ECONOMYNEXT – The International Monetary Fund is widely hated now by victims of currency depreciation who are pushed into poverty and asked to pay more taxes to maintain bloated states while their incomes evaporate in monetary debasement.

Critics of the IMF slam the agency calling it neo-liberal (whatever that is) but it is definitely not liberal as was understood by classical liberals. There can be no freedom for the people with unsound money.

The IMF was never really liberal as it was a product of Harvard-Cambridge interventionists, but before the collapse of the Bretton Woods in 1971 and widespread depreciation promoted from the late 1970s and 80s, the agency supported a sounder form of money based on its founding principles.

With inflationists’ hands partly tied by a commitment to specie-linked tighter currency pegs (maximum of 10 percent devaluation after mis-firing macro-policy) the poor and marginal income brackets were not harmed as much by collapsing un-anchored ‘flexible’ exchange rates as they are now.

Central banks before the collapse of the Bretton Woods and the IMF’s Second Amendment to its articles had limited legal room to steeply depreciate currencies and tip large sections of the people into poverty and countries into default.

As a result, monetary and exchange rate policies through which economic bureaucrats bust currencies now, were constrained to some degree. The main purpose of the Bretton Woods and IMF when it was set up was exchange rate stability and free trade, not depreciation as now.

According to the Article I of the IMF, the purposes were

(iii) To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.

And

(iv) To assist in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade.

The original Article IV did not permit depreciation of currencies more than 10 percent, helping maintain some semblance of good money, as well as social cohesion.

According to the original Article IV:

Section 5 (b) – A change in the par value of a member’s currency may be made only on the proposal of the member and only after consultation with the Fund.

Section 5 ( c ) (i) … does not exceed ten percent of the initial par value, the Fund shall raise no objection.

And under Section 06,

If a member changes the par value of its currency despite the objection of the Fund, in cases where the Fund is entitled to object, the member shall be ineligible to use the resources of the Fund unless the Fund otherwise determines.

Then how did this agency, which withheld support if a currency was depreciated more than 10 percent, end up presiding over programs with the central bank monetary laws that permitted and encouraged horrific currency collapses, triggering social unrest, civil wars, mass poverty and mass migration after 1978 in particular?

It happened in the absolute confusion that gripped the policy makers in countries that drove the Fund following the break-up of the Bretton Woods system, when they were clueless without a credible anchor for money.

But the collapse of the Bretton Woods system and the Great Inflation of un-anchored money goes back the origins of the Fund itself, which was based on Harvard-Cambridge flawed doctrine, that was in fundamental conflict with monetary stability, as well as being prey to shifting fads of the day.

Roots of Illiberalism

The roots of illiberalism go back to the foundations of the Bretton Woods system and the IMF.

As the IMF was set up by the US Treasury’s Harry Dexter White and John Maynard Keynes of HM Treasury (the Bretton Woods was mostly the White Plan not the Keynes one), the agency is necessarily driven by Saltwater-Cambridge monetary confusion that led to collapse of the Bretton Woods and Great Inflation.

The joint statement issued after talks between Keynes and White (and 30 experts) can be accessed at this link.  (https://www.elibrary.imf.org/downloadpdf/book/9781451972511/ch006.pdf)

After the bureaucratically fixed policy rate was devised by the Fed, which led to the Great Depression and later infected the Bank of England, many countries went off the gold standard as their economies went through a cyclical recovery in the 1930s.

Unlike the US, which had its banking system shattered, and Roosevelt’s New Dealers engaged in vicious interventionism scaring the living daylights out of investors with ad hoc policy changes like in Sri Lanka, other countries were not in the same position and recovered fast. (See: Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War – Robert Higgs)

The UK went off the gold standard in 1931 amid problems in Germany which led to capital flight. Keynes cheered the inflationism and discretion trumping rules as the pound fell and then stabilized.

White was himself a Harvard educated New Dealer therefore by definition an illiberal, who was further suspected to have links with the Soviet Union. USSR eventually did not join the IMF though White was willing to make concessions, over its gold contribution and voting rights.

Keynes also wanted to keep exchange controls longer than the original 3 years proposed as the UK was expected to mis-target policy rates.

But Bretton Woods and IMF was based on a liberal idea

Despite having its roots in illiberalism, monetary confusion, the Bretton Woods itself was based on a fully liberal idea of having free trade and some semblance of monetary stability which had been shattered by the fixed policy rate in the 1920s.

The architects of the post-World War II monetary order wanted to stop the devaluations that took place in the 1930s as the fixed policy rate infected countries while some like the US did it deliberately.

A key US politician with liberal ideas was Secretary of State Cordell Hull, a Southerner who opposed protectionism.

Hull’s ideas not only led to the United Nations but also to the WTO.

Classical liberals had always maintained that free trade was a key tool to avoid war, based on irrefutable logic that is too involved to go into now.

Hull in fact led the US delegation to the 1933 London Economic Conference which sought to stabilize exchange rates. Roosevelt opposed the plan eventually.

The illiberal inflationist Keynes who had cheered the float of the pound, said Roosevelt was ‘magnificently right’.

The US dollar which was not under pressure due to the depression was deliberately devalued by Roosevelt. The Supreme Court upheld the decisions, despite a constitutional requirement to coin money. Recall Sri Lanka’s Supreme Court which nixed a plan to ban provisional advances.

The Cost of the Inflationist Bureaucratically Fixed Policy Rate

As a result of bad monetary policy, the UK was weakened after World War II and had no reserves and little gold left.

It was just deserts for Keynes as he had to pay dearly for his policies implemented in the UK including after the War ended.

The US was still on the gold standard in the 1940s and he had to knuckle down before Dexter White and have his idea for a ‘Bancor’ and international clearing union rejected.

The UK owed money to the Ceylon Currency Board and the Reserve Bank of India. India, which was one of the countries in the original 44 in the Bretton Woods conference, wanted the issue of ‘blocked reserves’ taken up.

There were very few people in 1944 who knew how to run a self-correcting central bank. The French knew and submitted a plan. It was rejected.

J Walter Kemmerer, a Princeton economist who had set up a number of self-correcting central banks including in Latin America and helped set up the Fed originally, without a fixed policy rate and based on the gold standard, also proposed a plan.

Kemmerer’s Latin American banks were later modified and smashed by arch-Keynesian Robert Triffin into Argentina-Sri Lanka style interventionist sterilizing central banks, leading to severe currency trouble and hyperinflation and those agencies becoming top customers of the IMF.

If they had accepted Kemmerer’s ideas, or even later the proven stability of German liberals who came to power after the nationalists were defeated by the Allies in World War II, the later monetary debasement which drove social unrest, civil wars, military coups and communism which spread like wildfire from the 1960s would not have taken place.

Millions would have been saved from death, rape and mass migration.

The Khmer Rouge would not have emerged and Cambodia would have been a stable country like it is under dollarization now.

The IMF itself would not have been needed.

After the collapse of the Soviet Union, countries with monetary instability are now largely ending up in military coups, not communism.

The Second Amendment

An obligation to maintain an exchange rate is the best check on the ability to conduct macro-economic policy, generally known as the lack of monetary independence.

After the US ended gold convertibility in 1971 and countries went to floating rates, the IMF changed the specie fixed exchange rate undertakings contained in its Article IV.

Countries could now depreciate more than 10 percent. Countries also no longer could use gold as an anchor.

The exchange rate is an anchor or a very transparent restraint on macro-economists’ ability to print money.

With its removal unfettered money printing and devaluations could be done by rate cuts and other means.

By sterilizing interventions or engaging in open market operations by repurchasing government debt to inject money, budget deficits could be blamed. As the currency depreciated, budgets and state energy enterprises went haywire, just like the financials of individuals deteriorated.

Sri Lanka devalued steeply after JR came and the country continued to destroy the rupee, until A S Jayewardene came and policy changed, albeit slowly and industrial strikes reduced.

The currency started to fall again rapidly after W A Wijewardene retired in 2011 and overt potential output targeting began.

Steep depreciations hit Latin America after 1980 which had similar central banks and market access, defaults began.

Newly re-opened Eastern European countries suffered the same fate.

These countries did not have clean floats unlike the US, Japan, Germany, Switzerland and Canada to name a few.

They were reserve collecting central banks with un-anchored policy. As they ran from crisis to crisis, repeated stabilization programs were put in place.

Pakistan’s rupee slid alarmingly within the IMF program and is still wobbling. Argentina is still sliding.

Stabilization Programs on Liberal Lines

Unlike IMF programs, stabilization programs implemented on liberal lines with strong controls on the central bank are once-in-a-lifetime affairs.

Unfortunately, there are very few Americans who know how to do this, due to the lack of a history of central banking or deep monetary debate and the proliferation of so-called Saltwater University money printing and interventionist ideologies.

A key post-Keynesian was Alvin Hansen of Harvard. Others include Paul Samuelson from MIT.

A small group of universities led by Chicago where Hayek and later Friedman taught, know how to control central banks.

Other than Kemmerer, who died in 1945, only a few Americans have stabilized countries for a long period.

Joseph Dodge, a banker who worked with the Austrian economists and Ordoliberals (Ludwig Erhard) in the stabilization of West Germany also stabilized Japan at an exchange rate of 360 to the US dollar in 1948.

This was after Harvard types nearly destroyed the country with a central bank financed Reconstruction Development Bank which sent inflation soaring to triple digits in peacetime.

Korea was similarly de-stabilized by US economists with the Hwan currency and people starved until a halfway decent won was re-built in 1960.

Both Japan and Germany became export powerhouses and remained stable in the Bretton Woods period and their currencies appreciated against the US currency after the dollar collapsed and floated in 1971.

Another country that a US official helped decisively was Saudi Arabia. The Saudi Arabian Monetary Agency was set up on currency board lines by Arthur Young, who learned a lesson in the mis-use of a full central bank in China which led to communism. But that is another story.

Once in a Lifetime

Japan also underwent a stabilization program soon after the Meiji restoration in the late 1880s when the Bank of Japan was set up and other money printing central agencies were abolished and the world’s first mass privatization was done by then Finance Minister Matsukata Masayoshi.

The French Franc collapsed in the 1950s and by the end of the decade the country was mired in exchange and trade controls and the Algerian crisis was in full swing.

Finance Minister Antoine Pinay and Jacques Rueff, an ‘anti-Keynes’ economist, presented a stabilization plan, re-worked the new Franc after a devaluation and removed all trade controls, allowing France to meet free trade commitments under the European Economic Community.

The Pinay-Rueff stabilization plan made France a strong country again with a strong currency and allowed President de Gaulle to tread an independent path from the US when he wished. Stability held until shortly before the turmoil around the Bretton Woods collapse.

If a country does not want to go back to the IMF, it cannot follow Fund advice on central banking, which involves depreciation and more depreciation and instability and a new stabilization program.

The UK had exchange controls and instability until Thatcher with the intellectual backing of Friedrich Hayek himself, as well as Milton Friedman, stabilized the Sterling after high inflation and two back-to-back IMF programs.

When Steve Hanke fixed Bulgaria or Estonia, they stayed fixed. Once the monetary authority’s activism is constrained, other reforms can be done at leisure. Successful reformers will come back to power.

Japan’s Finance Minister Hayato Ikeda, a liberal who firmly believed in fighting inflation was once forced to resign after saying that even if five or ten small businessmen commit suicide it cannot be helped. He later became Prime Minister.

Stabilization programs are painful and should be once in a lifetime affairs. To stop them, the root cause, which is flexible central banking, should be blocked with strong rules which stop discretion or flexibility.

No Awards for Illiberal Recidivism

But that does not happen with the monetary reforms as advocated by the IMF. The flawed regimes trigger a crisis in a few years, a phenomenon that some economists call recidivism.

Sri Lanka’s new monetary law is a deeply regressive one which incorporates all the policy errors made after the civil war ended.

If the central bank is operated, as intended, to target potential output with printed money on top of monetary and exchange rate policy conflicts, a second default is inevitable.

The post-war near hyperinflation in countries under US influence like Japan (before Dodge line stabilization) came from the advice of experts from the Economic Co-operation Administration, the agency that administered the Marshall Plan.

There is also another difference. Whatever their faults, White, Keynes and company did not prescribe a third rate monetary regime to some countries and single anchor regimes to themselves.

Joseph Dodge prescribed to Japan, a fiscal and monetary regime that was superior to the US and was based on the German model.

IMF on the other hand is prescribing third rate monetary regimes to countries like Sri Lanka, with 5 percent inflation, which have a proven track record of failure in Sri Lanka and Africa, while clean floats with 2 percent inflation (whatever flaws that has) are operated in the home countries of its architects.

Joseph Dodge was decorated with the Grand Cordon Order of the Rising Sun by Emperor Hirohito on the tenth anniversary of Japan’s postwar independence, on April 28, 1962.

If the IMF was liberal and it prescribed a sound monetary doctrine, whatever the critics say in the first two years, the country will stay stable and grow and the people will be grateful.

But due to the illiberal third-rate monetary regimes prescribed through its programs to countries in Africa, Latin America and Asia, and ad hoc taxation, which cannot make up for denied monetary stability, no one will give awards to the IMF or the politicians who follow difficult fiscal policies to stop crises coming from bad money.

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Notes:

IMF Article I Purposes

• (i) To promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems.
• (ii) To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.
• (iii) To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.
• (iv) To assist in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade.
• (v) To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.
• (vi) In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.

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