The unthinkable as the new normal: the international economic organizations established after World War II have destroyed their credibility.

Author:Engelen, Klaus C.
 
FREE EXCERPT

On June 28, 2015, the oldest international financial institution, the Basel-based eighty-five-year-old Bank for International Settlements, asked in its annual report a most pertinent question: "Is the unthinkable becoming routine?"

The report pointed out that low interest rates "are the most remarkable symptom of a broader malaise in the global economy: the economic expansion is unbalanced, debt burdens and financial risks are still too high, productivity growth too low, and the room for maneuver in macroeconomic policy too limited. The unthinkable risks becoming routine and being perceived as the new normal."

Watching the malaise of major multinational and supranational institutions that were established after the ravages of World War II and in the post-war era in Europe as part of a historic process of ever broader and deeper economic and political integration, one could ask the same question in the shadow of never-ending financial turbulences: Is the unthinkable becoming the new normal?

Established in 1930, the BIS is the world's oldest international financial organization, with sixty member central banks representing countries from around the world that together make up 95 percent of the world GDP. Contrary to other major financial institutions, the "central banks bank," located in Basel, Switzerland, has preserved over decades a high level of credibility in its governing standards and with respect to the professional integrity and independence of its economic research.

When Europe's politicians embarked on establishing a monetary union, the BIS drew attention to the economic realities of irreconcilable differences between the potential member states. The BIS was right. When the French assaulted its independence by requiring the BIS managing director to supply a draft copy of its annual report to the member central banks, they were rebuffed on the ground that some national central banks had not achieved an adequate level of independency from political pressures. That was a reference to the Banque de France. Thanks to its outstanding economists, the BIS warnings on the banking crisis before 2007-2008 were legendary. And when a previous BIS general manager, long before the end of his term, announced that he would join a major commercial bank, but for the time being stay in his position, he was forced by the BIS board to clear his desk and leave the bank immediately.

The malaise the BIS is talking about in its recent annual report can be defined in much broader terms in today's financial world: Undermining the institutions' governance structures. Using political pressure to take away an institution's independence and neutrality. Breaking an institution's statutes and rules for reasons of political expediency. Letting mass conflict of interest erode objective decision making. Losing reputation and credibility among the public. Letting institutions be dominated by major constituencies and blocking agreed reforms. Putting blame on the institutions for failings that national politicians and corrupt elites have been responsible for, as in the case of Greece that descended into a financial maelstrom in the spring of 2010.

There we are talking especially about the two Bretton Woods institutions, the International Monetary Fund and the World Bank Group, with a global reach of 188 member countries. We are also talking about the twenty-eight-member European Union institutions including the European Commission. Nineteen countries form the European monetary union with the euro as then-single currency and the European Central Bank as their common central bank under the 1992 Maastricht Treaty.

WORRISOME DEVELOPMENTS DAMAGE CREDIBILITY

Some worrisome developments show how political leaders and governments are severely damaging major institutions:

* In the European crisis, the IMF was brought under enormous pressure to provide exceptional financing (especially in the case of Greece) in circumstances where the ability and willingness of the borrower to repay and the strategy for recovery were highly questionable. During five years struggling as the junior partner of the troika, the IMF experienced an unmitigated disaster with no end in sight.

* Since the spring of 2010, when the euro sovereign debt crisis threatened the continuation of monetary union with Greece defaulting on its debt, euro leaders have opted for a euro rescue scheme that puts aside EU laws and governance standards, thus damaging the integrity and credibility of the euro area's main institutions.

* When it comes to damage to the major international institutions, the United States turns up in the role of villain in another worrisome development. As the largest and controlling shareholder of the IMF, the United States has been practicing "malign neglect" for many years against the most important global financial institution by blocking a governance reform package that was agreed in November 2010 at the G-20 meeting in Seoul.

HOW THE IMF WAS DAMAGED IN GREECE

For decades, the IMF was seen as a useful provider of conditional balance-of-payment financing for developing countries--more or less operating in the interests of the leading industrial member countries. In the debt crises in Latin America, Asia, and Russia, the IMF broadened its role in financial crisis management and economic stabilization. Since the IMF got more global mandates to include checkups on its major stakeholders such as the United States, the major European countries, and Japan, it has faced more political tensions. The protracted disputes about whether--as was done with the other major economies--to require periodic Financial Sector Assessment Programs from the United States is one example. The politically charged controversies about China manipulating its exchange rate to the disadvantage of American workers is another. The IMF found itself in the middle of this politically charged dispute between its largest and controlling shareholder and the newly dominant China. The IMF's critical views on Germany's persistent large current account surpluses and its bank-based financial sector have also caused tension.

In the spring of 2010, important parts of the IMF staff had serious objections to mobilizing for a Greek and euro area rescue expedition. They were right in arguing that the complex Greek and eurozone rescue effort might well go beyond the IMF's political, economic, and financial capabilities.

In 2010, at the outset of the Greek tragedy, Ted Truman, the former U.S. Treasury and Federal Reserve official now at the Peterson Institute for International Economics, testified before the U.S. House Financial Services Committee that "the major policy instrument available to the United States to contain the European crisis aftermath is the International Monetary Fund." He urged that the United States "should continue to provide maximum, constructive support for the IMF in carrying out its responsibilities for the promotion of global growth and financial stability." Truman reminded the U.S. legislators that 20 percent of U.S. exports of goods go to Europe and, as of the end of 2009, U.S. bank exposure to the European Union was $1.5 trillion, half the total of foreign exposure of U.S. banks.

WHY THE IMF WANTS TO STAY OUT OF A THIRD GREEK BAIL-OUT

In the aftershock of the mid-July 2015 high-noon third Greek rescue agreement, the old objections from the IMF staff and in its Board to the Greek and euro rescue have become much stronger, as was leaked to the Financial Times at the end of July. The IMF Board has been told by the staff that high debt levels and its poor record of implementing reforms disqualify Greece from a third IMF bailout of the country. The recently reaffirmed access criteria for the Fund that would not be met in a third rescue operation include the failure of Greece to demonstrate ability to implement reforms, and the failure by the creditors to accept debt relief. Since the IMF indicated that the conditions are not likely to be fulfilled until the autumn, which implies that the Fund will not be able to join a third Greek bail-out until later in the year or next year, enormous pressure now rests on Greece and Germany. The fact that IMF representatives did partipate in the deliberations on the third Greek bailout can be taken by the euro governments as comforting sign that the Fund at least is staying on the side lines.

How German Chancellor Angela Merkel will get a third bailout of Greece through the German Bundestag without the IMF on board in a financing role remains to be seen.

Behind the hardening of the IMF position against the eurozone leaders--and especially against Germany--is the Fund's deep disappointment with the euro leaders' "malign neglect" in dealing with the Bretton Woods institutions' core rules and standards. Especially unsettling for the IMF was that the euro leaders allowed a euro area member country to default under a lending agreement that was part of the euro leaders' rescue for Greece and for keeping the whole eurozone together.

Some in the IMF argue that the euro leaders--including Merkel and German Finance Minister Wolfgang Schauble--did not live up to October 15, 2011, "G-20 Principles for Cooperation between the IMF and Regional Financing Arrangements" agreement on their "financing assurances."

Paragraph 6 of this agreement states the now-broken commitment that "RFAs [the eurozone] must respect the preferred creditor status of the IMF." This unsettling...

To continue reading

REQUEST YOUR TRIAL