Trump tells IMF & World Bank to get reformed or lost? How fair is the threat?

 

Article's Background

This short article highlights the bleak future of the IMF and World Bank ahead as a result of the President Donald Trump's new trade and governance policy for the American economy.

• The US Treasury Secretary Scott Bessent at a recent public forum heavily criticized the failure of the IMF and World Bank to deliver their founding roles envisaged for the global economic and monetary order and balance. Accordingly, present trade turmoil is a result of their failure (Listen to the speech here).

• He stated that the US would back both the institutions so long as they get reformed back to be IMF and World Bank and respective management and staff are accountable to respective roles.

• The IMF Managing Director's presentation made at the IMF-World Bank Spring Meetings held on 17 April also backed the US new trade policy as an outcome of the unfair international economic system prevailing at present (Read the article with the presentation).

Accordingly, the radical nature of the Trump's trade and domestic economic policy casts doubt whether both IMF and World Bank would survive for long unless they get fully reformed to serve the economic interests dictated by the US government.

In order to facilitate for understanding the above context, this article briefly presents;

• how the IMF and World Bank were born,

• how they failed as criticized by the US Treasury Secretary, and

• the near-term fate of them and their economic management model sold to debt-ridden developing countries. 

IMF and World Bank were born in 1945 under the Bretton Woods Agreement in 1944

The Bretton Woods agreement was signed by 44 countries in 1944 for the purpose of rebuilding the economies affected by the World War II. Therefore, it primarily set up a global monetary system and lending schemes to assist country development and stability. Accordingly, the agreement had three major elements.

• First, setting up a dollar-gold based fixed exchange rate system to enable the US dollar to serve as the global currency for international transactions and settlements. This system had two key features.

• The value of the US dollar was fixed as 35 dollars = one ounce of gold. Accordingly, the US government stood to buy and sell gold in any amount at that exchange rate (convertibility of the gold at fixed exchange rate).
• Exchange rates of currencies of other countries were fixed for the US dollar. Accordingly, the value of other currencies was linked to the gold through the US dollar.
• Second, setting up of the IMF. Its mandate was to supervise this global exchange rate mechanism and to provide short-term loans to countries confronting international balance of payment problems. This was to prevent countries resorting to different or competitive exchange rate and trade policies to resolve balance of payment problems which is normal under fixed exchange rates systems.
• Third, setting up of the World Bank. Its mandate was to provide long-term loans and promote international investments for the development of the member countries.

What went wrong with the Bretton Woods System, IMF and World Bank?

The Bretton Woods system confronted severe design problems by early 1970s.

• First, given the enormous discretionary money printing power of the US under the agreement, the US expanded the world dollar supply recklessly by disregarding its gold convertibility restriction/condition imposed in the agreement. Therefore, Bretton Woods members were foolish to think that the US would print dollars by confirming to the agreed dollar-gold exchange rate and control dollar supply of dollars. As it didn't happen, the dollar underwent a severe speculative attack through the increased demand for gold out of dollars and the US ran the risk of running out of gold stocks to defend the dollar and its exchange rate.

• Second, as a unilateral political measure to counter the speculative attack on the dollar, the US President suspended the dollar-gold convertibility in August 1971 and, therefore, the Bretton Woods Fixed Exchange Rate System or global monetary system collapsed (Read the statement).

As a result, countries started differently managed exchange rates between currencies and trade policies were implemented accordingly.

However, as the US dollar had already gained the global reserve currency status, its global economic power through the dollar dominance continued largely unaffected.

Overall, the international monetary system born in the Bretton Woods Agreement and its subsequent evolution have created several fundamental imbalances in the present global economic order.

• First, it promoted the US dollar as the global reserve currency in place of the Sterling Pound (Britain currency) and dollarized the rest of the country monetary and economic management systems.

• Second, the US could print dollars without limits for its geopolitical objectives including wars as the world trusted the dollar-gold convertibility like the old gold standard based private bankers.

• Third, the rest of the world had to depend on export surpluses to the US as the means for getting dollars for managing respective dollarized economies whereas the US could run excessive balance of payment deficits and consume excessively more than the national production by creating dollars and accumulating debt.

• Fourth, the IMF became a routine short-term lender to help dollar reserves of developing countries to resolve balance of payment deficits temporarily as part of protecting the global dollar system.

• Fifth, the World Bank assisted many developing countries akin to IMF lending programmes through its own long-term agendas as the second tier of dollar flows to these countries with conditions to promote private sector and to limit the government.

• Sixth, economic policies of many developing countries were oriented to source dollars to fund their import dependent economies through foreign capital inflows as their monetary and fiscal policies were tied to the dollar. Therefore, these economies were managed on balancing of a set of economic numbers such as the dollar reserve, dollar exchange rate, interest rate and inflation rate based on foreign borrowing rather than balancing the real growth sectors and living standards to suit the country resources and fundamentals. The IMF - World Bank economic models were largely behind this fate.

• Seventh, the Europe and a set of newly industrial countries such as Japan, China and East Asia emerged with significant volumes of dollar reserves built primarily through exports and own reserve currencies created through foreign trade and investments with the power to influence the global economy.

• Eighth, national leaders of developing countries have got used to manage respective economies openly through heavy imports to satisfy the public by falling behind the rollovers of IMF and World Bank loans and their global hot capital investor network whereas many country leaders became IMF-World Bank model followers by compromising the national sovereignty.

• Nineth, the US evolved as the world anchor economy through the reserve currency power of the dollar.

It is in this background that the President Donald Trump has announced his reciprocal tariff policy and trade talks for more balanced trade transactions and criticized the failure of the IMF and World Bank to promote an international monetary system and balanced growth as envisaged in the Bretton Woods Agreement.

What could be the fate of the IMF and World Bank and their economic management model sold to developing countries?

• First, as the US goes for trade talks with countries for a balanced trade individually and rebalancing economies as a part of the trade agreements, the supply of the US dollar as the reserve currency to the countries will confront a massive decline.

• Second, as part of the US trade agreements, the US is prepared to provide the countries with dollarised credit facilities and investments for development and rebalancing (i.e., restructuring of domestic product, consumption, investment, exports and imports for a sustainable balance) of country economies for greater stability and sustainability. This seems that the US government is to take over the role of the IMF and World Bank for the purpose of better global stability and resilience free from the IMF-World Bank bureaucracy. This option appears practical, given the insignificance in total loans outstanding from member countries to the IMF and World Bank in total of around US$ 372 bn or 0.33% of world GDP.

• Third, given the present magnitude of trade conflicts caused by the US between the member countries of the IMF and World Bank, both institutions will not be in a position to implement a reform agenda as the US proposes.

• Fourth, many debt-ridden developing countries such as Sri Lanka who compromised the national sovereignty for IMF-World Bank financing programmes will run the risk of a new round of bankruptcy due to severe financial and operational constraints that may confront the IMF and World Bank soon.

• Fifth, as these countries have already dismantled national economic policy management systems through legal amendments to implement monetary rules and fiscal rules as recommended/required by the IMF - World Bank, country national leaders will confront national crises not being able to consolidate their domestic economic policies as required by the US authorities for rebalancing the economies under trade agreements.

• Sixth, the possible breakdown of the IMF-World Bank's informally run global economic agency network will free national leaders to look for domestic experts who are knowledgeable for operating economies on domestic resources and fundamentals.

Overall, depending on how the US authorities proceed with trade talks, the global economy and country economies of all levels may confront severe shocks and uncertainties of the century whereas some of foreign debt-ridden countries may even confront new bankruptcies in the transition. 

Given the dominance of the US dollar in economies, banking and financial systems will be the trigger to pull crises in the event of protracted trade disputes and shortages of dollar supply to the world economy.

(This article is released in the interest of participating in the professional dialogue to find out solutions to economic issues affecting living standards. All are personal views of the author based on his research and knowledge on the subject and, therefore, the author has no intension to personally or maliciously discredit views and characters of any individuals or institutions.)

P Samarasiri

(BA (Hons) in Economics and MA in Economics)

(Former Deputy Governor, Central Bank of Sri Lanka)

(Former  Deputy Governor, Assistant Governor, Secretary to the Monetary Board, Compliance Officer and Director of Bank Supervision of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 13 Economics and Banking Books and a large number of articles published.)