1
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 theirfunds .
Walter Wriston, former chair of Citicorp, one of the largest US financial corporations, boasts about the power wielded by 200000 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 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 thatin 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 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 neo-liberalism, 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$99 billion into Mexico alone. Almost three quarters of this amount went into short-term portfolio investment, that is, purchase of bonds and non-controlling shares. This kind of investment created very few jobs as about half of it went to purchase government bonds. Unlike in Asia where bank loans were the predominant form of credit, Mexico financed most of its budget deficits by issuing bonds. The government of Mexico used the bond market to rollover old debts into new credits rather than face the fact that its foreign debt could never be paid off. Moreover, only 27% of the money that flowed into Mexico was in direct investment. And much of that went to buy some of the 269 state-owned companies that were privatised by the Salinas government. The managers of these newly privatised companies typically reorganized production and shed approximately 400000 workers from their payrolls, creating equivalent unemployment.
For the money traders, investing in Mexico was very attractive. Not only did the Salinas government privatise state owned companies, but it also deregulated the Mexican stock market, known as the Bolsa. It also offered higher interest rates on government bonds and then invented a new type of financial instrument, the tesobono (bonified rate), to keep the money flowing in. The tesobono was a type of government bond that was nominally denominated in pesos but effectively indexed to the US$ exchange rate. This put the risk of losses due to a devaluation on the Mexican people rather than on the bondholder.
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.