Reforming The International Financial Architecture

Reforming the International Financial Architecture Samuel Immanuel Brugger Jakob* / Silvi Hafianti** / Gabriel Pérez Lomeli Joseph***

Abstract: The actual international financial architecture is in crisis. Specially the IMF is loosing several of its members. On the other hand, new institutions from the Global South are being created. The afore mentioned, will transform the financial world order as we know it today. In this text we will try to explain why the international financial architecture is in crisis and offer alternatives towards necessary reforms. We propose three alternative scenarios.

Keywords: International Financial Architecture, International Monetary Fund, South Bank, Asian Monetary Fund.

JEL Classifications: F33, F34, F55, G20, G28

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Samuel Immanuel Brugger Jakob is professor and reseracher at the Faculty of Economics at the "Universidad Nacional Autónoma de México (UNAM)" in Mexico City. * Silvi Hafianti is professor and researcher in the Economics Research and Development, Faculty of Economics, Gadjah Mada University, Yogyakarta, Indonesia. ** Gabriel Pérez Lomeli Joseph is a Corporate and Banking Attorney residing in Mexico City.

1. Introduction After the crises in Mexico, Asia, Russia, Brazil and Argentina, is the International Monetary Fund (IMF) still necessary? Can it be reformed? Can it regain its credibility? There are two ways to consider this issue. First, if the element proposing the idea of reform relays on the fact that it can no longer carry out its financial activities with only a few loans and interest income, we are in presence of an internal issue pertaining to the IMF. However, if the question relays on how to regain international credibility, then the solution has to be focused on recovering a multilateral actor. The IMF was conceived a club for the “rich man” in 1944, when the United States (US) was almost the sole creditor and the rest of the world needed borrowing. (Ugarteche, 2006:315) Accordingly, the veto right had certain logic; even though such veto right was against the democracy concept trying to be implemented in the supranational institutions as well as in NationStates. This veto power was being used as a tool of foreign policy to prevent loans towards countries declared by the US as “enemies”, such as Nicaragua in the 1980's, North Korea or Cuba, among others. The US still retains its veto power even though in 2008 it became the global debtor leader, especially with Asia, Latin America and with any economy having surplus reserves in US Treasury Bills. The US is currently the largest debtor in the world, owing money to Asian and Latin American countries, all, except Japan, that are less developed than the US. This is an exercise of power without real financial foundation. The IMF uses the size of the GDP to measure the value of voting rights, and the US economy still remains important. However, the size of GDP is no longer an indicative of the financial capacity of the country. (Ugarteche, 2006:316) Moreover, the IMF has lost credibility mainly due to two reasons. First, because it was unable to withstand pressures over crises generated by its own economic model, consisting in opening capital accounts in Asia. Second, because of advice given on how to manage exchange rates in various parts of the world like Argentina. Paradoxically, the Under-Secretary of the US Treasury declared that the IMF should fulfil its original mandate of seeking international financial stability and adjust balance on payments. The problem according to Truman (2005), is that the IMF could become a development institution working only with low-income countries, and by doing so, losing its relevance. For the IMF to regain its credibility and do what the Under-Secretary of the US Treasury suggests, would need a lot of work in order to influence the US deficit, just as what it did with the rest, including Great Britain in 1977-78. The IMF has become weak and inefficient. Can the IMF rescue the US in a run against

the dollar? No. It could not rescue any important emerging countries, as seen in Mexico in 1994/5, South East Asia in 1997 and Argentina in 2001, just to mention the most important crises of the last decade. Therefore, it is impossible for the IMF to save the US dollar. Truman (2005:14), suggests that the IMF should reaffirm its central role in international crises, including loan activities on a large scale. He pointed out that in the 1970's, nobody spoke of the element of moral hazard and that given the financial globalization, today there is more need than ever for a lender of last resort. Is the issue of moral hazard relevant in international bank lending and financial rescues? Or is it an issue serving to confusion over the issues of a closed economy and private loans with those of public loans and an open economy? When Europe needed loans after the World War II, the Marshall Plan did not put any conditionality or spoke about moral hazard. The capital account and financial sector are fundamental if the IMF wants to the have a role in 21st century. (Truman, 2005) Moreover, the credibility of the IMF was also lost by not having a mechanism for transparent voting to elect their directors and executives. Since 1946, there has been a non written agreement, whereby chairmanship of the World Bank has belonged to the US. Meanwhile, the chairmanship of the IMF belonged to the Europeans. These “rules” are not to be found in writing; rather it has been a de facto way in which the International Financial Architecture (IFA) has worked. In addition, staff in both institutions is mainly employees of countries from Europe and the US. If the IMF wants to gain back its role as leader, changes are needed. Nevertheless, changing the above mentioned will not only take time, but also a policy change will be required. There is scepticism that European and the US politicians will accept loosing power in these institutions and accept the increasing power of emerging economies. Therefore, this has opened at least three possible scenarios for the future of the IFA that will be discussed within this document. However, before going deeper into these three scenarios it is necessary to analyse the IMF during the second half of the 20 th century comparing it with its current situation. Afterwards, in the next section, we will show three possible scenarios of the IFA for the 21st century. The first scenario comes directly from the IMF and it is not actually a new reform. Most of the scenario was proposed by the Committee of the Twenty in 1974. Because the suggestions in this proposal are similar to the ones of the reformist proposes, we will only point out the IMF’s proposal. The second scenario is a scenario from Freedman and the monetarist theory. Although he has written on the damage the IMF has done, he has forgotten the reason for its creation, based on the stabilization of the International Financial Arquitecture. The last scenario comes from the Global South, where many regional solutions are being created. This scenario is still new, and it is difficult to forecast if it will work better than the IMF. However, even if it fails, some competition to the IMF will be good for the IFA in terms of reducing political conditionality,

increasing loans, adapting voting rights and eliminating veto rights and last but not least, trying to regulate capital flows.

2. The Rise and fall of IMF The instability of the global economy during the 1930's was the result of deflation caused by the gold standard, and depression, therefore causing the implementation of policies of "beggar thy neighbour" and a crisis of overproduction. (Ugarteche, 2006:280) The creation of IMF in 1944 came directly from this instability. The end of the gold standard in 1933 opened the way for a new pattern of international reserves, based on the dollar. This was to become the gold/dollar standard established in 1944 at a fixed rate of US$35.70 per ounce of gold. The reason for using the US dollar was because the US economy was not destroyed by the war, thus being the healthiest one. Furthermore, the US was the world leading creditor and had the largest amount of international reserves. The dollar actually served as an asset of global monetary reserves. On the other hand, the United Kingdom (UK), a former economy with major international reserves, was no longer able to fulfil that role. During World War I, the UK became a debtor country, and despite the fact that the United States condoned these debts, once again, became a major international debtor during World War II. The concept of a board of monetary stabilisation began to develop in the 1930's, when different plans for monetary stabilisation were designed between 1931 and 1935. (Eichengreen, 1989) However, this concept worked only when the US Treasury chose to impose its pressure to make it work. (Ugarteche, 2006:281) The reason for such was the argument of the Secretary of State, Cordell Hull, arguing that multilateralism was essential for the future of humanity as well as for world peace stability. The establishment of the IMF in Washington DC in 1946 would unfortunately mark the importance of this institution for US foreign policy and its influence over the IMF. The first lack of confidence and lost of credibility was created by the IMF during the debt crises in 1980’s. Several analysts attribute the origin of debt problems to large irresponsible loans, a heavy bureaucracy, market distortions, corruption and public deficit. However, Edwards and Larrain (1989), Griffiths (1988), and Hamm and Wills (2003) argued that the analysis should be made by starting with the US interest rate as the external shock of the crisis. From this point of view, the IMF should have acted differently and would have avoided the “lost decade”. James (1996:355), suggests that in 1982, the IMF had concerns on the impact over rising the US interest rates and that these could have an impact beyond the immediate costs of debt servicing.

Problems between the IMF and the US have a long tradition. In the 1970´s, the liberalization of international markets began on August 15, 1971, with the Smithsonian Agreement 1. The IMF was not even consulted on this matter. The managing director of the IMF in 1971, PierrePaul Schweitzer, was invited one hour in advance to attend a meeting in the US Treasury, along with the Fed chairman, Paul Volcker, who briefed him about the main elements of the Nixon Agenda. Schweitzer then saw Nixon's speech on television. (James, 1996:220) The end of the fixed exchange rates, the scheme designed to maintain a stable world after World War II and reason of existence of the IMF was dissolved without taking into consideration the IMF. Instead, the US ceased the IMF original functions and started to use it as an instrument of its foreign policy.

The US put the IMF aside and negotiated their economic policies at the G4, which became the G5 and afterwards the G7, afterwards at the Rambouillet meeting in 1975, between France and the U.S. These few rich countries were maintaining their own discussions and coordinating their economic policies while the rest of the countries had to maintain their discussions at the IMF and accept all conditionality unilaterally. (James, 1996:266) The 1970's became an era of cheap money and easy credit as a result of the deregulation. The dollar devaluated and the commodities rose in terms of the dollar. The dollar price of gold rose from US$35 per ounce in August 1971 to US$ 455 dollars per ounce in 1980. Prices of raw materials measured in gold remained stable during the 1970's. However, prices of raw materials in terms of US dollar rose considerably, reflecting the devaluation of the US dollar. The real interest rate in the US fell, reaching an average of -0.75% between 1974 and 1975, while inflation reached an average of 10% per annum. This opened the way for irresponsible lending. At that time, the credit cycle did not begin to rise. It already raised in the 1960's, however, in the 1970's the rise of the supply curve rose even more by the increase of liquidity in the international banking circuits after 1971. (Marichal, 1989; Ugarteche, 1986) Inflation rose significantly in the United States, from 3.2% in 1972 to 11% in 1974.

In the late 1970's, the real interest rate began to increase while the ghost of stagflation was in the air. In 1979, the Federal Reserve of the US implemented a tight monetary policy. In 1981 the US changed their policy, introducing what is known today as “Reaganomics”, a policy with a massive 1

The Smithsonian Agreement ( December 1971) is an agreement that ended the fixed exchange rate established at the Bretton Woods Conference in 1944.

budget deficit and at the same time a restrictive money supply. (Boskin 1987, Niskanen 1988) This policy created the inevitable consequence of a jump in real interest rates, from 1.76% in 1980 to 8.57% in 1981, and at the same time a decrease of raw material prices.

The pattern of real interest rates in the US over the course of fifty years has four welldefined periods (Ugarteche, 2006:288-289): 1.From 1956 to 1972, real interest rates had an average of 2.67%. 2.From 1973 to 1980, real interest rate fell to 0.79%, with a period between 1974 and 1975, where it reaches its low of -0.75%. 3.From 1980 to 1989, real interest rate jumped to 6.80% with its peak at 8.65%. 4.From 1990 to 2005, real interest rates were reduced to 4.31%.

The above mentioned caused all debtor nations, which had a strong primary export base, to incur in default since 1982. Since then, debtors tried to refinance the loans and the unpaid interest, by, making them repayable in the future. The IMF seemed, contrary to its mandate, more concerned about the stability of the US banking system than the stability of the developing economies. Instead of controlling the US interest rate to reduce the unpaid interest, the IMF preferred to renegotiate year after year the refinancing of the debt. (Ugarteche, 2006:291) The IMF served as an instrument of foreign policy for the US in the Cold War, rather than stabilizing the world economy. Boughton, a historian of the IMF, argued that the failed policy of the IMF, made primary based sectors of the world suffer, thus resulting in one of the most serious economic tensions of the century. He also admitted that the IMF, instead of playing its role as an economic organization, played a role as a political organization. During the 1980's, governments facing debt crisis were coerced by the IMF and the Paris Club (G7) to pay and adopt their policies. This political adaptation led to high inflation, and in many Latin-American countries even to hyper-inflation after it was implemented. Over the time, this policy implementation generated adjustment and refinancing fatigue, revenues and growth decreased, wages fell. Consequently, consumption declined, political instability increased and income distribution became worse. At the end of the 1980's, the inflation was becoming under control but the problem of income distribution got worse, increasing the numbers of poor and migrants and economic growth stalled. Finally, the IMF imposed the elimination of the “Import-Substitution Model” which gave

good results during earlier decades. The history of the "flying geese" in Asia was ignored completely. These countries began with import substitution and then continued with the substitution of importing complex products, subsequently continued with the simple substitution of exports, and finally with the replacement of exports of complex articles. (Ugarteche, 1999) Obviously, the result of the political conditionality of the IMF in terms of economic growth is not very flattering. This can be seen in Latin America in general. The economy grew until 1980 and then changed to a growth rate of zero in the 1990's. During the 1980's, the emerging economies exported more than half of their national savings at the expense of adjustment policies that reduced the governmental spending, especially on education and health, and reducing government capacities in providing public services. This, later on created conditions that led to a loss of government capacity. It is not difficult to see that the Washington Consensus was just the next step. The reduction of governmental spending created the conditions for privatization of very lucrative sectors such as health, education and state companies, mainly oil and natural gas. Towards the end of the 1980's, the inflation could be controlled. However, the impact of the neo-liberal reforms seriously affected the economic growth. The IMF argued that these reforms -called First Generation Reform- needed to be followed by the Second Generation Reform. Up until now, every country that has implemented the Washington Consensus Reforms, as dictated by the IMF, cannot show any significant improving condition. The IMF economists called for a Third Generation Reform that almost none of the emerging countries listened to. Cases like Argentina, Brazil, China, India, Malaysia and Venezuela have shown that stopping the implementation of these reforms, and adopting their own reforms, has increased growth rates with stable inflation rates. A second lack of confidence and lost of credibility began in Thailand. Stiglitz has written extensively on such issue. The Stiglitz – Summers debate was broadly discussed, revealing how the IMF has lost its reputation and how the US has ignored the function of the IMF and used it as its foreign policy tool. Summers ensured that Stiglitz left the World Bank, where he served as executive vice president. An economist protected by Stiglitz was put in charge of drafting the World Development Report 2000, which focused in global poverty, but had also to leave the institution in June. This report was planned for publication in September. When the report was finally published, all sections written on the need for social spending, tax policies, and speculative capital controls had completely disappeared or had been significantly mitigated. (Ugarteche, 2006:298) The essence of the debate was the speed upon which capital account was opened. Stiglitz argued for a more discreet approach towards capital movements. Analyzing the situation ten years after the Asian crisis, it can be seen that countries that did not open, or did it on a slow pace towards opening their capital accounts, such as China, India and Taiwan, or that fully closed it, as Malaysia, have been

performing better than countries that liberalized after the recommendation of the IMF and adopted the Washington Consensus. Unfortunately for the IMF, the year after this debate (2000), the crisis in Argentina exploded.2 The IMF lost its credibility because it did not accept its responsibility. Instead, the IMF blamed the Argentinean government, which implemented the IMF’s conditionality without any changes. One of IMF’s research directors, Michael Mussa, wrote a book titled “Argentina and the Fund: from Triumph to Tragedy” in 2002. This book describes the problem and washed IMF´s hands for what happened to Argentina. While Argentina’s GDP contracted in 2002, the IMF implemented a public relations campaign to demonstrate their innocence, arguing that the IMF was only playing a roll as an external consultant. This disclaimer and the book of Isabelle Mateos (2004) weakened the credibility of the IMF even more. If the IMF supported a system of fixed exchange rate, it was not a mistake in Argentina’s policy making, but rather due to the conditionality of the policies set forth by the IMF. Moreover, if this conditionality did not include a contingency plan, in case of instability, it was incompetence on both sides. The new Argentinean government later procured an adequate financial and economic recovery. The result was impressive. The government was able to negotiate its foreign debt, control the inflation, and reduce the debt stock by 75%. More than 80% of creditors accepted these terms without advice from the IMF. Finally, Argentina paid its IMF loans (with loans from private banks that did not put any political conditionality) to re-establish its independence in economic and financial policy making. The IMF fell into a credibility crisis. It demonstrated the world that it was no longer guarantor of solid economic policies as well as a lender of last resort. The IMF has not found its way out of crises. On April 2008 approximately 500 IMF employees were set to leave after 20 per cent of the workforce requested voluntary retirement as part of a plan to deliver $100 million in cost savings. The IMF has seen a decline in its loan-making activities to nations in financial difficulty, which used to be its primary source of income.

3. Three Alternative Scenarios of Reforming the IFA 2

Argentina decided to follow a convertibility plan in 1990 to control inflation and stabilize the economy. The fixed rate stood at one peso per dollar, and it worked fairly well between 1990 and 1997. However, in 1998 Brazil devaluated its currency also equivalent at one real per dollar. By having devaluation rate from 1 real to 1 dollar to 3 real to one dollar it caused tensions in the Argentinean economy. The impact was fast and severe. Resource transfers were negative when savers removed their money from the banks and new foreign investment stopped. The level of external debt was once again increased The government, supported by the IMF, took the decision to maintain a fix exchange rate, restricting the money supply as much as needed to prevent devaluation. By 2001, the result was a shortage of liquidity and by December 2001 the government was no longer in control of the situation. The IMF decided to suspend its program contingency. A week later, Argentina declared payment cessation . The IMF did not learn the lesson from Mexico in 1994 where floating exchange rates are better than fixed ones, when there is a sudden and serious imbalance as a result of an external factor. (Ugarteche 2006:299-300)

For many civil organizations, the question in IFA, relays in whether if the IMF is still the head of the IFA, and if it is worth saving such position. The IMF is in trouble; it lacks credibility and financial resources. There are three alternative scenarios on how the IFA could be reformed. The first scenario comes from the IMF itself and includes some of the arguments of the reformist approach. The second scenario comes from the monetarist school of Milton Freedman and his disciples. The third scenario is based on regionalism, arguing that regional financial architectures will give better results.

3.1. First Scenario: the Proposal of the IMF and the Reformists The 21st century had a completely different start, different from that in 1944 when the IMF´s Articles of Agreement were first written. However, the IMF seems to be caught in a time warp. Its policies still tend to emphasize on short-term stabilization, often at the cost of including recession. (Griesgraber et al, 2006: 351) In September 2005, IMF´s Managing Director, Rodrigo de Rato, launched a review of the IMF´s role in “The Fund’s Medium-Term Strategy”. In April 2006, he also presented a medium-term strategy for “Implementing the Fund’s Medium-Term Strategy”. In such review, de Rato made specific proposals for implementing a reform strategy. It offered a new direction in IMF´s policy advice towards its members by giving emerging-market countries an evolving role as well as a more effective engagement in low-income countries. This review sparked a lively internal and public discussion over the appropriate role of the institution and changes needed to perform its role effectively. Almost everybody agrees that if the IMF wants to keep up with this rapidly changing world, it must identify and prioritize its elements in the next few years. The proposals included in the new report, cover the following issues: 1)New directions in surveillance. 2)The changing role of the IMF in emerging market countries 3)More effective engagement in low-income countries. 4)Governance of the IMF. 5)Capacity building. 6)Streamlining. 7)Medium-term budget. The first point speaks on tackling unprecedented global imbalances and the challenges facing individual countries. Also, the need for stronger exercise of the IMF’s policy analysis and ad-

vice towards its member countries, a process known as surveillance. On a global level, this means doing more to identify risks to economic stability, including payments imbalances, currency misalignments, and financial market disturbances. The IMF needs to sharpen its advice towards countries whose economies can have a regional or global impact, especially where there are vulnerabilities that could affect world financial markets. The second point deals with crisis prevention: The specific proposals concerning crisis prevention include: (i) clarifying the framework for high-access financing in situations, other than capital account crises; (ii) allowing high-access contingent financing through a new instrument available to countries with strong macroeconomic policies, sustainable debt, and transparent reporting, who still face potential balance sheet weaknesses and vulnerabilities; and (iii) standing ready to support regional and other reserve pooling arrangements, including signalling sound policies. Point number three speaks on poverty reduction strategies and poverty reduction based on growth facility. More flexible instruments by the IMF have recently been introduced as support to reach the U.N. Millennium Development Goals (MDGs), which seek to halve key poverty indicators by 2015. Some issues mentioned are: i) debt relief; ii) achieving higher growth; iii) focus and flexibility; and iv) projected aid flow to achieve MDGs. The fourth point is aimed at having voices heard from other members, as well as distribution of quotas. Such issues are important for the legitimacy and effectiveness of the IMF. New emerging powers should have a stronger voice in the IMF commensurate with their weight in the world economy. G-7 countries easily dominate the IMF with 45% of the voting power. European governments still control approximately one-third of the votes as well as eight to ten of the twenty-four chairs on the executive board. Meanwhile, the US government alone has the only veto right, controlling 17% of the votes, comfortably above the 15% needed to veto vital policy and budget decisions. (Reyes et al, 2005: 8) Such a degree of control by the US may have had some rationale during the immediate post-war years when it was the single most important creditor to the rest of the world and effectively the only creditor of the IMF. However, at the moment, the US is not the single largest creditor country in the world anymore, but it is one out of 45 creditors’ countries at the IMF. (Akyüz, 2008) The fifth point is based on helping members implement reforms, without questioning whether these reforms are necessary or not for the countries. Capacity building also needs to be part of the strategy to address vulnerabilities identified in surveillance. IMF’s efforts to build macroeconomic institutions through technical assistance and training can be strengthened with better prioritization and country ownership. The sixth point refers to internal management of the IMF, especially in making the decisionmaking process more efficient. The last point is to create a strategy for a medium-term budget that

deals with the projected fall in IMF´s income. Payment of charges and interest are projected to fall from US$ 3.19 billion in 2005 to US$ 1.39 billion in 2006 and to US$ 635 million in 2009. (Griesgraber et al. 2006: 352) Even with a declining real spending, it is clear that a new business model is needed to finance its activities in the future, with less reliance on margins from lending, relying more on steady, long-term sources of income. This proposal has several problems. The first and most important is that solutions for the crisis of credibility and legitimacy are barely touched. There was no real attempt to warn the US over its imbalances and to impose conditionality. The US deficit that created vulnerability in the global economy and financial system was avoided in the report of de Rato. After all, the IMF has been after Furtado, an arm of foreign economic policy for the US. A second problem is the incapacity of the IMF to accept its lack of power to reform its mandate. In point one, de Rato speaks of doing more to identify and promote effective responses towards risks to economic stability, i.e. financial market disturbances. Without knowing IMF´s history, this would sound promising, increasing the roll of the institution towards global stability. Studying its history, in 1974 the Committee of Twenty3 and the Atlantic Council of the United States4 already spoke on regulating capital flows. We hereby transcribe the following excerpts (Solomon et al. 1977: 60): “Another difficult issue concerns the huge and still expanding international capital market, […] is not regulated by any national or international monetary authority. […] These developments raise the question whether some regulation of those markets is not needed. To be effective, such regulation would require the cooperation of all monetary authorities; otherwise the market could migrate to an unregulated centre. The emergence of the fund as the principal authority overseeing balance-of payments adjustments and controlling international liquidity will be a slow and difficult evolution. But it is an evolution that is called for by the economic and political realities of the last quarter of the twentieth century”. De Rato’s proposal is not a new proposal. If in the last 30 years the IMF has not done anything towards a reform, it is unrealistic to think that it will start a reform in the next few years. According to a report by the Independent Evaluation Office (IEO, 2005:11):

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The Committee of Twenty was an ad hoc committee within the framework of the IMF and consisted of twenty developed and developing countries that should plan a reform for a new international financial architecture. The Atlantic Council of the United States was a bipartisan, non-profit, citizen’s organization concerned with the formulation of international policy.

“The IMF has learned over time on capital account issues and the new paradigm […] acknowledges the usefulness of capital controls under certain conditions, particularly controls over inflows [...] but this is not yet reflected in policy advice.” The policy of the IMF is capital liberalization, although it is very ambivalent as the cases of Chile and Colombia shows us how these countries used market-based measures in order to slow capital inflows. Although the IMF admitted that capital controls worked to stabilize Malaysia during the 1997 financial crisis, it still resists promoting a Tobin-tax or similar control. (Reyes et al, 2005:5) In September 28, 2008, the Managing Director of the IMF, Dominique Strauss-Kahn, proposed the transformation of the IMF into a global regulator in order to stop the “anarchy” of the financial markets. To this date, it has only been a declaration and until now, Dominique StraussKahn, has not revealed his plans to recover the IMF, and transform it into an institution with credibility and legitimacy.

Another old topic is the one related with the distribution of quotas. This topic is not only discussed within the IMF, but also in the entire UN system. Because of lack of interest of developed countries, the developing countries organized themselves in the G-77 – a group with 131 countries (the latest number on May 2008) – and the United Nations Conference on Trade and Development (UNCTAD), a place for developing countries specifically devoted to tackling trade problems and identifying appropriate international actions. The difference of the UN and the IMF, is that in the IMF the US has a monopoly on its veto right, which is the main problem. In April 2008, 54 countries saw their representation in the IMF increase. Korea's quota share was increased by 106%. China and Turkey doubled their share. Brazil, India and Mexico’s share increased by 40%. (IMF, 2008) A lot of experts critize the new formula for calculating quotas, arguing that such formula generates changes in shares, moving away from-a closer-alignment of voting power with economic realities.5 (Linn et al, 2008) As long as the US has 5

The proposed changes in member’s quota and voting shares are very modest, moving only slightly toward achievement of the goals announced for the reform. For example, the combined voting share of China, India, Korea, Brazil, and Mexico will increase from 8.2% to only 10.7% of total votes. The combined share of the five European countries Italy, Netherlands, Belgium, Sweden and Switzerland will decline only modestly, from 10.4% to 9.5%. Yet the world shares of GDP at market prices of these two groups, which are respectively 11.9% for the five emergingmarket countries and 8.1% for the five European countries. The disparity between GDP’s measured at purchasingpower-parity prices is even greater. The emerging-market countries account for 20.7% of the world total while the European group has only 5.8%. Moreover, the disparities between the emerging-market group for variables such as international reserves and population are still more extreme. China, India, Korea, Brazil, and Mexico combined have 43.1% of the world's population compared with only 1.6% for Italy, Netherlands, Belgium, Sweden and Switzerland. The increase in voting share for all "non-advanced" developing countries taken together is only 2.2 to 2.7 percentage points (depending on the particular definition of advanced and non-advanced countries).

a veto right and the European countries are over-represented, the IMF will continue to have legitimacy problems. Akyüz (2008) proposes a reform of the IMF, aimed at transforming the IMF into a technocratic institution, the institution advocated by Keynes during the Bretton Woods negotiations. Funding of the IMF would no longer be subjected to arduous and politically charged negotiations, dominated by major industrial countries. The funding could be done by introducing on a global level, a Tobin-Tax, as well as environmental taxes in order to avoid arbitrage against countries adopting such measures.

3.2. Second Scenario: Milton Freedman and the Orthodox Monetarists This group of laissez-faire economists and bankers lead by Milton Friedman, William Wriston, George Schultz and Walter Wriston believe that closing down the IMF is an optimal solution because it has done more harm than good. This is a very interesting critic. The IMF has almost unilaterally imposed monetarist conditionality, and having one of the main representatives of the monetarist theory, criticizing the IMF, creates not only a credibility problem for the IMF, but also for the governments that applied the IMF conditionality. The argument is that meddling in currencies by the IMF created market distortions, and instead of seeking a rapid exit of the problem, it has generated interference of the market. Currency traders in foreign exchange markets can effect macroeconomic adjustment more quickly and better than the IMF can. They accuse that IMF has only helped irresponsible bankers who generated the problems and have not paid for their irresponsibility. Freedman solution is to abolish the IMF and to distribute the assets to each country and let the markets take care of the fallout. (Forbes, 1998) Friedman and Shultz agree that the 1995 IMF bailout of Mexico set the stage for the East Asian and other crisis. The Mexican case created a sense that everyone thought they would be bailed out. As for East Asia, Russia, Brazil and Argentina. Friedman argues (Forbes, 1998): "Businessmen should not have a free insurance policy every time they take a risk in global markets. The Mexican bailout helped fuel the East Asian crisis that erupted two years later. It encouraged individuals and financial institutions to invest in the East Asian countries, and reassured them about currency risk by the belief that the IMF would bail them out if the unexpected happened and the exchange pegs broke. By encouraging people to speculate with other people's money, the IMF has been a destabilizing factor in East Asia. Not so much because of the conditions it has imposed on its clients, wheth-

er good or bad, as by sheltering private financial institutions from the consequences of unwise investments" The monetarists even argue that neither the money of the IMF nor its conditionality terms set forth, have worked. For them it is clear that the IMF´s money just goes to irresponsible bankers who will withdraw their money and transfer it into another country, therefore starting a new crisis. As an example Shultz (1998) said “Indonesia's solution isn't IMF money. The solution is to restore the confidence of the ethnic Chinese so they bring back the $80 billion they pulled out." The IMF has done much harm to several countries. The solution is not based on money, but on restoring confidence. The problem with such point of view is the purpose for creating the IMF in 1944. The idea of having a stabilization fund was to generate global monetary stability. The problem is not the existence of life jackets, but rather on how to use them wisely. If we compare Indonesia and Malaysia, we see two countries with a completely different approach over a crisis. Indonesia followed the rules of the IMF, reducing governmental spending, increasing tax and interest rates, affecting consumption and investment. Malaysia on the other hand, closed their capital accounts. Indonesia needed huge amounts of IMF loans, but the economy did not recover. Malaysia on the other hand, survived the crisis with much less damage. However, the argument of Freedman and the other monetarists are wrong when trying to trivialise the effects of conditionality. It is also wrong thinking that it is just a problem of irresponsible bankers. Financial crisis are not a zero sum game. They have deep economic impact, affecting the entire population. The solution is not to eliminate the IMF and suppose that inefficient markets will turn efficient. The solution is to seek ways to regulate capital flows and how to intervene on a crises scenario. The first question is on economical grounds: is closing capital accounts adequate, or rather to create a working international stabilisation fund. The second question is a political one, whereby the IMF needs to rethink its mandate and see if the conditionality established by the Department of State and the Foreign Office is a viable solution. As long as the IMF is a part of the US foreign policy instead of a technocratic economical institution, there is a need to create new institutions.

3.3. Third Scenario: Regionalism

This third scenario is supported by many civil society organizations (CSOs) from the Global South, proposing to reduce power of the IMF. In contrast to the monetarist point of view, these critics do not propose to leave the regulation of global finance to market forces. (Griesgraber, 2006:355) For them, the future of monetary stabilization is to transfer IMF´s functions to regional agencies. In this scenario, as proposed, among others, by Walden Bello and Oscar Ugarteche, regional stabilisation funds would provide the main insurance against financial instability. The idea of having a regional financial institution is also based on crisis prevention. Asian Crisis has shown us that the world is needy for an effective early warning system. This early warning system will most probably be effectively applied at a regional level, as countries in the neighborhood are much more likely to detect emerging problems than those farther away. (Bergstern, 1998) Moreover, currency crises tend to be regional. This is the essence of a regional monetary fund. Currency crises create regional costs; therefore, the region has an incentive to create institutions to mitigate these costs by providing a financial safety net. (Rose, 1999) This does not mean that the IMF would completely disappear. For some analysts, the role of the IMF would be in data search and collection as well as carrying out visits ordered by Article IV. Meanwhile, a framework of international arbitration would replace the Paris and London Clubs as the mechanism for restructuring sovereign debt. This third scenario has become popular in the last few years. Steps to build strong regional funds have been started in Southern Africa (Common Monetary Area of Southern Africa), East Asia (Asian Monetary Fund), Latin America (Latin American Reserve Fund, Fondo Latinoamericano de Reservas), and South America (The South Bank, Banco del Sur). All of these new forms of regionalization are completely different by nature. The next section will be on the Asian Monetary Union and Fund and the Banco del Sur. These two regional associations are important because these two regions have been the most affected by the last decade of crisis and also have enough liquidity. The Fondo Latinoamericano de Reservas, which was born in 1988, has been very successful in assisting Bolivia, Ecuador and Peru. However, it does not have enough members. Only the Andean countries and Costa Rica are members. It would also have a lack for sufficient funds in case assistance is needed towards a major economy such as Argentina, Brazil, Chile or Mexico.

3.3.1 Asian Monetary Fund (AMF) When the crisis broke out in South East Asia in 19976, the IMF did the usual recommendations, reduce government spending, reduce private demand, increase taxes, cut the money supply, and raise interest rates to attract foreign investors. This was recommended despite there was no fiscal imbalances inducing to an economic depression. Malaysia, on the other hand, defied the IMF and imposed capital controls. (Reyes et al. 2005:2) This decision raised a howl from short-term speculative investors, but that stopped the increasing capital outflows that were happening through out the rest of the region. The result is Malaysia survived the crisis better than the other countries in terms of GDP decline and recovery. Similar situation was also happening in Thailand where Shinawatra´s party ran against the IMF policies and revived Thailand’s economy. This started the debate between Stiglitz (Wold Bank) and Summers (IMF) on the recommendations of pro-cyclical policies. (Ugarteche 2006) The idea of creating a financial institution started when the financial crisis in Thailand spread through to other countries in East Asia. Japan proposed the idea of forming an Asian Monetary Fund (AMF) as a framework for financial cooperation and policy coordination in the region. The main objective of the AMF is to create a regional monetary fund that will provide lending facilities in the case of future financial crisis in Asia. At that time, in 1998, the Japanese government announced its readiness to create an Asian Monetary Fund with a possible capitalization of $100 billion (the United States Treasury resisted. (Lipscy, 2001) The US perceived that an institution similar to the IMF in Asia would reduce their influence in the region and could have negative effects on the IMF and the World Bank. The US saw this movement as an attempt to push US out of the region since the US is firmly believed to have ensured prosperity in Asia-Pacific and has a huge economic interest. In May 2000, Chiang Mai Initiative (CMI) was launched when the finance minister of Association of South East Asia Nations (ASEAN), China, Japan, and South Korea (what is later known as ASEAN+3) agreed to establish a system of bilateral swap arrangements. This swap arrangement enables such countries to share reserves through bilateral swap agreements, which accounts to a total of $36.5 billion. (Griesgraber 2006:355 and Ugarteche 2006) The CMI is designed to provide liquidity support for member countries that are experiencing short-run balance of payments deficits. It is expected that this initiative will prevent an extreme crisis or systemic failure in those countries and subsequent regional contagion. The formation of the CMI captured the attention of the financial 6

When these economies crashed in the summer of 1997, the impact on the reigning ideology of globalization was massive. Perhaps the most shocking aspect of the crisis for people in the developing world was the social impact of the crisis: over a million people in Thailand and some 21 million people in Indonesia found themselves impoverished in just a few weeks. (Reyes et al. 2005:1)

world because of the high level of international reserves held by these countries. The total reserves of ASEAN+3 were US$729 billion, which did not include Hong Kong and Taiwan foreign exchange reserves and ASEAN+3 non-currency reserves, such as gold, Special Drawing Rights (SDRs), and reserves in the IMF. (International Financial Statistics, 2000) Moreover, in the opinion of Eisuke Sakakibara, Ministry of Finance of Japan, the AMF would have been much more flexible than the IMF, by requiring a less uniform, perhaps less stringent, set of required policy reforms as conditions for receiving help. (Altbach, 1997:8 and Reyes et al, 2005:3) However, the obstacle to formalize the AMF is coming from inside the region itself. Furthermore, it comes more as a political issue rather than as economical issue. The issue is on who will take the role of leadership of this newly formed institution. There are two countries that will compete for this position, Japan and China. There is an increasing rivalry between these two countries over the leadership role in regional economic cooperation. The region is still reluctant to accept Japan’s domination and therefore having them as a leader. China is the world’s largest holder of foreign exchange reserves, and it will naturally assume the role as leader, a role China is probably not ready to assume. Moreover, there is also discussion regarding moral hazard. It is expected that AMF will follow the steps of the IMF, by lending with conditionality. However, there is doubt that CMI will create moral hazard in managing balance of payments due to the fact that participating countries will not be able to request tight conditionality. There is also discussion on the issue if the AMF will be challenging the IMF. The IMF argued that two rivaling monetary funds would create moral hazard problems by allowing countries access to emergency funds even if they failed to adopt tough economic reforms. What can not be set aside from this discussion is the objection from the US towards formalization of the AMF. By forming the AMF, the U.S. will likely be reducing its influence and possibly have an effect on the US economy. If regional central banks led by Japan had sold out their huge holdings of T-Bills to finance this operation, the interest rates on the US T-Bills and long-term interest rates would have probably increased and would have caused problems for the US economic upturn. Although the plan of formalizing the AMF is still far, plans to enlarge CMI keep on going. The enlargement includes Australia, New Zealand, and India. However, CMI has helped by improving the exchange rate stability and contributed to closer regional economic and financial integration. (Wang, 2002)

3.3.2 Banco del Sur

From 2002 onwards, Argentina7 decided to make their debt negotiations without the IMF, and the commercial and investment banks allowed it. Then, the two countries with the highest debt with the IMF, Brazil and Argentina, paid their debt in advance during 2005 to regain room for manoeuvre in their macroeconomic policies. In Latin America, the Fondo Latinoamericano de Reservas (Latin American Reserve Fund) was created in 1976 as the Andean Reserve Fund, attached to the Andean Pact and expanded to countries outside the Andean region in 1988. As mentioned above, only Cost Rica joined this Fund. Nevertheless, it has some success stories with Bolivia, Ecuador and Peru. However, it does not posses enough funds for a major crisis and less for a spillover crisis. Temporarily Venezuela has been acting as a lender, replacing the IMF for countries that do not want to follow the IMF conditions. In three years, Venezuela has bought bonds of Ecuador, Argentina, Bolivia, and Paraguay. (Ugarteche, 2006: 326) To resolve the lack of such institution, several countries in South America, led by Venezuela and Argentina, decided to create such institution. In February 2007, Argentina and Venezuela and a few months later Bolivia, Ecuador and Paraguay closed the deal by creating the Banco del Sur. On May 3, in Ecuador, Brazil signed its incorporation, and on June 25, Uruguay did the same. Colombia and Chile have shown interest in joining. Colombia even formally requested membership. The only bigger country still missing is Peru. On December 9, 2007 the bank was finally launched. From day one, the idea was to create a regional development bank, especially to gather funds for the construction of an 8,000-kilometre gas pipeline from Venezuela to Argentina. The increasing number of countries participating is intended to increase the functions of the institution. It should create a stabilisation fund for countries in crisis and develop a regional currency area or even a common currency. The possibility of having all these functions conducted by one institution is questionable. However, there should be no objections from member countries. On April 25 2008, some important political steps were taken, in the South America Finance Minister Meeting in Montevideo, Uruguay. The main resolution adopted at such meeting was related to the contribution of capital by its member countries. Three groups were created. The first one includes Argentina, Brazil and Venezuela, providing US$2 billion each. A second group, Uruguay and Ecuador, will contribute with US$400 million. The third group, Bolivia and Paraguay, will contribute with $100 million. This will give a first stock of capital of US$7 billion. (IFI, 2008) One thing still left uncertain, is the Bank’s governance, although this will be defined in the next meeting. While countries like Brazil and Venezuela prefer a system of one dollar equals one vote, Bolivia, Ecuador, Uruguay and Paraguay defend the idea of one country one vote. Argentina pro7

Nigeria also decided in 2002 to make their debt negotiation without the IMF.

posed a double system. That is, while the Bank’s governors (responsible for the policy of the institution) would be one per country, the executive directors (responsible for the daily decisions) would be proportional to its invested capital. (Furtado, 2007:4) The main problem for the South Bank, and almost all institutions of South America, is that civil society is not part of the decision making process. All governments are having their negotiations behind closed doors and there is no transparency over the information. Moreover, NGOs and civil society cannot participate and not even be able to put political pressure, because they do not know what governments are negotiating. In order for this process to gain credibility, it should open itself. The lack of information will only create suspicion that the Bank wants to reproduce the actual governance form of the Bretton Woods institutions instead of creating transparent governance. There are many democratic forms that can be replicated: 1.Consensus based decision making, similar to the one the OECD has. 2.Consociationalism8 Democracy, including not only countries, but also NGO´s and civil society. 3.One country one vote system, 4.Majority democracy whereby minorities have some protection, i.e., at least 3 countries can not be against .a proposal. Having resolved these two key questions, a decisions need to be made, if the Banco del Sur will have all three functions or if it should be divided. Politically, it is easier to work with three institutions than with one. Economically, there are no arguments against having one institution, with all three functions.

4. Conclusion The crisis of the IMF has created three interesting alternatives. Although we disagree with some, all alternatives have a valid point. The IMF and the reformist support global rules and the possibility of reforming the IMF for the 21st century by creating reforms implicating independence of the IMF from the US Treasury and foreign policy.

8

Consociationalism is a form of government involving guaranteed group representation, and is often suggested for managing conflict in deeply divided societies. It is often viewed as synonymous with power-sharing, although it is technically only one form of power-sharing. (Brendan, 2005)

The Monetarists do not believe in the IMF any more. Along with the Monetarists, we believe that irresponsible bankers and speculators should not be saved. We do not believe that markets will solve the crisis in the short run, but nonetheless countries need to be saved. Specially the case of Argentina, where poverty increased from 5% to 50% in a few months, or South East Asia, where millions of people became poor. All of the above mentioned facts lead us to conclude that an institution that stabilizes the economy must be created. As for irresponsible bankers, there is a way to deal with such problem by creating a legal framework, with a supranational court where claims and legal procedures can be initiated against irresponsible bankers. The scenario for creating regional institutions has much support. Not only East Asia and South America, but also Southern Africa has shown their political will. However, we still do not know how things will work, and if political interest will immobilize these institutions. There is also a problem with regions that do not have sufficient amounts of reserves, such as middle Africa or Central America. Nevertheless, we believe that this is the right way to go. The IMF will be reformed with new functions, such as coordinating regional banks in inter-regional spillover crisis, imposing a Tobin-Tax, or imposing an ecological tax. The future that lays ahead should have a supranational institution imposing worldwide taxes and coordinating regional institutions, which will be responsible for regional crisis prevention.

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