The world is facing its worst economic crisis since the 1930s and no-one has a solution to the problems, least of all the IMF.
Much faith is being placed in the IMF to come up with both funding and policies to fix things. After all, the Bretton Woods institutions were created in the aftermath of the 1930s crisis to ensure there could never be a repeat performance.
But as one emerging market after another goes under, it’s clear the IMF is way out of its depth. Unless there is a complete and immediate rethink, the 1997 crisis will be remembered as the one the IMF presided over rather than cured.
The problem is that the IMF has been treating one kind of illness for so long it now has a single remedy. Usually called in to deal with countries living beyond their means characterized by budget deficits, large imports of luxury goods, inflation and easy credit the IMF’s usual prescription is austerity. Monetary and fiscal policies must be tightened to put the house back in order. A policy-induced recession works fine as it slashes consumer spending and imports.
The IMF has delivered this medicine for so long that many governments, and especially central banks, now instinctively respond to trouble by putting on the brakes.
In dealing with the Mexico crisis in early 1995, the IMF experienced its finest hour. With strong US support it put together a $50 billion package to restore confidence and helped Mexico recover from the effects of excessive monetary expansion that had sucked in imports.
The mistake is in treating Asia in the same way as Mexico. Asia’s troubles are not the result of too much consumption but of too much production. The region is noted for its prudent spending policies and Malaysia, the Philippines, Thailand and Indonesia have all been running budget surpluses. Inflation is low and foreign exchange reserves, until they were blown on futile currency support operations, were high.
But savings and investments rates were way too high. Asian countries have been investing around 30% of GDP a year, with Thailand boasting a massive 40%, way above any calculation based on depreciation, the need to equip new workers and technological improvements. This has created huge overcapacity and excessive production which in the absence of strong domestic markets has been dumped on world markets, causing export prices to fall.
To make matters worse a lot of investment has been financed by cheap foreign loans borrowed by the private sector without being hedged. Now the currencies have cracked the repayment of this debt is in doubt and banks’ balance sheets are ruined. The funds that have gone into property speculation and prestige projects are the most supect of all.
Responding to this crisis with the IMF’s classic belt-tightening measures will make the situation even worse. This will throw countries into a downward spiral of less demand, less corporate sales, less ability to pay back, and more bankruptcies. Unlike Mexico, Asia doesn’t have a friendly neighbour such as the US to pull it out of recession. With the Cold War over, the US feels less obliged towards the region while Japan, Asia’s natural partner, is either too sick or uncaring to bother. China would dearly love the role but doesn’t have the economic might.
To recover, Asia will have to run expansionary fiscal policies using fiscal policy to stabilize the economy. The region’s banks do need fixing and the argument for a credit squeeze that brings them down quickly is valid. But the situation is really too serious for this approach. Setting aside moral-hazard arguments, governments will have to use public money to recapitalize banks and strip out problem loans.
As an institution that has strayed far from its Keynesian roots, the IMF finds such remedies difficult to stomach. But it is the nature of crises that off-the-shelf solutions don’t work and that policymakers must be creative. The IMF’s orthodoxy for dealing with troubled countries is woefully inadequate.
Even economists whose economic philosophy is broadly aligned with that of the IMF’s don’t believe the fund is in control. They criticize the IMF for not moving fast enough early on and for failing to quarantine Thailand to prevent the crisis spreading.
The IMF’s philosophy of working at the invitation of sovereign governments is also under the microscope.
Governments naturally like to bail out their friends first and in Asia politicians and businessmen work hand in glove. In effect, public money is being used to rescue private follies. The hard-line approach is that governments either do exactly what the IMF tells them to or the country is allowed to default.
It may yet come to that. The IMF is not a bottomless pit and the imminent collapse of South Korea could severely stretch its resources. So far billions have been spent on currency support operations and bail-outs without the slightest sign of the crisis being checked.
Radical new thinking is needed now.
