The IMF: Is it up to the job?

Written by: Notayesmanseconomics

We have seen the credit crunch develop in various ways but a main theme has been the way that private-sector debt problems have been transferred to sovereign nations on such a scale that these days sovereign nations are increasingly looking for supranational organisations to take some of the burden off them.

Recent constructions in this area have not gone well with examples such as the European Financial Stability Facility being examples of how not to do it rather than the reverse. This means that politicians are increasingly looking to existing supranational organisations to help them out. Of these the pre-eminent one is the International Monetary Fund or IMF.

So the IMF finds itself in a situation where politicians consider it to be a form of International Rescue but as I shall explain below it falls well short of the powers and skills of the Tracy family and in fact could do with a character with Brains.

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What is the IMF’s role?

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This is important as it has undergone something of a metamorphosis in more recent times.

It has plainly changed from an organisation which helps with balance of payments problems to one which helps with fiscal deficits. Whilst this may suit politicians, taxpayers and voters should in my view be concerned about the moral hazard of one group of politicians voting to increase funds available to help another group of politicians which increasingly includes themselves.
So from an organisation which helped with Balance of Payments problems as it did in the UK in 1976 it has become one which promises aid for governments fiscal/budget deficits. The most extreme example of this was on May 10th 2010 when the IMF’s President Dominique Strauss-Khan promised some 250 billion Euros towards the “shock and awe” package that the Euro zone had constructed.

Not only was this a change of scale in terms of the amount of money offered it was also a change of modus operandi as one of the nations that came to be rescued Ireland has a balance of payments surplus and not a deficit!

Oh and one can also question as to whether the IMF actually had the money to back up the offer.

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The IMF Explained

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Quotas

A member’s quota subscription determines the maximum amount of financial resources the member is obliged to provide to the IMF. A member must pay its subscription in full upon joining the Fund: up to 25 percent must be paid in SDRs or widely accepted currencies (such as the U.S. dollar, the euro, the yen, or the pound sterling), while the rest is paid in the member’s own currency.

Special Drawing Rights (SDR)

The SDR was created by the IMF in 1969 to support the Bretton Woods fixed exchange rate system when the international community decided to create a new international reserve asset under the auspices of the IMF. The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges between members; and second, by the IMF designating members with strong external positions to purchase SDRs from members with weak external positions. In addition to its role as a supplementary reserve asset, the SDR, serves as the unit of account of the IMF and some other international organizations

The value of the SDR was initially defined as equivalent to 0.888671 grams of fine gold—which, at the time, was also equivalent to one U.S. dollar. After the collapse of the Bretton Woods system in 1973, however, the SDR was redefined as a basket of currencies, today consisting of the euro, Japanese yen, pound sterling, and U.S. dollar.

New Arrangements to Borrow

The IMF can also borrow money and these are explained on its website thus. The NAB is a set of credit arrangements between the IMF and a group of member countries and institutions, including a number of emerging market countries. The NAB is the facility of first and principal recourse in circumstances in which the IMF needs to supplement its quota resources. Once activated, it can provide supplementary resources of up to SDR 370.0 billion (about $579 billion) to the IMF.

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How much firepower does the IMF have?

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This is not as easy a concept as you might think but let me run through some numbers and I will put them in US dollars as so few people have any concept of what an SDR actually is.The numbers are from the IMF website and are from late summer.

Quota Value US $362 billion

Ability to borrow (NABs etc) US $ 600 billion.

Amount Lent US $ 69 billion

Amount Promised but not drawn US $213 billion

Potential Firepower US $680 billion

Are there problems with this?

The most obvious problem is that if we compare it with the scale of the problems in the Euro zone it will not go very far. For example Italy’s national debt is around US $2450 billion.

Also a reasonable proportion of the Quotas promised have never actually been paid (the IMF is rather reticent on this point) and the United States has yet to fully ratify the expansion which took place in 2009. As the biggest shareholder this matters rather a lot.

What about the schemes announce recently?

On November 22nd the IMF announced new measures to help countries in trouble although by restricting the help to “members with sound policies and fundamentals” it left quite a few scatching their heads as to whether it will be any use. Perhaps the real answer was found in its description of these new tools as being for “liquidity needs” in a world with solvency problems.

The measures announced turned out to be relatively small and relatively short-tern which IMF officials probably received with a sigh of relief as “A member needs to be assessed as having sound economic fundamentals and institutional policy frameworks, having a track record of implementing sound policies, and remaining committed to maintaining such policies in the future” seemed to exclude pretty much everyone! They probably felt they had spent enough time trying to explain why a circle is in fact a square looking at Greece and trying to justify what has been happening there.

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Where does the IMF stand now?

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In my opinion the IMF is already finding itself overexposed in the Euro zone as a result of the commitment made by Dominique Strauss-Khan. Should other nations call for help it could begin to run short of funds itself. This is before we get to possible needs in te rest of the world.

Its concept of austerity as a solution to fiscal deficits is not going well either. For example application of it in Greece has helped turn a fiscal crisis into an economic depression which has exacerbated the crisis. the situation in Portugal looks as though it is on the same slippery slope too.

So there are questions in my opinion not only about its changed role but its ability to fulfil it.

Can we just expand it?

I am afraid not as where will the money come from? Politicians should stop implying that the help provided by the IMF is in effect free. For example US Treasury Secretary Geithner suggested that moves to expand the IMF “wouldn’t cost a dime”. This is one of those superficially true statements that are very dangerous. If you are liable for something it does not cost anything until it goes wrong. Any proper accounting system allows for the possibility of things going wrong. After the experience of the last three years we should know the implication of sticking your head in the sand like an ostrich and assuming there are no problems around…

So rather than an organisation with Thunderbirds galore to help us out we find one with limited funds and reduced credibility just at the time it is most in demand.

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