This selection first appeared in the Wall Street Journal on 3 February 1998. George Shultz, a distinguished fellow of the Hoover Institution at Stanford University, was secretary of state under President Ronald Reagan. William Simon, president of the John M. Olin Foundation, was secretary of the Treasury under Presidents Richard Nixon and Gerald Ford. Walter Wriston is a former chairman and CEO of Citicorp/Citibank.
Last winter President Clinton and the International Monetary Fund shifted into overdrive in their effort to save the economies of Indonesia, the Philippines, South Korea, and Thailand–or, to be more accurate, to save the pocketbooks of international investors who could face a tide of defaults if these markets were not shored up. But that must be the last time that the IMF acts in this capacity. If it is not, further bailouts, unprecedented in scope, will follow. Therefore, Congress should allocate no further funds to the IMF.
It is the IMF’s promise of massive intervention that has spurred a global meltdown of financial markets. When such hysteria sweeps world markets, it becomes more difficult to do what should have been done earlier–namely, to let the private parties most involved share the pain and resolve their difficulties, perhaps with the help of a modest program of public financial support and policy guidance. With the IMF standing in the background ready to bail them out, the parties at interest have little incentive to take these painful, though necessary, steps.
Largest Bailout Ever
The $118 billion Asian bailout, which may rise to as much as $160 billion, is by far the largest ever undertaken by the IMF. A distant second was the 1995 Mexican bailout, which involved some $30 billion in loans, mostly from the IMF and the U.S. Treasury. The IMF’s defenders often tout the Mexican bailout as a success because the Mexican government repaid the loans on schedule. But the Mexican people suffered a massive decline in their standard of living as a result of that crisis. As is typical when the IMF intervenes, the governments and the lenders were rescued but not the people.
The promise of an IMF bailout insulates financiers and politicians from the consequences of bad economic and financial practices and encourages investments that would not otherwise have been made. Recall how the Asian crisis came about. Asia’s “tiger” economies were performing well, with strong growth, moderate price inflation, fiscal discipline, and high rates of saving. But these countries encountered a currency crisis because their governments attempted to maintain an exchange rate pegged to the U.S. dollar, while conducting monetary policies that diverged from that of the United States. Capital inflows covered up this disparity for a time. But when the Thai currency wobbled on rumors of exchange controls and devaluation, the currency markets quickly swept aside increasingly unrealistic currency values.
This led quickly to a solvency crisis. It became difficult, if not impossible, to repay loans made in foreign currency on time. The devaluations shrank the values of local assets, which were often the product of speculative excesses, unwise ventures directed by government, and crony capitalism. The private lenders and borrowers involved were in deep trouble. They were more than ready for money from the IMF.
The world financial system has changed fundamentally since 1945, when the Bretton Woods agreement was approved. The gold standard has been replaced by the information standard, an iron discipline that no government can evade. Foreign exchange rates are now set by tens of thousands of traders at computer terminals around the globe. Their judgments about monetary and economic policies are instantly translated into the cross rates of currencies.
No country can hide from the new global information standard–but the IMF can lull nations into complacency by acting as the self-appointed lender of last resort, a function never contemplated by its founders. When the day of reckoning finally does arrive, the needed financial reforms are extremely difficult politically because they are imposed by the IMF under duress, rather than undertaken by the countries themselves. The photograph, widely published throughout Asia, of Indonesian president Suharto signing on to IMF conditions with IMF managing director Michel Camdessus standing over him imperiously reinforces the perception of an outside institution dictating policy to a sovereign government.
Even though the IMF recognizes the causes of the crises, and conditions its loans on remedial measures, many observers believe that these remedies often make the situation worse. In any event they are rarely carried out in a timely fashion. There are already indications that several Asian countries have violated the terms of their agreements. Furthermore, IMF-prescribed tax increases and austerity will cause pain for the people of these nations, producing a backlash against the West. There is already talk of a conspiracy to beat down Asian asset values in order to provide bargains and control for Western investors.
And yet, because these countries are able to avoid fundamental economic reforms, their currencies continue to collapse. Indonesia, South Korea, and Thailand have each seen their currencies lose more than half their value against the U.S. dollar, despite the promised IMF bailouts. The loans from the IMF are, in fact, trivial when compared to the size of the international currency market, in which some $2 trillion is traded daily. These markets’ instant verdicts on unsound economic and financial policies overwhelm the feeble efforts of politicians and bureaucrats.
The IMF’s efforts are, however, effective in distorting the international investment market. Every investment has an associated risk, and investors seeking higher returns must accept higher risks. The IMF interferes with this fundamental market mechanism by encouraging investors to seek out risky markets on the assumption that if their investments turn sour, they still stand a good chance of getting their money back through IMF bailouts. This kind of interference will only encourage more crises.
Asian nations are facing financial difficulties not because outside forces have imposed bad economic policies on them but because they have imposed these policies on themselves. The issue is not whether the IMF can move from country to country dispensing financial and economic medicine. The issue is whether the governments in these countries have the political will to fix problems of their own making.
What should we do about the problem? We certainly shouldn’t follow the advice of George Soros, a well-known figure in the international currency markets, who has called for the creation of a new international credit insurance corporation to be underwritten by taxpayers of the member countries. The new institution, which would operate in tandem with the IMF, would guarantee international loans up to a point deemed safe by the bureaucrats running the organization. “The private sector is ill-suited to allocate international credit,” Mr. Soros writes in the Financial Times. “It provides either too little or too much. It does not have the information with which to form a balanced judgment.”
When will we ever learn? This appalling comment is exactly the opposite of the truth. The protected markets, not the open ones, are in trouble. Only the market, with its millions of interested participants, is capable of generating the information needed to make sound financial decisions and to allocate credit (or any other resource) efficiently and rationally. Governments and politically directed institutions like the IMF have shown time and again that they are incapable of making these kinds of decisions without creating the kinds of crises we are now facing in Asia.
The IMF is ineffective, unnecessary, and obsolete. We do not need another IMF, as Mr. Soros recommends. Once the Asian crisis is over, we should abolish the one we have.