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The Global Financial Crisis,
the IMF and Strategies Towards Resolving the Crisis
John Dillon, Ecumenical Coalition for Economic Justice, Canada
1. Asian Flu? Cancer? or Collective Madness?
Everyone agrees that the global financial system is suffering from a chronic illness. But just what is the
sickness that afflicts the world economy? North American news media call it the Asian flu. This description implies
that the problem is a virulent virus originating in far off Asia that has to be warded off with strong medicine from the
International Monetary Fund.
But as Susan Sontag writes in Illness as Metaphor: To liken a...situation to an illness is to impute guilt, to
prescribe punishment. Indeed the IMF's standard prescription is more like a punishment than a cure. The Fund's
bitter medicine extracts a devastating human toll by causing mass unemployment, cuts in real wages, hunger and
poverty. If we are going to impute guilt and prescribe punishment then let's make sure we correctly identify what the
sickness is and who the guilty parties are.
I think it is entirely erroneous to say that the current financial crisis has its origins in Asia. The financial
turmoil that appeared to start in Thailand in the summer of 1997 is only the most recent manifestation of a much
deeper malady. David Korten compares the disease to a cancer, a pathology that occurs when an otherwise healthy
cell...begins to pursue its own unlimited growth without regard to the consequences for the whole. This analogy
brings us closer to the truth. Out of control, finance capital is like a cancer because it destroys the world's real
wealth. In Korten's words: It destroys social cohesion when it breaks up unions, bids down wages and treats
workers as commodities.
While the cancer image describes part of the problem, I prefer to think of what is happening as more akin to
a kind of madness. Behind the supposedly anonymous force called the financial market is a group of very powerful
corporations who control a pool of hot money worth over US$13 trillion. I call the managers of these banks, mutual
funds, hedge funds, stock brokerages and insurance funds the money traders. Business Week describes how this
new class of investment fund managers rules over international financial markets: increasingly dominated by
American mutual-and hedge-fund investors, this investor class is far different from the patient banks and multilateral
development agencies that once provided the globe's international capital supply. This set of hot money managers
can move huge amounts of investments, from US Treasury bills, Mexican stocks to German government bond
options just by picking up the telephone or with a few strokes on a keyboard through the Internet.
The managers of hot money have become a sort of shadow world government that is irretrievably eroding
the concept of the sovereign powers of a nation state. Business Week cites a New York banker who says Countries
don't control their own destiny anymore. If they don't discipline themselves, the world market does it for them. How
do the money traders exercise so much power? One way is by deciding who and which projects get credit and who
and which projects do not. Another way they exercise power is by selling off the currencies and bonds of any
government whose policies displease them or which makes them uncomfortable for the security of their funds .
Walter Wriston, former chair of Citicorp, one of the largest US financial corporations, boasts about the
power wielded by 200 000 monitors in trading rooms spread all over the world and who conduct a kind of global
plebiscite on the monetary and fiscal policies of governments issuing currencies. Who gave the money traders
voting rights? We never did nor do we want them to have a veto over public policy. Yet most politicians act as
though they have no choice but to follow the dictates of the money managers. For the high rollers of international
finance, people are becoming less and less important both as producers and as consumers. Latin Americans no
longer speak about the marginalized; instead they refer to the excluded. In Colombia the excluded have even been
described as those who are disposable.
Individually, the money traders claim that what they are doing is only rational; they are trying to maximize
gains for their clients by buying and selling all kinds of financial instruments whether currencies, bonds, stocks or
more exotic derivatives. Indeed, above the money traders are the money savers: enterprises and ordinary people
who for some reason or another have liquid assets at some time and who need to preserve the value of that money
for future use. If in addition, they can make more value, they are ready to invest. The money traders therefore have
a pool of ready money lenders before them; so they invent financial instruments to attract the savers to their
shop…. With the liberalisation of financial markets over the world, the money traders invent new instruments
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continuously to attract money; these instruments are made to render service to the savers. A typical instrument is
for example a variable capital company whose collected funds will be sunk in shares of mining companies, or
another one in computer companies, another in communication companies; the returns on these funds will depend
on the rate of growth of the sectors, of the companies and of the region(s), country(ies) selected…for example
South America, Brazil, Chile, or South East Asia, Malaysia, Singapore, Thailand, Indonesia, Philippines… Each
fund is managed by a fund manager whose role is to ensure the best possible return to the money he places…
Some funds will specialise only in European company shares, or European company bonds, some in Government
bonds…. In such case the returns are practically known in advance and can thus be guaranteed to the saver by the
fund manager. Some funds specialise in high risk enterprises i.e. start-up companies in various sectors of activity,
or projects for which the results are uncertain or risky like luxury hotels, business centres, golf courses which luxury
hotels…. A successful fund i.e. a fund that publishes a high return over several years, e.g. >50% over 5 years, will
see savers bringing money forward to the fund manager; typically a fund manager may receive US$5-10 million
every morning which he has to allocate….
Thus a major problem for fund managers is to allocate the money they receive from the savers to projects
that are economically sound, and that will yield enough value added to pay interest and principal, but also be useful
to the country and its population and be ecologically correct… Because fund managers are ill geared to undertake
proper project evaluations based on multi-criteria (technical, social, economic, ecological et.), they rely on local
demands for project funding, and here enter lobbying, corruption, on both sides i.e. by the fund managers
themselves and by local influential people not always dedicated to improving the well being of they fellow
countrymen. So, collectively, what fund managers are actually doing is often hardly sane at all; they only try to make
money by trading financial instruments and they have little regard for the real economy i.e. activities that produce
goods and services to meet human needs with due respect to social ecological and other constraints, because this
is far to complicated for them.
An international financing institution like the European Investment Bank in Luxemburg (EIB) has a staff of
1400 people of which 1000 are involved in evaluating projects for which local demands are made to them, and the
evaluations are made according to a complex set of procedures, including technical and financial analysis, social
economic and ecological impacts, and impact on the balance of payments of the country. Projects are evaluated in
3 successive stages and are submitted for approval to the board of directors of the Bank, the latter being appointed
by the different member countries, only when the evaluations have met all the criteria required in consensus among
the evaluators. This procedure is designed to ensure that only good projects are financed.
Such a process has its drawbacks: only non risk projects can be financed and a great amount of time and
money has to be spent in the evaluation process, so only large projects can be examined. Risk and small projects
have to be financed by local entrepreneurs and it is here that fund managers can be particularly useful. But project
evaluations still have to be made from scratch or assessed correctly, otherwise projects will fail. Failure means that
the monetary obligations cannot be balanced by the effective production of goods or services. The value added of
this production should pay for personnel costs i.e. wages and social security costs, government taxes for financing
government services to the population, cover interest and principal payments for debts incurred for financing the
project and provide dividends to shareholders. The problem in our contemporary world is that the prices of products
on the world market are sometimes, to low due to competition, that workers' and peasant farmers' wages have to be
kept low enough to permit payments of interest and capital. So local demand cannot grow because of the lack of
purchasing power.
Costs of personnel and social security in emerging economies, as well as in developing and poor countries,
depend on the pattern of consumption in a particular country, i.e. on GDP, GDP/capita, its distribution and growth. A
major problem is that in emerging economies and developing countries GDP and GDP/capita are still low compared
to developed countries of the USA, Europe and Japan. The governments of emerging economies and developing
countries have opted for a pattern of production which favours exports of goods and services to the developed
countries. Because of high competition between developing countries to attract demand, because many developing
countries adopt the same policy, because the developed countries produce themselves equivalent goods and
services, and because the developed countries have many opportunities across the whole world, there is a glut of
offer of goods and services to the developed world, a situation which maintains low price levels on the world market.
Moreover, such goods and services are designed to meet the developed countries’ needs for luxury goods e.g. cell
phones, computer components, video and DVD equipment etc… not the needs of local populations which are more
basic and remain unsatisfied.
Money traders allocate most of their funds to projects that serve developed countries interests, i.e. the
production of luxury goods and services. When bad news comes to the knowledge of the savers who have invested
their money e.g. low economic growth compared to another region, or problems in the sector of investments e.g.
office buildings… the savers sell their shares and the fund manager has to sell in turn to be able to pay back. If the
bad news spreads and aggravates, there can be panic so savers will all want to sell at the same time. In the
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process, the money traders sell shares denominated in local money or in US$ and request from commercial banks
to paid in US$, at the fixed rate of exchange. Banks will rapidly be unable to honour all the demands of US$ and will
request foreign exchange from the Central Bank. In the process, the Central bank will then have to take local money
and give foreign exchange in its place at the prevalent (fixed) rate of exchange. The whole banking system of the
country is then strained as foreign exchange reserves of the Central Bank are depleted in favour of the money
traders. As the situation becomes more acute, speculation on a devaluation or floating of the local currency starts,
further putting pressure on the banking system and aggravating the situation. In the process, money traders buy
foreign currency at the prevalent rate of exchange including as futures, with the expectation to be able to settle their
account at the end of the term, with devalued local money, therefore making a profit which may be substantial. For
example, if a devaluation of 10% or floating of the currency is expected to occur, by selling 100 million US$ worth of
local money as futures, a trader will obtain 110 million US$ worth of local money after the devaluation of the
currency. The process continues to the day when, having depleted most of its reserves of FE, the government has
to devaluate of float its currency. At that stage, the Government has to ask the IMF to come in and replenish FE by
a bailout loan, which the IMF will allow but assorted with stringent conditions to curb the economy towards neoliberalism, the political philosophy of the developed countries.
This means that the problem can only be solved by demanding sacrifices to those who are already poor;
This cannot go on forever. What sane person thinks a balloon can be blown up forever? Eventually it will popup
unless there is some kind of decompression. But the money traders behave as though their game of casino
capitalism will go on and on for ever. David Korten sums up the problem in this way, a vicious circle: The more the
world of money becomes global, the more the linkage between the real world and the money world becomes
tenuous,... and the more the money system predominates. The challenge we face is to bring control back to the
local level, so that the financial system is guided by people whose view of reality is not only shaped by the numbers
they see on their computer screens as they trade in shares, bonds, stock options and other derivatives.
Part of the money managers collective delusion is to think that history cannot repeat itself. Over the last two
centuries the international financial system collapsed several times. Charles Kindlebereger has chronicled lending
booms that ended in busts in 1810, 1825, 1861, 1890, 1913 and 1928. We ourselves have lived through the lost
decades of the 1980-1990s that began with the debt crisis of 1982, followed by the Mexican peso crisis of 1994-95,
the world financial crisis in South East Asia and by the current crisis in Argentina. Where will the next crisis be?
Brazil?
If the image of mental illness appears far fetched, listen to the testimony of one of the money traders
describing the herd like behaviour of his peers. The speaker is Kerr Neilson who is an executive of one of George
Soros' large hedge funds. Speaking in the aftermath of the Mexican crisis of 1994-95, Neilson said: “what is being
made clear by the Mexican problems is that in trading securities, you have to be very careful about where these
funds are going and where the herd is... What a lot of people have missed, are the implications of the global flow of
funds i.e. where maniacs, like ourselves, are driving the flow of funds around the world”
No, I didn't make that up. He actually said “maniacs like ourselves, are driving the flow of funds around the
world”. Maniacs like Neilson first destabilized Mexico before moving on to Asia. An examination of the lessons from
the Mexican crisis is a good place to start with to understand their madness.
2. Lessons from Mexico
Over a five-year period from 1989 to 1994 the managers of hot money poured US$99 billion into Mexico
alone. Almost three quarters of this amount went into short-term portfolio investment, that is, purchase of bonds and
non-controlling shares. This kind of investment created very few jobs as about half of it went to purchase
government bonds. Unlike in Asia where bank loans were the predominant form of credit, Mexico financed most of
its budget deficits by issuing bonds. The government of Mexico used the bond market to rollover old debts into new
credits rather than face the fact that its foreign debt could never be paid off. Moreover, only 27% of the money that
flowed into Mexico was in direct investment. And much of that went to buy some of the 269 state-owned companies
that were privatised by the Salinas government. The managers of these newly privatised companies typically
reorganized production and shed approximately 400 000 workers from their payrolls, creating equivalent
unemployment.
For the money traders, investing in Mexico was very attractive. Not only did the Salinas government
privatise state owned companies, but it also deregulated the Mexican stock market, known as the Bolsa. It also
offered higher interest rates on government bonds and then invented a new type of financial instrument, the
tesobono (bonified rate), to keep the money flowing in. The tesobono was a type of government bond that was
nominally denominated in pesos but effectively indexed to the US$ exchange rate. This put the risk of losses due to
a devaluation on the Mexican people rather than on the bondholder.
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A further reason why the money traders were willing to pour so much money into Mexico was the
protection offered to them by the North American Free Trade Agreement (NAFTA). NAFTA's investment chapter
(which is the prototype for Multilateral Agreements on Investment and for any Investment talks that may take place
in the framework of the WT, prohibits the use of all kinds of performance requirements that might direct investment
into productive endeavours. NAFTA (Article 1109 and 1401/2) also prohibits any kind of restrictions on cross border
financial flows including profits, interest, dividends and consultancy fees.
The mania for speculative investment in Mexico ended with the crisis of December 1994 when the peso
was devaluated and a massive outflow of portfolio capital commenced which continued on into 1995. Mexico was
powerless to stop this haemorrhage as the maniacs took their money and ran. One reason why Mexico could not
use capital controls to stem the tide was because NAFTA leaves Mexico without the tools it needs to confront
volatile, fly-by-night capital. Under NAFTA Mexico cannot impose capital controls like those recently adopted by
Malaysia. NAFTA (Article 2104) requires any member country with external payments problems to consult with the
International Monetary Fund and adopt any measures the Fund might recommend. Mexico did just that during the
peso crisis and found itself in a deep recession. During the 19 months of recession that followed the peso crisis
more than 15 800 small and medium sized Mexican firms went into bankruptcy.
The austerity measures that are integral to all orthodox Structural Adjustment Programs (SAPs) of the IMF
diminish effective demand in the domestic market as peoples' incomes are squeezed. In addition to having to
accept IMF-dictated measures, Mexico also had to accept additional conditions framed by the US Treasury just as
happened in South Korea. For example, the rescue package required the further opening up of the Mexico's
domestic financial system. Foreign banks are now allowed to own 100% of Mexican banks.
The prime beneficiaries of the bailout were the Wall Street investment firms, especially Goldman Sachs and
Company, the firm that Treasury Secretary Robert Rubin used to run before he was appointed to the Clinton
cabinet. The Wall Street Journal reports that the Goldman Sachs ranked as the No.1 underwriter of Mexican stocks
and bonds on the US and European markets for 1992 through 1994. In those three years......Goldman underwrote
US$5.17 billion in Mexican securities. While investment firms were the biggest winners, the people of Mexico are
saddled with paying back an even larger debt.
In the wake of the Mexican crisis the IMF and the World Bank acknowledged that too much financial
speculation and too little real investment were root causes of the peso crisis. An IMF study on the causes of the
Mexican debacle includes a recommendation that emerging markets like Mexico should favour foreign direct
investment over portfolio investment. The World Bank's assessment of lessons from the crisis states: The
composition, origin, and use of capital inflows is very important...Keeping speculative capital under control, while
encouraging long-term investment - as Chile has done - makes eminent sense.
The recognition that Chile was able to avoid being swamped by the tide of hot money is very important.
Chile was the one major Latin American country that escaped the tequila effect that destabilized Latin financial
markets in the wake of the Mexican crisis. The reason Chile's finances remained stable is largely attributable to its
encaje system. The encaje requires that foreign investors deposit a portion of the capital they bring into the country
in an interest free account with the central bank. Furthermore foreign portfolio investment had to remain within the
country for a minimum of one year. While Chile has temporarily suspended the encaje in recent months, it has not
revoked the legislation and retains the authority to re-impose these controls in the future. But Chilean-type capital
controls are not an option for Mexico because they would be illegal under NAFTA.
While the international financial institutions recognized it would be rational to use capital controls they did
nothing to encourage them. On the contrary they ignored the lessons of the Mexican crisis and embarked on a
process to amend the IMF's Articles of Agreement to promote capital account liberalisation. This initiative takes us
in precisely the wrong direction. The IMF already required its members to allow free entry and exit of funds used to
settle current account transactions, that is, payments for trade in goods and services and interest payments on
loans. Under its original Articles of Agreement, IMF member countries were allowed to put restrictions on capital
account transactions, that is, on funds transferred for long-term investment or payments of principal. Chile's encaje
is an example of one kind of capital account restraint. Malaysia's exchange controls are another.
Despite the lesson of the Mexican crisis, money traders and the IMF defend the liberalisation of financial
markets in the name of greater efficiency. However, the historical evidence is that free capital flows do not lead to
an efficient use of Investment funds but rather to crises, panics and manias. As George Soros himself has written
The private sector is ill suited to allocate international credit. It provides either too little or too much.
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3. Asian Crisis Mirrors Mexican
The Asian crisis can be traced to the financial market liberalisation that opened up one country after another
to inflows of hot money. This led to sustainable asset price bubbles. The United Nations Conference on Trade and
Development says the crisis was initially one of low liquidity rather than of insolvency. But the IMF's strong medicine
turned it into a far worse financial trauma.
The Asian crisis dwarfs the 1994-95 Mexican financial meltdown which required an unprecedented US$
billion bailout mostly from the IMF and the US government. Asian countries have secured two and a half times as
much emergency financing.
Walden Bello's description of how finance ministries and central banks in Bangkok, Kuala Lumpur, Jakarta
and Manila attracted massive amounts of portfolio investment as shown in the graph could equally apply to Mexico:
liberalisation of the financial sector; maintenance of high domestic interest rates to suck in portfolio investment and
bank capital; and pegging of the currency to the dollar to assure foreign investors against currency risk.
The results are evident in the white columns on the second chart showing the build up of huge amounts of
portfolio investment and bank loans in five countries - South Korea, Indonesia, Malaysia, Thailand and the
Philippines in the 3 years prior to the crash of 1997. While the absolute amounts involved in Asia are much bigger
than in Mexico alone, the pattern is strikingly similar. (as can be seen when the transparency for Asia is laid overtop
the one for Mexico)
The discrepancy that appears for the first year of crisis (1994 in the case of Mexico and 1997 in the case of
Asia) is more apparent than real as these are annual flows and I do not have the data to adjust them according to
the dates when the crises actually began. If the Mexican devaluation had occurred in June (as did the devaluation
of the Thai baht) instead of in December then the two charts would be even more comparable.
What these charts show is a pattern of fly-by-night behaviour by money traders who recklessly pour money
into countries only so long as the returns are high but then abandon them at lightening speed at the first sign of
trouble.
In the wake of the Mexican crisis there was a revealing interview with a European banker in the Mexico City
newsmagazine Proceso. Speaking frankly on condition that he would remain anonymous, the banker was asked to
explained why financiers would invest in a country undergoing severe economic, political and social turmoil, where
there is a risk of total financial collapse.
The banker's response reveals the cynicism of the money traders:
When a financier lends money or invests capital, his problem is not to loan to someone or invest in an
industry that will not go bankrupt. Potentially everyone can go broke. His problem is to lend or invest up to 15
minutes before the crash...[and then] get out on time.
As with Mexico, the prime beneficiaries of the Asian bailouts are foreign investors from North America,
Europe and Japan. Ordinary people have to make sacrifices so that their governments can pay back every penny of
these emergency loans. As a condition for receiving IMF credits, Asian governments are required to take over or
guarantee loans from private borrowers assuring that foreign lender get repaid.
These bailouts protect private profits while socializing losses. As Martin Khor has written The IMF practices
double standards... On the one hand it insists that the governments play by strict market rules and not put in money
to aid ailing local financial institutions and companies. But on the other hand it wants the governments to pay back
all the external loans contracted from international banks, including the huge debts of the private sector that have
gone sour.
The money traders are involved in and profit from every stage of the cycle. They earn money on their initial
loans. They contribute though their speculative assaults to the destabilization of currencies. They reappear as
creditors when troubles begin as they take their money and run. They act as policy advisors to the IMF when these
institutions are negotiating the bailout packages. And they are the largest beneficiaries of the bailouts. Finally, they
underwrite the issue of public debt in creditor countries to finance government contributions to the bailouts.
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Transnational corporations derive another benefit from this cycle as they take-over foreign assets at
firesale prices. At the insistence of the US Treasury, the bailout agreement for South Korea lifted the ceiling on
foreign ownership of Korean industrial assets and made it possible for foreign firms to takeover Korean banks.
A similar phenomenon occurred in the wake of the Mexican crisis when foreign ownership rules for the
financial sector were relaxed at the insistence of the US Treasury.
A report in the Financial Times of London observed that The Chinese year of the tiger may prove to be the
year of the corporate predator. The British paper announces a string of foreign acquisitions of Asian financial, real
estate, pharmaceutical, packaging and telecommunications firms.
Now a similar process is occurring in Brazil which has sold off US$32.2 billion worth of state assets since
1991. Many companies were sold at prices far below their real value. For example the mining giant Vale do Rio
Doce went for just US$5 billion, only enough to cover two months of interest payments. Now there is even talk of
privatising municipal sewage and water. As University of Ottawa economist Michel Chossudovsky observes
Washington's hidden agenda is to take over productive assets and recolonise the Latin American continent.
4. More than a financial crisis
Michel Chossudovsky calls the current situation of falling standards of living for the majority of the world's
population the most serious crisis in modern history...more devastating than the Great Depression of the 1930s.
He compares the situation, not to a disease, but to financial warfare [which] knows no boundaries. In Korea,
Indonesia and Thailand [and now in Brazil] the vaults of the central banks were pillaged by institutional speculators
while the monetary authorities sought in vain to prop up their ailing currencies.
Central banks cannot defend their currencies because the amount of hot money available to speculators far
outweighs even the foreign exchange reserves of the industrial countries. The daily turnover of speculative trades
on money markets is twice as large as the total reserves of all industrialized countries' central banks.
The global financial crisis must be seen in the context of a world economy plagued by the twin problems of
overproduction and lack of effective demand. More goods are produced than can be sold because the workers who
produce them are underpaid. Michel Chossudovsky calls our era a global cheap labour economy. The underlying
problem is only made worse by IMF-sponsored Structural Adjustment Programs that impoverish millions of people.
One reason why so many of the billions that were invested in Asia went into dubious speculative activities
rather than production of goods and services was the lack paying customers. This lack of effective demand has
brought the world to the verge of global deflation that is falling prices due to overproduction.
As Canadian Labour Congress economist Andrew Jackson explains: When productive capacity exceeds
demand prices inevitably fall, unemployment rises, and wages are further put under downward pressure... It is this
kind of downward pressure - touched off by a financial crisis - which gave us the Great Depression of the 1930s.
Some business economists say that the way to avoid global deflation is to keep the US economy running at
full tilt. Business Week refers to the United States as the consumer of last resort warning that if growth slows down
in the US the world could end up with all sellers and no buyers--and on a path that leads to devastating deflation.
While stimulating imports into North America might stave off deflation in the short term, it does nothing to
solve the underlying problem. Under the IMF formula, Asian countries' recovery is predicated on an expansion of
cheap labour exports at the expense of internal purchasing power. But this spiral cannot go on for long as the
expansion of these exports is undermined by the destruction of demand. As Chossudovsky puts it the expansion of
exports [from low-wage] countries is predicated on the contraction of internal purchasing power. Poverty is an input
on the supply side.
The IMF medicine, as applied in Asia, is not only causing massive poverty. It is also endangering the world
economy. What is needed is another kind of adjustment where wealthy investors are made to absorb their share of
losses and the problem of overproduction is confronted by raising the incomes of the poor promoting effective
demand for necessities instead of luxuries. Trying to deal with overproduction of unneeded goods by promoting
more consumption by those who already have more than enough is no solution. In fact it threatens the ecological
health of our planet. The ecological footprints left by overconsumption of non-renewable natural resources in North
America are already too large.
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5. Strategies for Resolving the Crisis
The global financial crisis has put international monetary reform on the agenda in a way that was unheard
of just two years ago. We are at a crucial turning point as both progressive and regressive measures are vying for
approval.
Some of the so-called reform proposals on the table are clearly regressive. For example, the conditions
attached to the US$18 billion funding for the IMF by some Republicans members of Congress are truly deplorable.
Their demand that the IMF charge above market interest rates on loans is simply punitive. Other measure that are
currently on the policy agenda may appear progressive but amount to only minor tinkering when radical surgery is
needed. For example, the Group of Seven industrial countries talk about a new architecture for the international
financial system is so far vacuous and inconsequential.
Nevertheless, some worthwhile policy initiatives that many of us have been advocating for many years are
finally making their way onto the policy agenda. Our challenge, as I see it, is to sort out what are genuinely
progressive proposals from what is mere rhetoric.
An Insurance Fund for Speculators
Let me illustrate what I mean by a divergence between rhetoric and substance by first examining a proposal
that has attracted a lot of attention, not because of its merits, but because of its sponsor - the biggest hedge fund
owner of them all George Soros.
In an article published in the Financial Times of London on December 31, 1997, Soros sounds like
someone who agrees with much of my analysis. He writes that the events in Asia had exceeded everyone's worst
fears including [his] own and that the efforts of the IMF had borne no fruit. In Soros' own words:
The prevailing system of international lending is fundamentally flawed, yet the IMF regards it as its mission
to preserve the system...Without [the IMF], and without other official creditors, the system would already have
collapsed in 1982 and again in 1994-1995. With luck, we may pull through once again. But it is high time to
recognize the defects of the system and reconsider the mission of the fund.
The private sector is ill suited to allocate international credit. It provides either too little or too much. It does
not have the information with which to form a balanced judgment. Moreover, it is not concerned with maintaining
macro-economic balance in the borrowing countries. Its goals are to maximize profit and minimize risk. This makes
it move in a herd like fashion in both directions.
I find this analysis compelling, especially the reference to the inefficiency of the private sector as an
allocator of international credit. If the money traders allocated investment dollars efficiently the we would not have
one billion workers, or one-third of the world's labour force unemployed or underemployed.
Soros' proposed solution falls far short of what his own explanation would suggest is needed. His proposal
is for an International Credit Insurance Corporation as a sister institution to the IMF. This Corporation would gather
information about the economic policies of potential borrowing countries, and keep track of the extent of borrowing,
both public and private. With this information it would set a ceiling on the amounts it would be willing to insure.
Borrowers could obtain favourable terms for loans until the ceiling was reached. For amounts above the ceiling,
interest rates would rise and lenders would no longer have their loans insured.
In my view this proposal amounts to an insurance plan for lenders, not a fundamental reform. Soros'
scheme would not fundamentally alter the allocation of credit by the private sector nor would it return power to local
governments and local communities. In fact his proposal does not even a new idea. The World Ban already has an
underused function that can insure international loans. Nevertheless, Soros' critique adds credibility to calls for
measures that would actually regulate international capital flows.
6. Eight Discussion Points
When we published Turning the Tide: Confronting the Money Traders early in 1997 we were hesitant about
putting forward too ambitious a program for monetary reform because it appeared that most of our ideas were not
on anyone's political agenda.
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Now all the main ideas we discuss in our book are part of public discourse. Here I propose to discuss
seven proposals that are in our book and an eight promising development as a way of opening up the debate on
what proposals might help to bring about a progressive resolution to the current crisis.
1. A New Bretton Woods System
In Turning the Tide we discuss the idea of convening a United Nations Conference on Money and Finance
to create a new Bretton Woods system. While I still hope that such a UN Conference does occur some day, I do not
think that such an eventuality is imminent. I think we are more likely to make progress on particular measures to
cool down hot money than to achieve monetary reform in one grand moment.
Then why talk about systemic reform? The reason I think we should talk about a New Bretton Woods
system is because we need to seize the initiative in defining the agenda for monetary reform, just as civic
movements led the debate on the MAI. We need to make a forceful case for replacing the IMF with other kinds of
international institutions. If we are not out front in this debate then we are leaving the terrain open to other like
former US Secretary of State George Schultz and Citibank's Walter Wriston and University of Chicago's Milton
Friedman who have used the pages of the Wall Street Journal to proclaim: The IMF is ineffective, unnecessary and
obsolete. We do not need another IMF... Once the Asian crisis is over, we should abolish the one we have.
Yes, we should abolish the IMF. But Milton Friedman's libertarian prescription that governments should
simply get out of the way and let the money traders have free reign is no solution either. We need other more
progressive governance measures. Recently, British Prime Minister Tony Blair gave a speech in New York calling
for a New Bretton Woods for the next millennium. Although I have not seen the text, I am told that Mr. Blair's speech
did not contain any detailed proposals. Nevertheless, I welcome his initiative because it opens up an opportunity for
a debate on actually replacing rather than just trying to reform the IMF.
Talking about a new Bretton Woods enables us to juxtapose our critique of the actual workings of the IMF
and the World Bank with the original vision of John Maynard Keynes. At the time of the original conference in New
Hampshire in 1944, Keynes wrote the following: We intend to retain control of our domestic rate of interest, so that
we can keep it as low as suits our own purposes, without interference from the ebb and flow of international capital
movements or flights of hot money... Not merely as a feature of the transition, but as a permanent arrangement, the
plan accords to every member-government the explicit right to control capital movements. Before the actual Bretton
Woods conference took place Keynes wrote several drafts of his ideas for a post-war monetary system for the
British government. He even sub-titled one of them drafts a plan for financial disarmaments. What Keynes had in
mind was a monetary system that would have prevented the money traders from interfering with national monetary
and fiscal policies thus allowing sovereign states to keep interest rates low in pursuit of full employment.
Keynes wanted a system that would have obliged creditor nations, and not just debtors, to make
adjustments to rectify balance of payments disequilibria. Most important of all, both Keynes and his US counterpart,
Harry Dexter White, initially wanted members of the IMF to maintain full sovereignty over inflows and outflows of hot
money. In an early draft of his proposals for Bretton Woods, White even suggested that governments not allow
deposits or investments from another country without the approval of that country's government. When the New
York bankers got win of this key put pressure on the US Treasurer, Henry Morgenthau, to instruct White to modify
his draft which he did. Nevertheless, the original Bretton Woods agreement did allow national governments to use
some kinds of capital controls.
The decisive factor at the first Bretton Woods conference was not the intellectual merits of Keynes ideas but
the reality of US power. As the IMF has evolved over the years it has moved farther and farther away from Keynes
vision and become an enforcer of neo-liberal orthodoxy for the benefit of the money traders.
G-7 Still US Dominated
Despite all the criticisms that have been made of the IMF and its role in Asia, the recent October 30th
communiqué from the Group of Seven industrial countries appears to be repeating the history of the original Bretton
Woods conference with the United States imposing its position on partners. The key element in that communiqué is
more money (US$90 billion) and more power for the IMF. The G-7 endorses President Clinton's proposals for
establishing an enhanced IMF Facility to offer contingent short-term credit for countries pursuing strong IMF
approved policies.
Furthermore the G-7 communiqué reiterates the goal of the orderly opening up of capital markets in
emerging economies. The only qualifier is that this opening must be carries out in an orderly and well sequenced
manner. In the US and the IMF's view capital account liberalisation is still the goal. The communiqué papers over
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real policy differences among G-7 countries. French support for capital controls, a Canadian proposal for an
Emergency Standstill Clause in international loan agreements and British reservations concerning the advisability of
proceeding with full capital account liberalisation are barely acknowledged.
For example, a background paper prepared for Mr. Blair by John Eatwell and Lance Taylor argues that the
liberalisation of capital flows is inefficient due to the volatility of capital markets. Eatwell and Taylor argue for a new
World Financial Authority which would supervise the IMF and the World Bank and for abandoning the campaign to
rewrite the IMF Articles of Agreement to require full capital account liberalisation.
2. Coordinated action to bring down interest rates
Howard Wachtel's idea of international cooperation to lower real interest rates seemed like an exotic idea
from an academic economist when he first published his book The Money Mandarins in 1986. Yet an extraordinary
thing happened in September of this year. After much talk in the financial press about a coordinated interest rate
reduction among the central banks of the G-7 countries, the stock markets began to anticipate a rate cut. When the
actual interest rate reduction was only a quarter of a percentage point stock markets actually fell in the US because
rates had not come down far enough.
3. A Tobin Tax on International Money Trading
The idea of financial transactions taxes like the Tobin tax on currency trades has been around since it was
first floated by James Tobin in 1978. In the wake of the escalating crisis the proposal is gaining a new momentum.
The French newspaper Le Monde Diplomatique has even set up a non-governmental organization known as
ATTAC (Action pour une taxe Tobin d'aide aux citoyens) to campaign for the tax.
James Tobin's proposals for taxing international currency transactions with a modest levy of between 0.1%
and 0.25% is best known as a measure for slowing down currency speculation. However, the most important effect
of a Tobin tax would be to give countries more control over domestic monetary policy allowing for lower interest
rates to stimulate productive investment. In Canada most of the debate on the Tobin tax has revolved around not its
desirability but its feasibility given the propensity of the money traders to avoid taxes by shifting operations to
offshore tax havens or by inventing new financial instruments. However, there has been a breakthrough in the
debate with the publication of a study by Rodney Schmidt, an economist who formerly worked for the federal
Finance Department. Schmidt concludes that a Tobin tax, properly designed is feasible and can be unilaterally
imposed by any country on all foreign exchange transactions worldwide involving its own currency. Schmidt shows
that a Tobin tax is feasible if it is applied at the intermediate, netting stage of foreign exchange transactions rather
than at the initiation stage when deals are made or at the final settlement stage when payments are completed.
The other main argument for a Tobin tax is its revenue potential. I argue that at a time of declining Official
Development Assistance the revenues from taxes on international transactions should be used predominantly for
social and economic development. David Felix and Ranjit Sau estimated that a Tobin tax of 0.25% would raise
about US$300 billion a year by 1995 based on the Bank for International Settlements 1992 estimates of daily
currency trading of about US$1.3 trillion. The BIS has since reported that daily currency market activity reached
about US$1.5 trillion in April of this year. Thus, the revenue potential of a Tobin tax is even larger.
4. Substantial Debt Relief
The alternative to massive bailouts of the money traders is to write off or write-down unpayable debts, just
as capitalist societies rearrange corporate debts through national bankruptcy courts.
Moreover, debt relief for less developed countries must not be tied to orthodox Structural Adjustment
Programs. The World Bank and IMF's Highly Indebted Poor Country initiative offers too little debt relief, for too few
countries, over too long a waiting period and has too many harsh conditions attached, namely the obligation to
implement orthodox Structural Adjustment Programs over a six year period.
Nevertheless, the HIPC Initiative is important. It has put debt reduction, including the idea that World Bank
and IMF debts could be cancelled, squarely onto the political agenda.
In Canada we are taking part in a world-wide Jubilee 2000 debt remission campaign that goes much farther
than the insipid HIPC initiative. We are calling for 100% debt remission for low income countries and substantial
debt reduction for middle income debtors. Our criteria for eligibility for debt remission includes a more realistic
definition of what constitutes low income than that of the World Bank. It also includes criteria such as the
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relationships between government revenues needed for social spending and those dedicated to debt payments
that were absent from the original HIPC formula. Under our criteria the Philippines would be eligible for debt
remission whereas it is not among the countries deemed eligible for the HIPC initiative.
5. Renegotiate Economic Integration Agreements
When we were writing Turning the Tide our calls for renegotiation NAFTA especially the most objectionable
parts of the investment chapter that I described earlier seemed a pipedream. What was happening in actual
negotiations for other economic integration agreements was worse. Canada was negotiating a bilateral agreement
with Chile as a way of the Clinton White House which lacked fast track negotiating authority from the US Congress.
What was most disconcerting about those bilateral Canada-Chile talks was that Canada was asking Chile to give up
its encaje system of capital controls just to get a treaty with Canada.
Fortunately, the Chileans refused and eventually the Government of Canada relented. Now Canada's
Finance Minister says he actually supports Chile's encaje system of capital controls albeit only as a transitional
measure. This fact, along with the setback for the MAI in the OECD talks in Paris, has given us new hope that the
most regressive features of economic integration agreements can be rolled back.
At last April's Peoples Summit in Santiago, Chile we, representatives of civic groups in Canada formed a
Hemispheric Social Alliance with partners in Mexico, Chile, Brazil, the United States and other countries throughout
the Americas. One of the goals of this continental alliance is to redefine the economic integration agenda by
demand that the regressive measures contained in NAFTA's investment chapter not be incorporated into any
agreement for a Free Trade Area of the Americas. The suspension of MAI negotiations under the OECD was an
important victory, now we must demand that NAFTA not be used for as the basis for investment talks under the
WTO.
6. Use Capital Controls to Contain Hot Money
Back in 1996 it seemed foolish to buck the prevailing ideological winds by talking about legitimate uses for
capital controls to stem the tide of hot money flows and allow countries to pursue independent economic policies.
Now in the wake of the global crisis, the government of France went to the G-7 Finance Ministers meeting in
Washington in October with a proposal to allow capital controls. While the French view did not prevail over the
American, it is notable that some G-7 governments are now willing to defend capital controls publicly.
Now some mainline North American economists like Paul Krugman are writing articles in Fortune magazine
of all places arguing that foreign exchange controls could be used by Asian countries to allow for the adoption of
expansionary monetary and fiscal policies. While Krugman has reservations about the bureaucracy and
opportunities for abuse that controls might create, he pronounces them as a better alternative than trying to regain
the confidence of international investors by keeping interest rates high.
Then when Malaysia actually did impose exchange controls Krugman hurriedly wrote an open letter to
Prime Minister Mahathir that was published in a subsequent issue of Fortune. That letter emphasizes that Krugman
would only support temporary controls and that they should be carefully designed so as disrupt ordinary business
as little as possible.
7. Regulate Hedge Funds and Derivatives Trading
When we called for the regulation of derivatives trading it seemed like a cry in the wilderness since the high
flying hedge funds were the darlings of the investment industry. Then last September one of these funds, LongTerm Capital Management crashed and had to be rescued with a US$3.5 billion bailout from other Wall Street
investment firms. Long-Term Capital was perceived as too big and too important to be allowed to fail because its
bankruptcy might have destabilized the entire US financial system.
This spectacular failure occurred despite the fact this particular fund was staved by two whiz kid Nobel Prize
winning economists who thought they had developed a mathematical formula to beat the odds. They used
sophisticated computer programs to make massive wagers on the global financial casino. But as John Maynard
Keynes observed back in 1936 when the capital development of a country becomes the by-product of the casino,
the job is likely to be ill-done. Now the regulation of derivatives is firmly on the agenda.
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8. An International Insolvency Court
To avoid a new debt trap the world needs a tribunal that could arbitrate the write down of middle income
countries' debt ensuring that losses are shared by all creditors just as domestic bankruptcy courts rearrange the
debt of insolvent corporations.
Canada's Finance Minister Paul Martin, has taken a modest proposal to the G-7 that would be a small step
in this direction. Martin proposes that international loan agreements contain an Emergency Standstill Clause that
could be activated be debtor countries. After invoking the clause creditors would have 90 days to negotiate a debt
rearrangement. The biggest weakness in Martin's proposal is that the IMF Executive Board would have to approve
the negotiations. Similarly the UNCTAD Report on Trade and Development 1998 recommends that debtor
developing countries facing speculative attack on their currencies should have the right to impose unilateral
standstills on capital transactions.
A standstill arrangement would serve to ward off predatory investors and give countries to renegotiate their
debts. If no agreement can be reached with creditors then an international insolvency court should have powers
similar to national insolvency laws in the US and Canada which have provisions empowering tribunals to impose
settlements.
When an international insolvency tribunal is established it should be independent of the IMF. When I floated
this idea at a seminar in Ottawa last month, Jack Boorman, Policy Development Director at the IMF replied that an
insolvency procedure could be established under the IMF. In my mind this would be unacceptable as it would tie an
insolvency procedure to accepting IMF conditionality.
7. Conclusion
While reforms like a Tobin tax, permitting use of capital controls, deeper debt relief for low and middle
income countries and an international insolvency tribunal under the United Nations are all important, at the end of
the day primary responsibility for building just societies remains at the national and local level. We cannot expect
the money traders to manage our savings so that they are reinvested in ecologically sustainable development. We
have to do it ourselves. We must be wary of dependence on what the Brazilians Jubilee debt campaign says is a
fearsome Trojan Horse filled not with soldiers but with foreign finance capital which when brought into Brazil has
had disastrous results.
The eight points I have outlined above are not a complete formula for resolving the global financial crisis.
But I do believe that they offer more hope than the alternative which is to let the maniac financiers lead us over a
cliff into another Great Depression. I believe we must become involved in the debate with our own progressive
proposals because just as war is too important to leave to the Generals, financial reform is too important to leave to
the IMF and the money traders.