November 4, 2001

West should declare war on IMF

Posted in International Economy ·
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While cloaking itself in the language of economics, it is in fact anti-economic, anti-modern and regressive. Some would go so far as to suggest that economic fundamentalism seeks to reverse all the gains made by the profession since the great depression.

Economic fundamentalism is trying to move economics back into the Dark Ages. Its world is a place of shibboleths where sloganeering replaces hard thinking as the answer to all the economy’s ills. Despite having absolutely no grounding in conventional economic thought (or any appreciation of the real world), this secretive movement appears to be well financed and has come to dominate policy making in most western states.

Proper, or “reformed” economics, stems from the 1930s depression. The triumph of Keynesian economics set the standard and despite all the huffing and puffing of religious free marketeers, Keynesian economics forms the bedrock of the political economy of all western countries. Reformed economics is based on the view that the government matters. When the economy goes into cyclical recession, the government acts, taxes are cut, public spending is increased and interest rates are slashed.

In tandem, the exchange rate is typically allowed to fall. These measures inject demand into the economy and after a while, people borrow again, run down their savings and away we go. Irrespective of the origin of the recession, this is the normal course of events. Populations vote for reformed economics and the government usually takes this responsibility seriously.

As a result, there has never been a second great depression. Recessions since the 1930s have tended to be shallow, short affairs (this one in the US may be different, but I suspect not too different) and after some pain, the economy normally heads upwards again. Mr Keynes had allowed for a smoother, gentler business cycle.

However, somewhere along the way, this thoroughly logical view of the world has become compromised by fundamentalism. The fundamentalists reject the notion that the government matters. Nor do they accept the basic tenet that if the state sits idly by, a slowdown will almost certainly descend into a full-blown recession.

In fact, they contend the opposite. Fundamentalists insist, without any empirical evidence or theoretical logic, that the best response to a crisis is to raise taxes, cut public spending and raise interest rates.

An example of this perversion is evident in Argentina. Argentina is on the brink of default. The economy has been contracting for 28 consecutive months. Unemployment is rising, people are rushing to get savings out of the banks and the country is on the skids. What it needs is lower interest rates, bigger government spending and lower taxes. In addition, its exchange rate should fall to allow Argentine companies to export their way out of trouble. Instead, the IMF — the great Washington citadel of economic fundamentalism — is advising Argentina to do the opposite: to cut spending, raise taxes and keep interest rates extortionately high.

If Argentina heeds this advice, the country risks massive political instability and losing all the progress made since the Junta finally hung up its jackboots in the mid 1980s.

Why is a normal, relatively developed country committing economic suicide? Because the fundamentalists at the IMF believe that Argentina’s currency peg with the dollar, fixed at one for one in 1991 is more important than soaring unemployment and the rapid impoverishment of the population. This currency obsession implies that Argentina can’t be treated like Australia, Britain, New Zealand, the eurozone or the USA — all of which allow their exchange and interest rates to fall, and increase government spending when the recession bites.

The reason for this double standard appears to be poverty. There is one set of economic rules for the rich and one set for the poor.

Rich countries stick to the economic rules that every economics student learns in the Leaving Cert and as a consequence, have shallow, manageable recessions. Poor countries, by trying to attract speculative money, set down a set of simple rules that investors can understand and experience booms and busts. When the financial markets believe that a poor country is obeying the IMF rules, money cascades inwards seeking huge rewards.

This causes rapid booms such as those experienced by Mexico between 1990-1993 or the Asian Tigers from 1990-1997. When the financial markets get nervous and believe that the country is likely to break the IMF’s simple rules, panic ensues and the money flows back out again. Thus the fundamentalists have turned poor countries into places where hard economic thinking has been replaced by a set of confidence tricks used to persuade the financial markets that everything is OK.

Not so long ago, a much poorer Ireland was in the grip of the fundamentalists. Back in 1992, I was an economist at the Central Bank during our currency crisis. The fundamentalists who had long before taken over the Dame Street asylum screamed, “No devaluation” in the face of a weakening economy.

According to Ireland’s establishment Taliban, a devaluation of the pound would lead to a slump, a loss of confidence and permanent isolation from the big boys. (In reality, this visceral fear of devaluation was probably driven by the desire to avoid embarrassment for our Brussels-centric functionaries following a devaluation.)

The Irish Taliban allowed overnight interest rates to rise to above 100 per cent. A modest slowdown in 1991, associated with a mild recession in the US and a deeper slump across the Irish Sea, turned something bad much worse.

Unemployment and emigration rose. The high interest rates were meant to signal virility to the financial markets; it was a type of muscle-bound macho stance, revealing how much pain we could take. When the devaluation finally came, the economy boomed — precisely the reverse of what the fundamentalists had forecast.

Throughout the developing world the same sort of carry-on pertains. In Asia, initial crises in 1997 were made far worse by the IMF fundamentalists insisting that Asian governments cut back spending in the depths of recession or that they defend ridiculous exchange rates.

We saw the same mullarkey in Turkey earlier this year, in South Africa in 1996, in Brazil in 1999 and now in Argentina.

Playing games with the financial markets is for traders not countries. Indeed, when a country is on the ropes, the markets respond to every move by the fundamentalists in precisely the opposite way to that expected by them.

For example, when the IMF made a last gasp effort to prevent Russia from devaluing in July 1998 by lending $10 billion to the Russian government, the bank I worked for took this to be the last opportunity to sell Russian assets. Thus we were using the IMF as a “buyer of last resort”.

Likewise the higher the interest rates in a country, the quicker investors will get out. So not only are the IMF rules ruining the countries but the markets are already two steps ahead.

Given that it is poverty, inequality and a lack of hope that is driving young men to arms around the world, the best thing the west could do is declare war on the economic fundamentalism of the IMF. However, this would demand a really new, New World Order and this might be a step too far for the international status quo.