Fernando Fernández. Professor. IE Business School
15 November 2011
The IMF’s absurd proposal to buy debt from threatened European countries like Spain or Italy would have made it into a hedge fund, and it would have been developing countries that paid the price.
Ever since the Mexico peso crisis resulted in the so called tequila effect in the early nineties, the International Monetary Fund has been trying to find the formula to prevent financial contagion. To be more specific, it has been searching for the way to stop financial market dynamics from unfairly impacting countries that have no serious solvency problems, but which will end up having them if they fall out of favor with investors, who then pull out en masse causing spiraling debt differentials coupled with a credit crunch. But what it has not done so far is to suggest that it should serve as a highly speculative investment fund that would intervene directly in the debt market, stockpiling the currencies of countries under threat. This is exactly what Portugal’s Antonio Borges, the inexperienced head of the European Department, proposed. The suggestion was only on the table for the space of a few hours, because it was such a ridiculous idea, so out of synch with the nature and functions of the IMF, that he had to withdraw it before the end of the day.
The IMF has two tools that could be used to achieve such an objective, namely the precautionary credit line and the flexible credit line. The first of these, if I am not mistaken, has never been used, and the second has been granted to Poland, Colombia and Mexico, but none of these countries have ever had to, or indeed wanted to, draw on it. The advantage of this system is that it can provide a country with immediate access to IMF aid without having a program in place, and without having to temporarily give up economic sovereignty, and pay the inevitable political price. Countries who request this procedure must have a good economic base, a sustainable position in terms of balance of payments and public debt, and a financial system with no systemic problems. They also have to pass a pre-qualification process, and that is more problematic because the mere fact they ask for it is a sign of problems to come. Why would a country submit to such examination and international scrutiny unless it was afraid of entering into crisis? These financial tools were designed to help with the difficult and often volatile transition from emerging country to developed country, but nobody imagined that it might be needed for a European country, much less Spain or Italy. And therein lies the problem for which our good man Borges wanted to find a genial solution.
The desperate proposal serves to show the level of concern about the possible impact of the European crisis, on world economic stability, and the growing doubts that the Europeans are capable of finding a timely solution on their own. There is also a whiff of opportunism, as the IMF sees its chance to place itself at the epicenter of the world system, because in essence, the IMF actually volunteered to do what current statutes and the Maastricht Treaty prevented the European Central Bank from doing. But rush jobs and short cuts are not a good idea.
The rejected proposal would have supposed a deep change in the nature of the International Monetary Fund, converting it not only into a central world bank, capable of creating liquidity, but also rendering it as leveraged as the investment banks it criticized so fiercely in the post Lehman era. After all, it would be reasonable to assume that countries would not be willing to extend their contributions to their reserves assigned to the IMF, given that it would mean giving more the IMF than they already refuse to give the ECB. Hence the IMF will have to resort to the private capital market to finance the plan, and that would jeopardize its AAA rating and raise the cost of its traditional balance of payment adjustment programs. In short, emerging and developing countries would end up paying part of the European bail out - a growing and limitless part, because I fail to see member countries extending an indefinite guarantee to the IMF to cover it for all potential losses derived from their performance in the debt market.
Moreover it would need to make changes in its operative systems, because the dynamics of its intervention in the debt market would inevitably mean transferring decisionmaking powers from its Directorate, as it likes to call the Board where governments sit as shareholders, to its staff, namely the civil servants who would be responsible for carrying out specific operations with an extremely high level of discretionality and scant knowledge and experience, given that it is not their field of specialization.
Borges’ blunder, or rather the IMF’s, because knowing how it works it is difficult to believe that he came up with it all on his own, was no accident. Although I wouldn’t go as far as to state that it was part of a strategic plan, set to be revealed in installments, aimed at creating a new international economic governing body with a central world bank. I am more inclined to think that it forms part of investors’ general weariness of Europe. Get on with recapitalizing your banks, decide what you are going to do with Greece and its inevitable bankruptcy, create a European finance ministry and a single bank supervisor. Or dissolve the whole thing and just leave us alone.