IMF - Kill or Cure?
THE crisis in Asia shows no sign of abating. Despite the efforts and the vast sums of money that the International Monetary Fund is applying to the problem, it has failed to restore stability. In Indonesia this week, despite a rescue plan worth $43 billion, matters took a decided turn for the worse. The Fund’s many critics are once again in good voice. They are a motley chorus: right-wingers in the United States who cannot bear to see tax-dollars spent on foreigners (whose only thanks, after all, will be to steal more American jobs); surviving left-wingers everywhere, who regard capitalism as evil and the IMF as its instrument; clever types who feel the Fund dispenses money too easily; other clever types who feel it is insanely stringent.
Of the particular criticisms directed at the Fund of late, some are fair, some unfair and some nonsensical. Critics are right that governments with small budget deficits should not have to make them smaller: Asia is not suffering from fiscal laxity or excess demand. Yet they are wrong, on balance, to say that interest rates should be brought down: even faster depreciation of the region’s tumbling currencies, which lower rates would imply, would add to the burden of companies’ foreign-currency debt. And one of the most popular charges—that the Fund insists on slow growth and rising unemployment in return for its help—is just absurd. If not for its intervention, the region’s recessions would be worse.
These macroeconomic issues matter, but they are not what matters most. The character of the IMF’s new operations in Asia—notably the package of $57 billion it has put together for South Korea—raises a bigger question. Should these bail-outs be happening at all?
The end of capitalism as we know it?
Invoking the risk of “systemic” breakdown is the most obvious way to justify the IMF’s intervention. Without an emergency injection of dollars, it is argued, companies in South Korea and the rest would default on their debts. This would cause distress elsewhere, especially in Japan, where stagnation could turn into outright depression. From there the crisis could spread to the United States, Europe and the rest of the world, as banks fail, credit disappears, stockmarkets crash and economies collapse. This is the nightmare that has driven governments, notably America’s, to support and indeed insist upon the Fund’s course of action.
How likely was this apocalypse, supposing the Fund had done nothing? Not all that likely, in fact. A deeper recession in South Korea, much the biggest of the four main invalids, would have slowed growth only a little in Europe and the United States. By itself, it would have posed no danger to the integrity of the global financial system. That risk would amount to something only if deeper trouble in South Korea caused Japanese banks to fold, if Japan’s authorities then failed to contain that crisis in their own monetary system, and (assuming the highest degree of contagion) if Western central banks then failed to protect theirs. This full sequence is implausible. Certainly, if the IMF had stood aside, markets worldwide would have taken a bigger short-term beating. But remember October 1987: a financial-market crash need not bring on a global depression.
To say the apocalypse was unlikely, of course, is not to say it was impossible. So you might ask, why accept even a small risk of such a dreadful outcome, if it can be made much smaller at moderate cost? Or at no cost. Recall the Mexican bail-out of 1995. Nobody feared a global meltdown in that case, though there were worries (justified, it turned out) about Latin American contagion. Guided by other considerations, America and the IMF nonetheless arranged support amounting to $40 billion. It worked. Confidence was restored. Growth in exports allowed the emergency loans to be serviced at market rates and repaid. American investors in Mexico didn’t lose their shirts and, in the end, American taxpayers didn’t pay a cent.
If such is the price of a multi-billion-dollar bail-out, you might think, what’s the problem? Suppose, in the present case, that the risk of a global depression is actually zero. Why not have the IMF rush to the rescue anyway—not to protect the world economy, but to save Asia from a worse recession than the interruption of capital inflows would otherwise cause?
What this argument ignores is the hidden cost of bail-outs. In a market-based system of finance, the risk of losing your money is not an avoidable nuisance but a fundamental requirement. If bank depositors, for instance, are assured that their savings are safe no matter what, they will exercise no care in choosing their bank, and a crucial discipline over the prudence of bank lending is lost. If the banks’ loans are themselves protected, the banks’ owners likewise have no incentive to require caution of managers—quite the opposite. This problem of “moral hazard” is all too familiar to central bankers. To promote safe lending in the long term, some risk must be left with depositors, and far more (it is to be hoped) with owners, but not so much as to make the system vulnerable to short-term instability. A trade-off must be struck, involving guarantees of one kind or another on one side and regulation to curb excessive risk-taking on the other.
The failure of Asia’s domestic regulators to strike such a balance is the chief cause of the region’s problems. For years, lenders and depositors felt too safe for their own good. Yet the Fund’s response to the crisis is to make another set of lenders, foreigners this time, feel safe. Some argue that the true cost of that costless Mexican bail-out is today’s crisis in Asia—because foreign lenders learned in 1995 that they would be rescued if their loans turned bad, and therefore lent more than they should to Asia. That may be over the top, but the point is not nonsense. And this time round, international lenders have learnt something else—namely, that for a country deemed too big to fail the IMF will underwrite private as well as public liabilities. The South Korean rescue is a qualitative as well as quantitative advance, if that is the word, on Mexico.
But spare a thought for the Fund’s exhausted staff. Striking the balance between short-term systemic instability and long-term moral hazard is hard enough for domestic regulators. How much harder for the IMF, which is only ever called in once the damage is done. Unable to act as an ongoing supervisor of Asia’s financial systems, all it can do is demand reforms that may or may not be carried through (though some, such as opening the region’s banks to foreign competition, will be harder to reverse than others). And how is the Fund to punish rescued lenders to the necessary extent? Rich-country governments are doing some of this by banging bankers’ heads together until they agree to reschedule their Asian loans. That is good: the lenders are not getting away scot-free. Yet the penalty for their folly is looking dangerously small.
In light of all this, would it have been better for the Fund to leave well alone? In our view, no. Given the small though not negligible risk of systemic failure and the opportunity to spare Asian economies much pain, it was right to intervene. Once that was decided, the circumstances required very large sums to be deployed (it remains to be seen whether even the present ones will suffice). But the balance of the argument was finer than the Fund and its principal sponsor appear to think—and chances to strengthen the case for action have been missed. After Mexico, governments should have found ways to punish rescued lenders more assuredly and more severely. After Asia, to neglect this again will be unforgiveable.
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