Global South debt crises and the evolution of the international monetary system
Fifty years on from the collapse of the Bretton Woods system, the role of the international monetary system and international financial institutions in managing the global economy are in question.
What role should these institutions have in fostering development, closing the North-South divide, tackling inequalities, and promoting a global green transition? Can a more progressive international monetary system be forged?
In May, a Phenomenal World event tackled the political, economic, and legal questions thrown up by the present state of the post-Bretton Woods system. A recording of the event can be seen here. The transcript was edited for length and clarity.
A conversation on the IMF and the legacy of Bretton Woods
Karina Patricio Ferreira Lima: It’s been fifty years since the collapse of Bretton Woods. As the global pandemic, various economic shocks, and a generalized state of financial instability have now converged into a debt crisis, the inadequacy of the international monetary system is on full display.
The aim of this panel is to examine the legal, political, and economic problems that plague multilateral institutions and, in light of that, to consider paths forward. What systemic changes have occurred in the international monetary system since the end of Bretton Woods, and what have been their distributive and developmental consequences?
With its system of fixed exchange rates, Bretton Woods relied on countries’ ability to manage their capital accounts. With Nixon’s unilateral decision to end dollar convertibility to gold, this combination of fixed exchange rates and capital controls gave way to the emergence of the so-called fiduciary dollar. The centrality of the dollar in this new system, combined with capital-account openness and hyper-financialization, has generated great financial instability and exacerbated inequality between the Global North and the Global South.
The monetary arrangements currently in place generate a significant gap in access to liquidity between the core and the periphery. There are some procyclical effects in the periphery: money flows in search of higher interest rates when things are going well, but flees at the slightest sign of instability. Capital flight further destabilizes the economy and exacerbates inequality.
While core banks are able to use bilateral currency swaps with the Federal Reserve, developing and emerging countries typically rely on accumulating substantial foreign reserves to avoid monetary instability and payment problems. They can also resort to the IMF as a source of emergency liquidity or tap into regional financial arrangements, though these resources tend to be insufficient.
Because the conditions typically attached to IMF financing are highly procyclical, emerging countries have in recent decades decided to accumulate foreign reserves to avoid being subjected to IMF programs. Because these reserves are accumulated in treasuries, this results in a massive transfer of wealth to the Global North at an aggregate level. These are misallocated resources, however, which could otherwise be used to fund industrialization, low-carbon infrastructure, and other development initiatives. Despite their monetary character, there are no legal mechanisms to deal with insolvency crises at the periphery.
There are also no institutions explicitly geared towards promoting development. The World Bank acts as a market maker for financiers at the core by enforcing structural adjustment in the periphery. It shifts risk away from those financiers, using public resources to leverage private financing. It seems clear that the rules of the game are exacerbating global inequality.
Misery is increasing in vast segments of the global economy. Combined with the crisis of multilateralism, it seems likely that the post-Bretton Woods institutions will fragment and ultimately decline in importance. But what will replace them? In the following discussion, we unpack some of these questions.
Richard Kozul-Wright: Looking at the world economy today, the growth dynamic in advanced economies and, in particular, in the United States, is key. The financialization of the US economy and its changing role in global markets is critical to understanding the demise of organized labor, the rise of intellectual property as a source of wealth, and a rent-seeking form of wealth creation. The domestic and international shifts are deeply intertwined.
MONA ALI: One clear outcome of the present crisis is increased dollar weaponization. The unilateral sanctions that have been imposed by the G7 effectively constrain and disable developing economies—we can go back to the Bank of England’s freezing of Venezuela’s gold reserves in 2018. Janet Yellen recently proposed the reshoring of supply chains, which has dire implications for the Global South. We’re also seeing these escalatory tactics with the US Treasury’s proposed secondary sanctions on countries purchasing Russian oil. Developing and emerging economies are cornered by over-compliance with sanctions and acute crises, preventing countries like Afghanistan and Yemen from converting their Special Drawing Rights (SDRs) into hard currency.
KPFL: The emergency liquidity available to developing countries is channeled through the IMF, which puts the burden of adjustment on the jurisdiction facing the balance of payment problem. This has recessionary effects. Apart from the attempted 1990 reform to the Articles of Agreement, which proposed liberalizing capital accounts, the Fund has not had a legal mandate to regulate capital accounts since its founding. With increased financial instability, what it can do is exercise its surveillance and technical advisory functions to advise countries with its institutional view.
When it comes to lending, there is a legal obligation to make sure that the general resources of the IMF are not used to fund substantial and rapid capital outflows. Article One of the Agreement states that one of the Fund’s key purposes is to shorten the duration and lessen the degree of disequilibrium in members’ international balances of payments. For this reason, Article Six entitles the Fund to request capital-management measures as a condition to access this liquidity. If we construe the scope of the IMF obligations and entitlements on the basis of those two articles, we should agree that there is a legal obligation to request those capital management measures when it’s reasonably foreseeable and, when it’s not, to request that the general resources of the Fund be used to meet a large or sustained outflow of capital. This is not, however, what we see in practice.
What role does the IMF currently play in the international monetary system, and is that role compatible with its legal mandate?
CHRIS MARSH: The Bretton Woods Agreement gave the IMF some responsibility over members’ balance of payments. Prior to that, under the classical gold standard, there was an understanding that the balance of payments had an automatic adjustment connected to it, which was related to gold flows. This adjustment mechanism was built in, but the attempt to rebuild the world economy after the Great Depression nevertheless failed. The balance of payments constraint was intensified by trade wars and competitive devaluations. At Bretton Woods, it was agreed that the balance of payments had become a public-policy issue. But with the end of Bretton Woods, the emphasis on the adjustment mechanism—that is, the means by which a country’s balance of payments adjusts—has been almost entirely forgotten.
At its formation, the IMF sought to adapt the legal legacy from Bretton Woods, including balance of payments support under adequate safeguards. It developed its approach to financial programming over time through the adequate safeguard provision. There were a series of sector-consistent macro accounts that would underpin any lending agreement, and that in turn would underpin the adjustment mechanism whereby the country’s balance of payments would be adjusted temporarily to the external constraints that it faced. If a fundamental disequilibrium couldn’t be resolved, there would be an expected devaluation. This framework existed in the 1950s and ’60s but with hyper-financialization and the growth of capital flows, the nature of the balance of payments problem changed—it became less an internal problem of fiscal spending, and more an external problem where a country borrows money from abroad and then that money suddenly leaves.
That doesn’t change the accounting constraints or the need to build a financial program. However, with the Asian financial crisis and the Mexico crisis in the 1990s, and then later with Argentine crisis in 2000–2001, the IMF framework was silently abandoned. Now, when the IMF arrives in a country, it produces documents that are analytically inconsistent. That results in a situation in which countries are forced to adjust to external constraints that they have no chance of meeting. We have a world where capital is freer than ever before, but analytically and intellectually we are more dysfunctional than we’ve been for decades of international monetary history.
LARA MERLING: For decades, IMF conditionality has pushed countries to liberalize their capital accounts. In 2012, they adopted the position that in certain situations, preemptive capital controls on inflows, but not outflows, were viable. This was seen as a step forward, but it was actually a backwards step from the Articles of Agreement. After the collapse of Bretton Woods and the start of the structural programs, the Articles did not change. What changed was how the IMF operated, and how its new conditions departed from its legal mandate.
RKW: The Fund emerged in a very particular ideological environment. Managing markets was embedded in the ideology of the time, and the Fund reflected that. They recognized that in order to preempt advanced economies from adjusting through austerity measures, they would need some sort of short-term liquidity support in response to current-account difficulties. Most of the lending in the early days of the Fund through to the 1970s was to advanced economies; in the ’70s, the US repeatedly borrowed from the IMF.
Now, the major borrowers from the Fund are peripheral economies, and that’s a significantly different power structure. In that context, the aims of the Fund are much less about managing markets and much more about enabling flows of capital. They then have to respond to the crises that these enabling actions create. The size of the flows are so significant that, ironically, the Fund doesn’t actually have the resources to respond. It needs partners to manage these crises. This was the case with Mexico in the early 1990s, again in Asia and Russia, and all the way through to Greece.
MA: I wanted to talk about what was dropped in those original Anglo-American negotiations of 1944. Keynes’ White plan for capital controls included not only controls for countries experiencing capital flight, but also for the countries to which capital was fleeing—tax havens. That was left out of Article Six, in large part because the US is not compelled to place a legal gate on capital inflows. We see this right now with net outflows from emerging markets since the war in Ukraine.
You guys have done fantastic work criticizing the IMF for not holding to the articles of the Agreement, but there’s also room to revisit the articles themselves. Michel Camdessus, former IMF Managing Director, recently brought this up—the Global South cannot be paralyzed by the statutes of the IMF.
Chris, the IMF previously worked on financial programming and sectoral disequilibrium, is that no longer the case?
CM: As capital flows have become more complicated and more difficult to manage, the tools that we use to manage them have become more simplistic. In the beginning, IMF financial programming would involve building a set of macro-financial accounts so that the macroeconomic outcomes were underpinned by financial flows, including through the central bank, and through the balance of payments and the banking system. This ensured that the programs’ objectives and in particular the GDP growth objectives, could be meaningfully met, while also building a buffer of reserve assets. That was the stereotype of how the IMF worked.
But the 1990s—with the capital-account problems and the second generation currency crises—showed that the IMF was not designed for these issues. The Fund was originally building programs to address overprinting to finance the fiscal deficit—the external problem was a reflection of the internal imbalances. The second generation currency crisis was an external problem, so it’s not clear that the balance of payments work makes sense anymore. In Paul Blustein’s book The Chastening, he quotes a mission chief who tells him, in reference to the Fund’s financial programming during the Asian crisis, “It’s not clear our economic theory works.”
At that stage, it seems to me that the IMF threw the baby out with the bathwater. They maintained that the framework still worked, but that it needed rejigging. They made the case that you need to change domestic flows to meet the external financing outflows, rather than changing the external flows to meet domestic problems. It’s because the IMF suddenly dropped this iterative approach to different financial-sector accounts, that there are massive inconsistencies and black holes in its program document today.
In the Argentine program, Karina and I noted three closely linked problems. The first is that there was a fiscal adjustment without any accompanying external adjustment. This is basically the idea that as long as you impose fiscal austerity to bring about primary surplus in the fiscal accounts, fiscal sustainability will be achieved. It doesn’t make sense because quite a bit of debt in these cases is external, so in order to service the public debt, you need the external accounts to generate the foreign exchange to service the external component of the debt. In Argentina’s case, they assumed a fiscal adjustment of maybe 5 percent of GDP. But if there’s no external adjustment, you can’t service the external debt. It won’t be sustainable from external accounts, and the whole thing will not fit together.
The second problem is that they assumed that there would be a massive accumulation of reserve assets of the international reserves at the central bank. However, there were several inconsistencies within the document in how they presented the balance of payments—rollover rates of foreign investors, and so forth. Most importantly, they assumed that residents in Argentina would bring back tens of billions of dollars that they held abroad. But this wasn’t the case; those residents were taking money abroad because they were worried that the program would not work.
The third problem is that the central bank itself was printing money to finance its own deficit; it was issuing its own liabilities in lieu of the government issuing them. In other words, it was financing the government, then issuing these central-bank bills to mop up the liquidity. It was a fiscal problem that was hidden on the central bank balance sheet. They hadn’t programmed at all how this was going to get serviced and paid for—another big accounting black hole. The point of the paper is that alongside the legal problems, the macroeconomics of IMF programs just don’t add up.
If it were an accounting firm, IMF documents would resemble an Enron-style fraud. Yet everybody turns away and says, “they’re doing their best.” But they’re not doing their best. They are destroying livelihoods in countries that they are supposed to help.
KPFL: What short and long-term reforms would be needed in the international monetary system to make it fit for achieving the UN Sustainable Development Goals (SDG) at a global level?
RKW: It’s always surprising how “short term” solutions can actually prove extremely difficult, given the way in which the system has evolved over the years. For example, it is ridiculous that the head of the organization has to be from Western Europe; trying to change that, however, is extremely difficult. In response to Chris’s point, the level of conformity amongst IMF staff is quite astounding. There’s a lack of diversity not just among the economists they hire, and they don’t really engage with other disciplines in the social sciences. There’s somehow a belief that their mechanistic brand of economics is the pinnacle of intellectual prowess, and everyone else is in some way secondary or inferior.
Given the financial pressures in many developing countries and the investment demands implicit in delivering SDGs, they are currently undeliverable. From our perspective, delivering SDGs would require the restructuring and, in some cases, the cancelation of debts. Obviously this would require a fundamental institutional change, which as a creditor the IMF would resist. At the least, we should have a more independent process. The IMF should be a neutral venue that can properly manage debt in a way that allows countries to work through their problems and come out at the other end with some hope. The IMF will not contemplate that—we know what happened to the discussions around the sovereign-debt workout mechanism in the early 2000s.
In Washington a couple of weeks ago, we met with a senior IMF official who simply stated that the Board will not tolerate this type of institutional change around restructuring. But there’s a much gentler way of moving the needle on issues of debt. This would involve advancing a set of principles for sovereign-debt restructuring, around which any sort of restructuring exercises should be framed as soft law, without having legalistic power. When that was attempted in 2015 with Argentina, the IMF simply opted out of any discussion on a set of principles. Soft law is not the thing you think would antagonize parties, but because the advanced economies were not really interested in engaging, the IMF didn’t engage either. UNCTAD was the support for that initiative at the United Nations. Soft law should not be a deeply ideological fight, but the resistance was extremely strong.
Intermediate-term proposals that we’ve offered include establishing some sort of multilateral swap facility inside the IMF. We know how important the Federal Reserve has become in terms of offering swap arrangements in response to crisis. These are always biased as the Fed only offers those facilities to certain favored emerging economies. We don’t see any traction to that idea inside the Fund, although it would be an obvious way of dealing with some of the problems in implementing SDRs. We’ve reached a sad state of affairs, where the obvious solution to using SDRs more effectively is to recycle them from the countries that don’t need them to the countries that do. That would seem to be a mechanical issue, but it has become highly politicized to the point where it may be easier to have another very large allocation, even though that allocation will suffer from the problems of the bias in the system, because SDRs are allocated on exposure on the basis of the quota system.
I don’t think there’s any doubt that we need the Fund. Indeed, we would argue that we need a bigger Fund. Compared with the size of the global economy in 1945, the Fund has shrunk hugely over the course of the last 75 years, and its challenges have only increased. But a larger IMF will need these accompanying changes that we’ve mentioned. In the case of debt, we need to talk about more serious radical changes to the institutional architecture if we are going to genuinely make progress.
LM: Most people know about the $650 billion SDR allocation of August 2020, as a response to the pandemic. Many of us here were advocating for a much larger allocation and are still advocating for more. As Richard said, because of how the system is designed, only about $200 billion of that original allocation went to the countries that needed it. At CEPR, we published a paper with Kevin Cashman and Andres Arnauz tracking the use of these SDRs—90 countries spent their SDRs, and it was the only meaningful debt-free relief that they received.
In the end, it does all go back to IMF quotas and US power. The US is very resistant to any type of meaningful change. Even decades ago, when they pushed bringing neoclassical economics or Reaganomics into the IMF, they did so without changing the Articles of Agreement. We see the US talking about the rules-based international order, but they change the rules according to their own agenda.
RKW: I don’t think a single dollar of SDR has actually been recycled, is that correct?
LM: The IMF’s Resilience and Sustainability Trust (RST) was the first mechanism to recycle, and it was supposed to provide long-term loans for climate and health needs. They got about $40 billion in recycled SDR commitments. It started with an idea to recycle and provide financing, and was ultimately linked to an IMF program. Countries that already go to the IMF might use it, but it’s not a meaningful additional financing tool for climate or support.
MA: Andrés Arnauz estimated $550 billion in unused SDRs lying in advanced economies’ central banks or Treasury accounts. The Articles of the Agreement say that these can be bilaterally donated. I do want to ask you, Richard about your views on the new RST, because as you said, Laura, it is a loan rather than a donation.
RKW: We are still waiting to find out the lending conditions. The Fund attributes a lot of importance to transparency when it comes to developing countries. but they don’t necessarily promote it when it comes to their own practices. That sense of hypocrisy needs to change.
This is again part of the evolution of the international financial institutions; the Fund has begun to move into areas of lending that it was not originally set up to to deal with. Arguably, the IMF should not be responsible for financing around the climate, whether it is for mitigation or adaptation. The $40 billion figure itself is not the kind of number that developing countries want to hear when it comes to financing the climate transition. Of course, the numbers are much larger, and they will almost certainly come with conditions attached.
My impression from the last meeting in Washington is that developing countries are increasingly frustrated by the fact that none of these proposals deal with the major problems they face—immediate adjustment problems on a significant scale. Sri Lanka is just the first of many; if we don’t develop new arrangements, what is happening there will become a widespread feature of the periphery over the next eighteen months, and probably beyond that.
KPFL: Mona discusses the ways in which the current geopolitical landscape and the sanctions imposed on poor countries will impact the needs, content, and prospects of a structural reform in the international monetary system. Does the current geopolitical landscape encourage or undermine reform prospects?
MA: I think we are currently seeing the weaponization of the global financial architecture. Yemen and Afghanistan have been issued SDRs in the new $650 billion issuance. Yemen, an internationally recognized government, is unable to convert its SDRs into hard currency with a partner because of the weaponization.
This situation is getting worse in the aftermath of the pandemic. Emerging economies have calculated their need at about $4.3 trillion, while the G20 committed last year to $100 billion that has yet to be delivered. The numbers are just way off.
Richard, I want to come back to your very important point, which is that we’re looking at two decades of lost growth in developing and emerging economies. The problem is not a lack of liquidity—the $550 billion in the coffers of advanced economies could be supplied to diminish some of these very short-term needs in countries like Sri Lanka that have actually gone through default. As you say, those problems are so intractable given the very opaque and oligopolistic structure at the IMF. Weaponization is going to lead to a fragmentation of the global economic system. Sri Lanka, for instance, said that they were very grateful to China, which released them from some of its debt commitments. Is this the world we want to see, where there’s a real geopolitical divide between the West and the Renminbi bloc?
KPFL: Do you think the emergence of multiple actors and multilateralization will lead to some cooperation, or the opposite?
MA: I think the hegemon has been a force for greater disruption. Interest-rate hikes by the US and the resulting capital flight are only worsening the debt burden faced by emerging countries. In my view, the US central bank mandate should include exchange-rate management. That was implicit in the ideas of Ronald McKinnon and others who have been thinking about this idea of hegemonic stability. If the US imposes capital controls, it is going to allow the possibility for exchange-rate management of the dollar which is very much needed.
LM: In practice, the US Fed is the central bank of the world, but the world has no say over it, nor is the rest of the world really taken into account when the Fed makes decisions.
RKW: We won’t see the dramatic demise of the dollar anytime soon. What we have seen is the rise of new players, key among them, China. We have also seen the emergence of new dynamics in South–South relations. That is true of the New Development Bank, which has both a swap dimension as well as a longer term development finance arm. We have seen emerging banks like CAF in Latin America. But it’s still not anywhere near the scale needed to be able to provide a genuine alternative to the existing arrangements. This points to a much more fragmented system. There’s a worry that this could become quite chaotic and ultimately stifle the development agenda.
Our position at UNCTAD is that developing countries need to get back to depending more on their own resources. The system we’ve described has reduced the power of developing countries to pursue their own agendas, but they need sufficient fiscal and policy space. We need to see reforms that at least begin to claw back some of this policy space. The relationship between the international financial and trading system becomes very important in this discussion.
Everyone’s rediscovering history in this discussion around hegemony: the new Bretton Woods, the Marshall Plan, and Lend Lease. What no one has talked about is the Havana Charter, which was actually the most radical of the efforts to fashion a different kind of international order in the late 1940s. We should be looking hard at the Havana Charter, particularly in light of what’s going on at the World Trade Organization (WTO). It was agreed on in 1948, and had its seventieth anniversary without attracting any attention from the international community. But it was probably the most developmental of all those efforts that took place at the end of the Second World War. In my opinion, it remains hugely relevant for thinking through today’s challenges.