The politics of the IMF

The IMF frequently steps in to offer financial aid when countries need it most, but how often does politics play a part in the solutions it supplies?

The politics behind the IMF
Managing Director of the IMF, Christine LaGarde  

With the global economy still reeling from two world wars and one devastating depression, the worldwide community decided on a new approach to international relations: liberalism. Forsaking the power politics of realism, proponents advocated robust international cooperation in a bid to revive the world economy and consolidate peace.

Such an approach took shape with the establishment of two supranational organisations, the first and biggest of their kind. At the historic New Hampshire-based Bretton Woods Conference of 1944, delegates from 44 nations across the globe came together to create the International Monetary Fund (IMF) and the World Bank. The former was officially founded on 27 December 1945 with 29 member countries; financial operations commenced on 1 March 1947.

From that first meeting in New Hampshire, it was established that the thrust of the IMF’s mission would be to promote greater economic cooperation within the international arena. Though today the IMF maintains its mandate has remained as such, over the years the organisation has evolved alongside a changing global landscape, becoming an extraordinarily powerful organisation as a result. And while it indeed plays the role of oft-needed international lender, there are those who argue the IMF actually causes far more harm than good.

Crisis in Indonesia
Perhaps the biggest mark against the IMF is its interventions in Indonesia during the 1997 Asian financial crisis. The crisis saw the entire region flooded by economic woes, during which the IMF recommended Indonesia float its currency. The result was disastrous: the rupiah sank immediately, tremendous inflation followed, as did food riots. Desperate for a solution, Indonesian President Suharto got in touch with noted economist and currency expert Professor Steve Hanke of Johns Hopkins University.

Many argue receiving a
loan from the IMF is when
a country’s problems
really begin

“Suharto knew that the inflation and food riots would continue, and that he would become extremely vulnerable, if not expendable – he was very clear about it”, Hanke told World Finance. “I agreed to become his chief advisor, and recommended that Indonesia should install a currency board system similar to Hong Kong’s in which the rupiah would trade at a fixed exchange rate to the US dollar, backed 100 percent by US dollar reserves… The rupiah would be fully and freely convertible.”

On the very day that Suharto announced Hanke was his new advisor, the rupiah appreciated 28 percent on both the spot market and the one-year forward market in Singapore. Having fully embraced Hanke’s suggestion, Suharto gave a ‘state of the state’ speech outlining the plan, known as the IMF Plus. This plan involved the structural reforms recommended by the organisation, alongside a currency board and a rupiah fixed to the dollar. Things, however, quickly turned sour.

Hanke explained: “All hell broke out politically and internationally.” The IMF, led by the US and the Europeans, he explained, strongly opposed the idea of a currency board. But what some considered suspect about this reaction was its misalignment with other initiatives endorsed by the IMF: mere months before, in February 1997, Hanke had guided the implementation of a currency board in Bulgaria with the IMF’s blessing. The outcome was outstanding: inflation stopped almost immediately, and the economy soon stabilised. The same strategy was also included in the Dayton Peace Accord for Bosnia and Herzegovina in August of the same year, again with the backing of the US and the IMF, the former of which Hanke acted as a representative for. Further still, it was just a matter of months afterwards that the IMF recommended the same course of action for both Brazil and Russia.

“It was very strange getting this huge push back”, said Hanke. “And in particular, [Bill] Clinton, who was the president at the time, he was pushing very hard not to do this. While I was advising Suharto, he called us three times, and Clinton said, ‘If you do Professor Hanke’s currency board, you’re not getting the $42bn [in foreign aid that had been pledged to Indonesia]’. Ultimately, Suharto stuck with the plan and was going to institute it, but then the US sent about half of the Pacific fleet to do exercises off the coast of Jakarta. The military got very nervous and backed off of the currency board idea… Suharto dropped it. This was in May of 1998.”

One can ask the question why, in the case of Indonesia, the IMF – and, in effect, the US – went against the regularly given prescription. Hanke suggested: “They weren’t worried that [the currency board] wasn’t going to work – they were panicked that it would work!”

Though the US had helped Suharto overthrow his predecessor and had forged in him a vital regional ally, the economic crisis of south-east Asia and growing corruption within the regime had made Suharto a looming liability for the West. Given the level of power Suharto wielded during his dictatorship, his ongoing leadership had become too risky for the US to allow it to continue.

Hanke told World Finance: “The main thing is that the US, as it often does, was engineering what it thought was going to be – and what it ultimately was – a regime change. They wanted to get rid of Suharto, and they wanted the Asian financial crisis to take care of him, which they thought would not be the case if they followed my advice and put in a currency board. So it was a very scandalous affair on the part of the IMF; it’s all recorded and it’s a real black mark because they were literally involved in the middle of overthrowing a government.”

Former President of Indonesia, Suharto

It’s all about US
In order to understand how and why this was even possible, it is necessary to go back to the very beginning. Though numerous countries were involved at the Bretton Woods conference, the US played an undeniably dominant role in establishing the IMF and dictating how it would operate. A crucial factor in its make up, and in the US’ ongoing influence within the organisation, was the distribution of voting power among member states. Rather than allocating votes in accordance with the size of a member’s population – which would be the most democratic approach to take – the US instead pushed for voting power to correspond with the volume of contributions made. Unsurprisingly, those contributions made by the US, the world’s biggest economy, were far greater than those of any other member state.

By contributing $2.9bn – double the amount made by the UK, the second biggest contributor at the time – the US was guaranteed twice the number of voting rights, together with veto privileges and a blocking minority. The manoeuvre enabled the superpower to secure near-absolute control of the IMF’s activities.

In order to further consolidate its dominant role, the US also claimed the right to remain fully informed about the financial comings and goings of every single member state, thenceforth and permanently.

Adding to some people’s belief that the US has used the IMF to peddle its own agenda is the fact the organisation’s headquarters – as well as those of the World Bank, for that matter – are located in Washington DC, just a short walk away from the White House, rather than near the UN headquarters in New York, as initially discussed. Hanke said: “The reality is that this should not surprise anyone. I mean, the United States is a big imperial power – why wouldn’t they have a lot of influence?”


The year the IMF was officially founded


Member countries today


The organisation’s annual quota

As an indication of just how important the IMF is to the US, Hanke pointed to an occasion that he witnessed while serving as one of President Ronald Reagan’s economic advisors: “Reagan himself actually personally lobbied 400 out of 435 congressmen to obtain an approval for a quota increase [for the IMF]… It is very rare… I never observed that kind of personal lobbying!”

When the idea of the IMF was first conjured up, the world was a desperate place. The international community was shell shocked from a level of human suffering that, even decades on, is beyond comprehension, while economically so much that had been achieved in the decades prior had been brought crashing down. In such a broken landscape, international cooperation was needed more than ever – even the need to feel as though something was being done and that change was going to happen had bourgeoned phenomenally.

While states may have joined the IMF with the very best intentions, the organisation that was discussed in New Hampshire is quite different to the reality that was produced. The IMF’s course has changed over the years in response to global challenges and complexities, yet it is now clear that shaping this course are the political motivations and inclinations of the global hegemon.

Hanke agreed with this theory: “It’s evolved into a very political organisation, and [Indonesia] was a perfect illustration of something that was completely politically motivated.”

Political building bloc 
There are three major events that can be singled out as having altered the course of the IMF throughout the years. The first, of course, was the Bretton Woods Conference. The second was the 1973 oil embargo.

In response to the growing credit needs of developing economies, the IMF initiated the Extended Fund Facility in 1974, which enabled member states to take loans of up to 140 percent of their quota. Without checks in place, many took out loans imprudently.

As the debt burden of developing economies mushroomed, it became impossible for western banks to default on these loans without collapsing. The IMF therefore stepped in to act as an international lender; facilitating the balance of payments had become its new mission. It was during this time that the IMF first earned a reputation for imposing harsh conditions, with many arguing to this day that it does so to entrap borrowers and, in turn, yield more power.

Third, there was the Mexican peso crisis of 1994-95, which was sparked by the currency’s devaluation against the US dollar in December 1994. The devaluation rattled markets and caused dire consequences for the Mexican economy, alongside a significant spill over across the region, and even beyond to Asia.

In a bid to limit the widespread impact of the crisis, the US organised a $50m bailout for Mexico, administered through the IMF. Ultimately, it was Mexico’s adoption of the Brady Bonds Initiative – which was formulated by the US Government, Wall Street banks and the IMF – that proved successful and alleviated the region’s turmoil. Hanke maintains the success of the Mexican deal was largely the result of the work of Jacques de Larosière, who he praises as being the last great managing director of the IMF.

History suggests the US has used economic crises to broaden the scope of the political power it wields through the IMF

At the time, however, a great debate arose as to whether a moral hazard had been created that would encourage serial borrowing in the future. Adding further to the criticism that had begun proliferating about the IMF was the outcome of its intervention in Mexico: under imposed economic reforms, the country experienced a severe recession. Banks collapsed, unemployment boomed, the population living in extreme poverty rocketed to more than 50 percent, and the average national wage dropped by some 20 percent.

Crucially, the Mexican crisis marked a significant transition for the IMF, from having an overarching goal “to rebuild the international economic system”, according to its website, to one that attempted to prevent crises through “strengthened and broadened… surveillance”. Hanke underlined: “It’s really like a hydra-headed monster – you do away with one mission, and then something else pops up.”

He added: “To drum up that new business and so forth, you become more political. So that is one cost that’s associated with the hydra – more politicisation of the whole thing and less emphasis on the technical. And if you’re not relying so much on the technical, you get weaker [with fewer] competent people.” It is this point regarding the IMF’s competency – or arguably lack thereof – that has led some to proclaim the organisation’s involvement actually causes irrevocable damage to a given economy.

Indeed, many argue that receiving a loan from the IMF is when a country’s problems really begin. Hanke went so far as to say: “I would say that [the majority of] countries that have been involved with IMF loans… have been countries that serially come back to the IMF, because they go from the frying pan into the fire with these IMF programmes. They all fail! So that’s the proof of the pudding.”

It can certainly be argued that the US has used economic crises, such as Mexico and the Asian financial crisis, to broaden the scope of the political power it wields through the IMF. Yet it is precisely because of this politicisation that the IMF has lost the technical prowess that enables it to promote economic progress in a recipient state.

Though this politicisation allows the IMF to peddle the agenda of its strongest member, it does so over the needs of those it claims to help in the first place.