economies and reassure foreign investors.

But the IMF and other multilateral lending institutions, like the World Bank, which may soon ask for a capital increase, alleviate the pain of failure. They should be closed, not expanded.

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