The outdated IMF kept in pocket by the BRICs and PIGs

As the former Citibank head once declared, countries don’t go bust

THE International Monetary Fund’s managing director, Christine Lagarde, has inherited an organisation that has outlived its purpose. It takes just a bit of history to explain why.

The IMF was created under the 1944 Bretton Woods agreement, a plan to promote open markets through exchange rates tied to the US dollar. If a country couldn’t cover its trade deficits, the IMF was to step in and lend it the needed dollars — on certain conditions.

To ensure that the emergency loan would be repaid, and to clear the way for other financial institutions to make or renew longer-term loans in safety, the recipient nation had to adopt a programme of strict austerity.

When the fixed-rate regime of Bretton Woods ended in 1971, economists imagined at first that a new era of freely floating exchange rates would keep imports and exports roughly in balance, thus eliminating large trade deficits and the need to borrow abroad to cover them.

However, many governments were loath to let exchange rates float freely.

To hold down prices for imported food and energy, they kept their currencies at overvalued levels — and so their foreign debts mounted.

The governments borrowed abroad for other reasons, too: For grandiose public-works projects; to keep state-owned industries afloat; and, not least, because it suited sticky-fingered ruling families.

Foreign lenders were untroubled. As former Citibank head Walter Wriston famously declared, countries don’t go bust.

Still, governments cannot borrow without limit. When the pretense that a country was credit worthy became impossible to sustain, the IMF was wheeled in to do the dirty work and make the country safe to lend to again — until the next crisis.

Bold reforms that transformed emerging economies like the BRICs — Brazil, Russia, India, and China — nearly put the IMF out of business. The Chinese in particular showed that an undervalued currency can supercharge a country’s export sector and turn trade deficits into huge surpluses.

Privatisation of state-owned enterprises became popular and finance ministries shed their traditional reluctance to let domestic companies borrow abroad. With emerging economies riding high, their private borrowers received a warm welcome in international capital markets.

Their gain became the IMF’s pain. Demand dried up for stopgap funding and austerity programmes. By 2008, it was the IMF’s turn to struggle with its own budget deficit of about $400 million (€282m) through spending cuts, staff reductions, and sales of gold reserves. But just when the IMF seemed undone by the BRICs, it was saved by the PIGS — Portugal, Ireland, Greece, and Spain.

Athens had been borrowing hand over fist for years, hiding its debts through dishonest accounting and duplicitous swap transactions. (That was in contrast to the Irish Government, which landed in trouble practically overnight by taking over the bad assets of its insolvent banks.)

In April 2010, when rating agencies downgraded Greek government bonds to junk, a familiar story unfolded. Athens negotiated the usual austerity package and secured a loan from the IMF and the EU.

Now, before Tunisia and Egypt even have new governments in place, the IMF has jumped to offer them loans for vast infrastructure projects in the desert — as if the fund didn’t know that young Arabs there want ways to start businesses and have careers, not temporary construction jobs.

The Greek debacle and the north African drama raise existential questions about the IMF.

Responsible governments have no business borrowing vast sums from abroad, rather than from domestic sources. That’s what tin pot regimes do. And lending even more to borrowers who can’t pay what they already owe? That’s what loan sharks and mafiosi do.

The IMF’s business model sabotages properly functioning capitalism, victimising ordinary people while benefiting the elites. Do we need international agencies to enable irresponsible — verging on immoral — borrowing and lending?

Instead of dreaming up too-clever-by-half schemes to stumble through crises after they happen, why not just stop imprudent banks from accommodating foreign borrowing by feckless governments?

After all, it’s French and German taxpayers who are on the hook — not just the Greeks and the Irish.

* Amar Bhide and 2006 Nobel economist Edmund Phelps are founding members of the Center on Capitalism and Society. Copyright 2011, Newsweek/Daily Beast Company LLC. All rights reserved.