What Is the IMF and Why Is It Controversial?
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Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein. Today's episode, 409. It's titled, What is the IMF and why is it controversial?

In July 1944, 730 delegates from 44 nations met at the Mount Washington Hotel in Bretton Woods, New Hampshire, for the United Nations Monetary and Financial Conference. Their goal was to establish a new monetary system, one that could tap into some of the lessons from the gold standard, where currencies were backed by gold. That system fell apart after World War I, but at

At times, countries did back their currency with gold. Sometimes they didn't. Sometimes they would devalue their currencies to make them more competitive or to make their exports more competitive. They would put up barriers or tariffs, protection to protect their economies from foreign trade. The idea was to make a system that fostered more stability in exchange rates.

and more cooperation, more globalization. The primary designers of this system were John Maynard Keynes, who was an advisor to the British Treasury, and Harry Dexter White, the chief international economist at the U.S. Treasury Department. There were two years of preparation for this conference—

A lot of discussions and potential agreements. The conference itself was held from July 1st to 22nd, 1944, and they came to an agreement. And as part of that, they established two new organizations, the International Bank for Reconstruction and Development, which later became part of the World Bank, and the International Monetary Fund.

According to the World Bank, here's what they do. The World Bank Group works with developing countries to reduce poverty and increased shared prosperity, while the International Monetary Fund serves to stabilize the international monetary system and acts as a monitor of the world's currencies. The Bretton Woods monetary system lasted from 1945 until 1971.

Countries agreed to keep their exchange rates pegged to the U.S. dollar, and the U.S. agreed to keep the U.S. dollar pegged to gold. Countries could only adjust their exchange rate relative to the dollar if there was some type of fundamental disequilibrium, and only with the agreement of the International Monetary Fund. The IMF had a great deal of power in policing this Bretton Woods scandal.

currency exchange system. In August 1971, U.S. President Richard Nixon announced what he called at the time temporary suspension of the dollar's convertibility into gold.

Under the Bretton Woods system, central banks from other nations could take dollars and exchange them for gold at the U.S. Federal Reserve's gold window. That system started to break down because the value of gold, there was upward price pressure because there were more and more dollars being created relative to the supply of gold. The system collapsed finally in 1973-74.

Most major currencies began to float the exchange rates relative to each other. Members of the International Monetary Fund, and they're now 190 countries that are members of the IMF, they can allow their currencies to float freely relative to other countries. They can peg it to another currency or a basket of currencies. They just aren't allowed to peg it to gold directly anymore.

In this episode, we'll take a look at the IMF, but briefly on the World Bank, they have funded over 12,000 development projects since 1947. And they're really there to help developing countries to reduce the amount of poverty. They provide zero to low interest loans and grants. They provide direct investment or equity in companies.

through some of their private equity funds. They provide some risk insurance through their multilateral investment guarantee agency, in which they insure eligible projects against breach of contracts, currency inconvertibility, expropriation, war, and civil disturbances. And then there's the arm of the World Bank that settles investment disputes.

That's all we're going to say about the World Bank in this episode, that they're controversial in and of themselves, and in the sense that development goals in general, helping poor countries developed is in and of itself a controversial topic. When the IMF was established in 1944, there were 44 founding members. Now, as I mentioned, there are 190 countries, and the staff of the IMF comes from 150 nations.

The IMF has three principal missions. One, to further international monetary cooperation. Second, encourage the expansion of trade and economic growth. And third, to discourage policies that could harm prosperity. And to accomplish that, the member countries of the IMF try to work collaboratively together. The IMF itself is governed by and accountable to the 190 countries that are members.

There is a board of governors, and that's the highest decision-making body of the IMF, one governor from each country and one alternate governor. Voting rights for this board of governors, the percent of the vote that they get depends on their quota or capital contribution or promise contribution to the IMF. The country with the largest percent of votes is the U.S.,

at 16.5% of the votes. China has 6% of the voting rights, Japan 6%, and Germany 5%. The IMF has a managing director, Kristalina Georgieva. She has been the managing director of the IMF since September 2019.

There are three principal activities of the IMF, and their aim to further international monetary cooperation, encourage the expansion of trade and economic growth, and to discourage policies that harm prosperity. And the three principal activities that they go about to accomplish that mission is, first is policy advice. The second is technical assistance. And the third is lending, and we'll spend the most time on lending, and that is...

the most controversial aspect of the IMF,

The policy advice falls under what is known as surveillance, which I thought was an odd term to use. But the IMF vigilantly monitors what other countries are doing in terms of their monetary policy. What are their level of interest rates in terms of how they go about trade? The other economic decisions that the governments and the central banks make in those countries, how they set their foreign exchange policy.

The staff of the IMF visits all 190 countries once per year, meets with government leaders, central bankers, labor and business leaders, academics, and other stakeholders in the economy.

And they make recommendations on how the country can promote growth and stability and prevent financial crises. All that data goes into a report. And the report, for example, they just released, the one from Mexico, is called an Article 4 Consultation. This is the report, describes what's going on and any recommendations for the country.

So that's the first area, policy advice. And of course, if you go on the IMF's website, they provide research on a vast variety of topics, highly educated and qualified staff. And that leads to the second role, to provide technical assistance, to train leaders of the economic institutions on best practices and policies for leading a

a country and help it prosper economically. The IMF provides this capacity development at the request of member countries. They ask for the IMF staff to come and provide help. So this is separate from the surveillance policy recommendations that the IMF gives.

The third area then is lending. IMF provides financial support for countries that are experiencing some type of crisis, hopefully to create some breathing room so they can adjust their economic policies and keep capital from flowing out of the country. When there's a crisis, capital wants to leave, and that can lead to a

crash of the exchange rate. It can lead, oftentimes, because of a currency crashes, the price of imports skyrocket. That leads to inflation, can lead to an economic contraction, a deep recession, so essentially stagflation, high inflation, along with an economic recession. Effectively, the

The IMF is the lender of last resort for governments and central banks that are experiencing a crisis. Some call the IMF a firefighter. And if we look at the IMF, they have about a trillion dollars that they can draw on to make loans to countries that are experiencing a crisis.

Their first line of defense are quotas that the member countries have that basically pledges of capital that they need to be willing to make available to the IMF to help other countries. And that's about $452 billion. In addition, the IMF can borrow from other countries.

countries, another $408 billion, above and beyond the mandatory quotas from the IMF members. And then there are additional borrowings that the IMF can do, upwards of $152 billion. So a total of around $1 trillion.

Now, these crises that countries experience, some can be domestic crises, a large economic imbalance, let's say a huge current account deficit, basically a huge trade deficit where a country is importing significantly more than it's exporting. That shortfall needs to be financed somehow because there's a shortfall of foreign currency and that can put pressure on the currency.

Currency weakness was the reason for the largest IMF loan ever in 1976 to the United Kingdom. This was three to four years after currencies started floating relative to each other and investors felt that the pound, the British pound, was overvalued and that the government might devalue the pound. So apparently at that time it was sort of floating, but not exactly. But there was pressure on the

the pound sterling, as it lost value relative to the dollar. And at that time, the U.S. Treasury Secretary in the U.S. agreed that the pound had fallen too much and was undervalued. And the U.S. offered to basically work with the International Bank of Settlements and the IMF so that a loan could be given to the U.K. to support the pound. And there was a $3.9 billion loan in September 1976.

As part of that, and this happens anytime there's a loan, and this is where the IMF gets controversial, is there are negotiations, actions the government has to take to reduce its budget deficit, to cut expenditures, to raise taxes. And the U.K. agreed to do that in order to take this $4 billion loan. By the end of 1977, partly due to new oil revenues, U.K.'s balance of trade, they were running less of a trade deficit,

The pound strengthened and the crisis was averted and Britain didn't have to draw on the entire loan amount. But it's an example of the IMF stepping in with the financial fire hose to aid a country that's facing some type of financial crisis. So that's an internal domestic factor. There's also external factors that can lead to shock, such as a natural disaster or a large swing in commodity prices.

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IMF uses to provide funds to member countries are known as standby agreements. They're heavily negotiated and they come with some pretty strict conditions. Typically, these loans last 12 to 24 months, but potentially up to 36 months with specific terms, things that countries have to do,

If we look then at the level of loans outstanding by the IMF, there's a total of $108 billion. Of the trillion dollars the IMF has at its disposal, the largest borrower by far is Argentina at $32 billion.

Egypt has $14 billion, Ukraine $8 billion in loans outstanding, and Pakistan $6 billion. Argentina is an interesting case. They were just approved in March for, I believe it's a loan, up to $36 billion. Now, Argentina already had IMF loans outstanding from 2018, and they've had a horrendous financial crisis. We looked at Argentina in more detail back in episode 233.

And I've been intrigued by Argentina the last few weeks after interviewing Asha Mehta, who's a managing partner and CIO of Global Delta Capital. This is a firm that specializes in emerging markets and frontier markets. And we'll share that interview in episode 411 of the podcast here in a couple of weeks. But Camden and I asked her, where's her favorite place to visit? She's traveled the globe extensively. And she said her favorite country to visit is Argentina.

To visit, she emphasized, not to invest. Simon Kuznets, who's a Nobel laureate, said there are four kinds of countries in the world, developed countries, undeveloped countries, Japan, and Argentina. In other words, he feels Japan and Argentina are unique.

which makes me want to go visit Argentina. I've been to Japan numerous times. I've not been to Argentina. Argentina used to be one of the richest countries in the world, but has had struggles for decades. Rafael Dittea is an Argentine economist. He says if a guy has been hit by 700,000 bullets, it's hard to work out which one of them killed him. And he suggests that's the way Argentina is. It's so difficult to figure out why the country continues to have economic challenges.

Certainly political instability. There were military coups in Argentina in 1930, 1943, 1955, 62, 66, and 76. Argentina has defaulted on their government debt eight times.

Two decades ago, the IMF stepped in to try to prevent a crisis in Argentina. This would have been in the late 90s, but the crisis happened anyway. GDP fell 20% and the government defaulted on its debt for the seventh time in its history. The economy at times has been significantly mismanaged with high inflation, hyperinflation in 1989 and 1990.

And then in 2020, Argentina defaulted on their debt again, including a $60 billion loan from the IMF in 2018. So there's been ongoing negotiations. And in March of this year, Argentina again has a new standby agreement with the IMF with conditions that they need to meet, including reducing the budget deficit, which it's been a challenge.

The Economist points out the government effectively has been printing money with the cooperation of Argentina's central bank in order to plug the deficit between the difference between what is being spent and the tax revenue. In March then, the IMF,

IMF agreed a new $44 billion agreement with Argentina, not the $36 billion I mentioned. They have to achieve a surplus of their primary deficit. That would mean they would need to spend less than they take in in revenue, and that doesn't count interest on the debt. So a 2.5% budget surplus in 2022 and 1.9% in 2023. And to make other reforms.

These loans that were made to Argentina and other countries are denominated in what is known as Special Drawing Rights, or SDRs.

SDRs were created in 1969, and they are a basket of international currencies made up of the U.S. dollar makes up 43% of SDRs, the euro 29%, the Chinese yuan 12%, the Japanese yen is around 7.5%, and the pound sterling is...

is 7.4%. So basically an SDR, it's a unit of account. It's how the IMF accounts for loans. They don't do them in dollars. They do them in SDRs. And then the value of an SDR fluctuates based on the strength of the underlying currencies. Each member country has a quota of capital denominated in these SDRs.

And when IMF makes a loan, it's done in these SDRs into where basically it's a big accounting book.

A country has a certain quota of SDRs. It's their contribution that they're willing to make. And if they have taken more SDRs than their quota, then they owe SDRs to others. And if they owe SDRs to others, there's an interest payment, and that interest payment is adjusted weekly. So right now, if you have more SDRs than your quota amount, you have to pay an annual interest rate on 2.6%.

of the excess. And if you have less SDRs on your IMF accounting book than your quota, then you're receiving interest. Isabella Kaminska writing for the Financial Times, she's no longer there, this was back in 2015, she says, for an IMF loan, you can't actually technically default because it's not a loan. It's a swap, she writes, a swap of one country's relatively crappy currency for

for currencies that can actually get you stuff on the market. So when Argentina takes out a $44 billion loan, they haven't taken all that amount yet, it's denominated in SDRs, and they provide the IMF Argentine pesos, and then they get SDRs in return, which because SDRs are made up of a basket of currency, they can sell those SDRs for dollars.

or other currencies. They are traded among central banks. They're convertible to actually buy things with them. Here's the thing about SDRs, though. It's made up money.

In August 2021, the IMF, having got approval from at least 80% of its members, allocated an additional 456.5 billion SDRs to its members, the equivalent of $650 billion. Made it up. We now have $650 billion more SDRs. So everyone had more currency, basically, on their IMF account book.

And again, these SDRs are reserves. They're reserves the countries have that they can draw on, that they can sell to then buy things. And they did. And they can be used to support their currencies because it's just a unit of account.

Now, I thought about this creation of SDR, $650 billion. That would have to put some additional inflationary pressure, I would think, because now there's essentially more money. Now, as individuals or businesses, we can't get a hold of SDRs, but a government could take their SDRs, convert it to dollars, and then go spend the money on vaccines or whatever would flow through the economy.

The IMF points out that the SDR is not a currency, so it can't be used directly in transactions, but it can be sold to other member countries in exchange for five what they call freely usable currencies. U.S. dollars, euros, Chinese renminbi, the Japanese yen, and the British pound sterling. And so they're able to get some liquidity. The IMF's been around since 1945.

Is it helpful? There are a lot of crises, ongoing economic crises that occur, some due to external factors beyond their control. A big borrower from the IMF is Ukraine due to Russia's invasion of Ukraine. Harvard economist Benjamin Freeman said, we cannot reliably know whether the consequences of the IMF's policies were worse than whatever the alternative would have been. The

The IMF is controversial because they're tough negotiators. They're providing capital to countries such as Argentina that are suffering an economic and currency crisis. Some have said negotiating with the IMF is like negotiating at the barrel of a gun.

IMF seems like they did a good job with the Asian financial crisis, helping emerging market countries, many of which were able since then to build up foreign currency reserves, to be in a much better position working through what happened with COVID and the current economic slowdown. Even though the dollar is strong, emerging markets, many of the emerging markets that

actually run trade surpluses, they're doing fine compared to other periods of crisis, such as the late 1990s with Asian emerging markets where a number of those countries' stock markets fell over 50%. In fact, I believe one fund I remember, I think it was a Morgan Stanley Asian fund,

that one of my clients was invested in because they felt emerging markets were too risky to hold Latin America. They just wanted Asian emerging markets. That fund was down 80%. That was probably not my most positive moment as a newly minted financial advisor allowing my client to go into an Asian emerging markets fund right before the Asian financial crisis.

The IMF has been criticized for how it's handled the situation with Greece, which this was a number of years ago following the great financial crisis. But the Greece was challenging because Greece didn't have a crappy currency. It had the euro. So if it was borrowing from the IMF, it basically would have to provide euros

to get SDRs back that are partially made up of euros. So the IMF organization just wasn't as effective in that. But generally, having some organization to be a lender of last resort of countries, at least...

provide some counsel, some advice, some policy recommendations, I think generally is a good thing. The ability to tap in to the financial capital and have an organization that can facilitate that as different countries basically effectively are helping out other countries that are struggling with the IMF, sort of the quarterback, assisting with this capital allocation through the SDRs and through this quota system.

We don't know if having the IMF has actually averted more crisis because monetary systems, creating a monetary system is incredibly complicated. The Bretton Woods system worked for only about 30 years. We've had a floating rate system for 50 years, a period when we've had more inflation and potentially more economic crisis.

I'm not absolutely sure on that, but my sense is yes, or maybe I'm just more aware of them. But that's what the IMF does. It's controversial. It uses its own made-up currency, SDRs, which is funded out of thin air. But it does allow for some coordination among 190 countries. It's been in existence for over 80 years and continues to evolve as the global economy evolves. That's episode 409. Thanks for listening.

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