Who’s Afraid of the IMF?

COLBECK
COLBECK
Jul 24, 2020 · 10 min read

7.24.20

Jón Gnarr wanted Iceland to have more fun. Because in 2009, after the three biggest banks in the country had collapsed under $85bn of debt (the equivalent of 850 percent of Iceland’s GDP), and after 1 in 3 Icelanders had lost their life savings, not many people were laughing anymore. Nobody could understand how, in the span of just a few short weeks, the country went from having Range Rover traffic jams to begging the IMF — an institution best known at the time for indebting third world countries — for a loan.

Gnarr hated politics, but, as an artist, he also hated the idea of borrowing money from the IMF. “I started asking around, ‘What is the IMF?’ and people said, ‘You know what the first thing the IMF does when some country enters a program [with it]? They start by cutting funds to the arts.’” And so, Gnarr decided that the best thing for the situation was a democratic self-help group. He named it Besti Flokkurrinn, or The Best Party, and, in honor of transparency, pledged to commit any forms of corruption openly.

Recruitment was easy. Gnarr Facebook-messaged a group of old friends from his days in a punk rock band and asked them to join his ballot. “Is it going to be hard?” they asked. “Nah,” he said. “All I need is your name and a photo.” Their theme song for the campaign was a remix of Tina Turner’s song, “The Best.”

Campaign promises were crowdsourced. A drug-free parliament by 2020! Free towels at the swimming pool! (So that city pools could claim spa status). A polar bear display at the zoo! (So that Iceland would stop shooting them). But above all, the party promised one thing: to cancel all debts.

“Why should I repay money I never spent?” said Gnarr, echoing much of the general public’s attitude towards repaying British and Dutch creditors for money they never gambled. “I consider myself a very moral person. Suddenly, I felt like a character in a Beckett play, where you have moral obligations you have no possibility of understanding.”

Despite Gnarr’s reservations, the IMF’s services have never been more in demand than they are today. Its Chief Economist, Gita Gopinath, who is credited with coining the term “The Great Lockdown,” reports that “we’ve had over 90 countries come to us for financial assistance. This is unprecedented. It hasn’t happened before.” The IMF — once infamous for exacerbating Ebola and malaria by imposing harsh austerity measures — is now looked to as a principal source of assistance during a global pandemic.

What is the IMF?

In order to grasp how unusual it was for Iceland to ask the IMF for a loan, it’s important to understand what the IMF is and who it usually lends to. For a public organization with a lending arm of $1 trillion dollars, the inner workings of the IMF aren’t very well known. In fact, it’s precisely because it flies under the radar that some speculate why Donald Trump hasn’t threatened to cut funding or gone off on a tweet storm against its international agenda.

The International Monetary Fund just celebrated its 75th birthday last year. It dates back to the Bretton Woods Conference of 1944, when a group of economists and a Soviet spy locked themselves in a Gilded Age hotel for three weeks and expected something good to come out of it. In fact, they did more than just play golf: they produced two sister organizations — the IMF and the World Bank — that were charged with keeping economic order. (This was considered nothing short of miraculous, considering how little past conferences had accomplished). The two are often confused and, in recent years, many of their policies work in tandem. But, traditionally, the World Bank was geared towards poverty reduction while the IMF was geared towards enforcing neoliberal economic policies and was “staffed mainly by disciplinarians.”

The biggest objective of the IMF was to avoid another Great Depression and another world war. Christine Lagarde, former Managing Director of the IMF, describes the impetus for starting the organization: “Countries decided that killing each other was probably not the way to go. It all started with a bad economic situation. So they thought, why don’t we set up a club, give it a lot of money, and have competent people, number one, give some economic advice, number two, give some loans in case any member of the club is not doing so well and, number three, give technical assistance. That’s what we do. We try to help countries with better prosperity, and we try to help with financial stability, so the world is not going in too bad of a direction.”

The IMF has de facto preferred creditor status, which has been recognized by the official community and is generally accepted by private creditors. Almost no one ever defaults for fear of never getting credit again. As former chief economist Simon Johnson explains, “If you want to play in the international community, if you want to get credit again, if you want to have any kind of normal relationship with the outside world, you need to have a normal relationship with the IMF.”

Since 1952, the IMF’s Stand-By Arrangement (SBA) is the most common lending instrument for countries. Its duration ranges from 12–36 months. Repayment is paid in quarterly installments over the course of 3.25–5 years of disbursement. Interest payments are based off of the IMF’s own reserve currency, the Special Drawing Right (SDR), which is calculated from a basket of five currencies. As of June 2020, Argentina, Armenia, Egypt, Honduras, and Ukraine had current SBA loans and 31 countries had alternative lending arrangements.

Why Does the IMF Have So Many Critics?

Sovereigns have been defaulting since the days of Greece’s first tumble in 377 BC. And the bailout is at least as old as the Bronze Age, when rulers simply wiped away all debts owed to the government. But any Western institution going into distressed countries (many of which are former colonies) and telling them how to run their economies probably won’t get a five-star rating from locals. Portrayals of the IMF are checkered at their best. They range from a philanthropic angel offering democracy to the world to, as Columbia economist Jeffrey Sachs describes it, “a modern day Typhoid Mary of emerging markets, spreading recessions in country after country.”

It probably doesn’t help that its organizational structure smacks of colonialism. The post of managing director is treated as a “hereditary fiefdom” and has always been held by a European. In exchange, the leader of the World Bank is always an American. There is no written rule; it’s just how the gentleman’s agreement played out at Bretton Woods.

The IMF is funded by a quota system — essentially, membership dues — paid by its members. It also has an endowment fund formed from the profits of its gold holdings that is used to cover administrative expenses. Voting rights are not proportional: they are determined by how much money a country donates. As of today, the United States is the only member with vetoing power, and the G-7 countries — Canada, France, Germany, Italy, Japan, the United Kingdom, and the U.S. — collectively control over 41% of voting rights. India, for example, has only 2.64% of the fund’s total votes while accounting for over 17% of the world’s population.

Then there’s the unpopularity of austerity measures. Tellingly, many of the IMF’s loans are described as “shock therapy.” The loans are heavily conditional, coming with a set of structural adjustment policies (SAPs) that typically include deregulation, rapid privatization, liberalization, and austerity measures. Only when a country signs off on the policy will the IMF restructure the country’s debt and lend enough to prevent default on international loans. Given that the IMF is often the lender of last resort, most countries simply accept the terms. In recent years, the effectiveness of such strict fiscal discipline has been questioned, and the IMF has apologized and admitted to some of its more notable bungles, including its role in Greece and the 1997 Asian financial crisis.

Did the IMF Help Iceland?

Iceland was the first advanced economy to approach the IMF for aid since 1978. Thanks to the swift deregulation and privatization of its banking industry in the 1990s, total assets of Iceland’s three largest banks grew from 1x GDP in 2001 to nearly 10x GDP in 2008.

Compare this to Switzerland’s balance sheet, the second-largest banking sector at the time, which had total assets of 8x its GDP after three hundred years of banking. This helps explain how a tiny nation of fishermen transformed into a tiny nation of investment bankers in less than ten years.

All this growth was largely dependent on foreign money, with funding coming from selling bonds in the European and U.S. markets and later turning to foreign retail deposits. Following the collapse of Lehman Brothers, Iceland’s three major banks quickly failed. Taken together, the three bankruptcies would rank third in the U.S. history of bankruptcies.

The IMF swept onto the scene, proposed a $2.1 billion bailout package (an amount equivalent to 18% of Iceland’s GDP), and now lists Iceland on its website as one of its most “spectacular turnarounds” to date. Indeed, Iceland is one of the IMF’s most successful programs, but not without a number of extraordinary measures atypical of most countries. First, it helped that the Icelandic program was significantly less demanding than prior programs, particularly those applied to the Asian Financial Crisis. Second, Iceland remains the only country that forced its government to resign, let its banks collapse, and jailed many of its bankers following the crisis.

In a much debated spat with the IMF, Iceland refused to pay back its private banks’ foreign creditors who were demanding the equivalent of $17,000 per Icelandic citizen. “We were told that if we refused the international community’s conditions, we would become the Cuba of the North,” said former President of Iceland Olafur Grimsson. “But if we had accepted, we would have become the Haiti of the North.” Things escalated to such a degree that Iceland was placed on an anti-terrorist watchdog list by the UK before they reached a settlement in international court.

Even so, austerity measures were still severe. Jón Gnarr, after sweeping the municipal election for mayor of Reykjavík in 2010, optimistically promised that: “Jón Gnarr will first and foremost be a fun mayor.” While it may have been fun to watch Gnarr dress up in drag for the city’s pride celebration, not much else was festive. The city’s budget was severely slashed, energy prices were raised by 30%, and Gnarr was forced to do mass layoffs, including his own campaign manager’s father. “It was one of the most horrible times in my life,” said Gnarr. “On some days I think I’d like to be mayor for the next 12 years, and on other days … I scan Google Earth looking for nice places to escape to.”

Globalization and Its Discontents

The Best Party, while no longer politically active (it has been replaced by the Bright Future Party), remains the first political party formed around a public debt liability. The popular revolution that toppled Iceland’s government arguably began the start of an anti-globalization movement that would inspire the Arab Spring and Occupy Wall Street movement a few years later. Jón Gnarr, after starting a countdown of his final days as mayor, chose to return to comedy rather than to run for a second term. “I was mayor for four years,” said Gnarr. “That’s the longest I’ve held a job, ever.”

Joseph Stiglitz, Nobel laureate and former chief economist at the World Bank, is one of the IMF’s most vocal critics and at one point had to be told to stop talking to the press. In his work, Globalization and its Discontents he argues that the IMF’s biggest mistake was that it “believed that capital market liberalization would lead to faster growth for the developing countries, believed it so strongly that it did not need to look at any evidence and gave little credence to any evidence that suggested otherwise.”

Stiglitz believes that abolishing the IMF would be useless: people love to feel like someone is in charge during a crisis, and it would soon be replaced with something similar. According to Stiglitz, only if the IMF can enact significant reforms — i.e. continue its movement away from austerity measures and blind dogma — can globalization “be a force for good … that has the potential to enrich everyone in the world, particularly the poor.”

About Colbeck: Colbeck is a strategic lender that partners with companies during periods of transition, providing creative capital solutions to meet their evolving needs. You can reach the team at inquiries@colbeck.com.

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