Congress and the IMF's Power Grab

Congress and the IMF's Power Grab. By Judy Shelton
There are better ways to promote international economic stability
WSJ, Jun 18, 2009

A sad spectacle played out in Washington this week as House Democrats pushed through a $106 billion supplemental appropriations bill to fund our troops in Iraq and Afghanistan that also provides a whopping $108 billion in expanded credit to the International Monetary Fund (IMF). The bill, which will soon be voted on in the Senate, also permits the IMF to sell $13 billion in gold for the chief purpose of establishing a permanent endowment for itself.

The Obama administration went to great lengths to get the IMF its billions. Last week, congressional leaders received a letter that made a firm connection between global economics and global security. "We know from the 1930s that a protracted global economic slump can foster undesirable and unforeseeable reactions to hardship and adversity," it stated. "Financial hardship and poverty breed desperation, which helps terrorist networks to attract new recruits with messages of hate, violence and intolerance."

The letter then urged Republicans and Democrats to support the president's request for IMF funding. "We believe that the current instability poses a significant risk to the long-term prosperity and security of the United States." It was signed by Secretary of State Hillary Clinton, National Security Adviser James Jones, and, most notably, Secretary of Defense Robert Gates.

Whoa! Clearly the implication was that a vote against the IMF funds would be a vote against national security. But does such a claim make sense? To answer that we must first seriously consider: 1) the impact of international financial instability on global security, and 2) whether the IMF is a force for good in establishing a stable financial foundation for economic prosperity.

The era of the 1930s is invoked often these days, usually to compare today's economic recession with the Great Depression years triggered by the U.S. stock market crash on Oct. 29, 1929. The international impact was exacerbated as countries grew protectionist and turned inward, erecting tariff barriers against imported goods and engaging in competitive currency devaluations. Monetary nationalism and the breakdown of international trade worsened the downward global economic spiral, paving the way for Adolf Hitler to come to power in hard-hit Germany and leading to World War II.

Certainly, it was recognition of the damaging economic impact of currency chaos and its worrisome political implications that drove U.S. Treasury Secretary Henry Morgenthau to ask his deputy, Harry Dexter White, to begin devising a plan for coordinated monetary arrangements among the U.S. and its allies. It was Dec. 14, 1941, one week after the attack on Pearl Harbor. The goal was to lay the groundwork for a more hopeful future for the Allied nations. Instead of returning to the beggar-thy-neighbor policies of the 1930s, they could look forward to a stable postwar international monetary system that would provide a foundation on which to rebuild their economies and attain new levels of prosperity.

Ultimately, the plan was developed into the Bretton Woods agreement of 1944 -- which established the IMF to operate a gold-exchange standard. White had decided early on that maintaining stable exchange rates was a separate task from providing cheap loans to Allied countries. A different organization -- the International Bank for Reconstruction and Development (later called the World Bank) -- was designated to perform that function.

The IMF carried out its exchange-rate duties for the next quarter century, permitting foreign central banks to redeem excess dollars at the fixed conversion rate of $35 per ounce of gold. The period from 1947 to 1967, known as the "Bretton Woods era," marked the emergence of a new world economic order based on solid money and increasingly free competition in the international marketplace.

The system came under pressure in the late 1960s as the U.S. began to inflate its money supply to accommodate growing fiscal strains. A liberal agenda of increased spending for social programs coincided with an escalation of the Vietnam War. The U.S government borrowed money to pay for it all, forcing other nations to absorb some of the inflationary impact through their own fixed-exchange rates with the dollar.

The Bretton Woods system ended on Aug. 15, 1971, when President Richard Nixon "closed the gold window" -- i.e., denied the convertibility privilege and thus delinked the dollar from gold. Since then, in the absence of a monetary anchor, exchange rates have been left to "float." Today, the dollar's residual role as key global reserve currency reflects the waning credibility of the U.S. government in carrying out responsible fiscal and monetary policies. Which is why China, Russia, Brazil and other developing nations are now calling for a new global reserve currency to provide an alternative to the dollar. And why the IMF funding provision in the current wartime supplemental bill needs to be closely examined.

Officials concerned about global security are right to recognize that financial instability breeds discontent and fosters social resentment that can challenge ruling interests and topple whole regimes. The question is whether short-term fixes -- in the form of emergency loans to a flailing government, the sort of assistance the IMF is prepared to offer -- provide a solid foundation for economic growth.

Just as overdone fiscal "stimulus" undermines confidence in future prosperity due to its inflationary consequences, it makes no sense to throw money at struggling nations without providing the hope of a more permanent solution that will enable them to meaningfully participate in the global marketplace. Money meltdown occurs when governments face overwhelming gaps between revenues and expenditures; foreign investors abandon the currencies as they race to the exits, leaving bereft citizens with worthless paper.

Putting out financial fires has become the specialty of the IMF, and the temporary respite offered through emergency loans may mitigate immediate damage to certain vulnerable countries, especially those exposed to contagion from neighbors. But the IMF is not capable of fulfilling its original mandate to oversee a stable international monetary system because there is no international monetary system. And the IMF's desire to sell gold to obtain windfall profits to fund its own permanent endowment was never envisioned under the Bretton Woods Articles of Agreement.

That agreement offered the countries fighting World War II the prospect of a more stable world. All the IMF is offering our dangerous world is the prospect of lurching from one short-term economic fix to the next.

Ms. Shelton, an economist, is author of "Money Meltdown: Restoring Order to the Global Currency System" (Free Press, 1994).