Who guards the guardians?

Feb 09, 2009 Editorial

At the Davos World Economic Forum, when President Jagdeo was asked what changes may be necessary to deal with the global financial crisis, one suggestion he proffered was that, “What we need now is a global institution that is empowered to deal with global financial instability.”

This body that would provide the necessary, “independent analysis” etc., he intimated, was the IMF; but he pointed out, “I find myself in an uncomfortable position of having to defend the IMF, because many times I have problems with their conditionalities.”

We are in agreement with the President on both the need for a supra-national institution to become a watchdog of the integrated world financial system and his reservations on the IMF playing that role under its present makeup and perspective.

The “conditionalities” imposed by the IMF on nations in financial straits are not unconnected with the way the body has been run. And we do not have to go back as far as the eighties, when Guyana, for instance, needed help.

This differential treatment became very clear recently when the very lenient conditions granted to Iceland after its financial system imploded last year are compared with the onerous ones imposed on the Eastern Tigers after the 1997 financial crisis.

In fact, one of the contributory factors to the present crisis stems directly from the dogmatic doctrinaire position adopted by the IMF in 1997, when the Western world would not suffer from conditionalities that placed a stranglehold on fiscal and monetary policies.

The lesson that those Asian countries (including China) learnt was that they should never allow themselves to get into a position where they had to seek help from the IMF. They resolved to build large foreign exchange reserves that they could deploy to ward off speculative attacks on their currencies. These attacks, ironically, had been facilitated by the liberalisation on financial controls imposed by the IMF in earlier interventions in the eighties.

To build up these foreign exchange reserves, the countries tightened their domestic belts and poured manufactured goods and commodities into the US, so as to receive greenbacks. The latter were recycled into US Treasury bonds and other US securities in such gargantuan quantities that interest rates there were pushed to the floor.

This process ensured that the dollar remained strong compared with the Asian currencies, and it kept exports from those countries very cheap. Not so coincidentally, it perpetuated the unbalanced global economy, with one set of countries running current account surpluses and the US plunging into record deficits. The US credit bubble generated by the almost zero interest rates had to pop at some time – which it did by 2007.

The question that must be asked is what was the IMF doing when the crisis was not only building, but when it was evident to all but the most casual observers?

As late as mid-2007, the IMF staff indicated that in the United States “core commercial and investment banks are in a sound financial position and systemic risks appear low.” Part of the problem is that even though the IMF had been established at Bretton Woods in 1944 to be the world’s financial policeman, its control by the US has never permitted it to play an impartial role.

For instance, diagnostic tools such as the Financial Sector Assessment Program (FSAP) run by the IMF (and the World Bank) to identify domestic financial sector vulnerabilities have never been applied to the US – as it was to the Asian economies or ours.

While claiming that such an exercise would tax the resources of the institution, the US has preferred dealing with crises in the club-like atmosphere of G7/8 and/or G-20, rather than empowering the IMF with the resources to deal with contingencies such as the one that brought all of us down.

It is unlikely that G-20, which will meet in London on April 2 to deal with the crisis, will rise to the challenge to create an independent, impartial supranational global financial watchdog. One test would be to see if they would be willing to create the necessary vast pool of Special Drawing Rights (SDR’s) that could replace the US$ as the global reserve currency as it was designed to do, and remove the advantage that the issuance of a fiat currency gives to the US. We are not even hopeful.

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