IMF May Need to Print Money to Pay for Bailouts
The shocking revelation that the world's financial firefighter - the International Monetary Fund (IMF) - is close to running out of money from all the country bailouts, is deeply worrisome. It means that the agency will have to resort to manufacturing money, rather than using its reserve of real wealth. When such a thing happens, it can lead to hyperinflation and wealth destruction. As a modern day example of where this sort of money manufacturing can lead, take a look at Zimbabwe in Africa. Officially, it now has inflation in the millions of percent.
Historically, the text book case is of the Weimar Republic in Germany prior to the rise of Hitler and the Nazis.
It is worth remembering that once the IMF is done, there is no other place to turn to. There is no interplanetary bank of last resort. It would mean the existing monetary system and the faith it needs to sustain itself, would be exhausted and spent. What happens after that will be a highwire act of historic proportions. Stay tuned!
IMF may need to "print money" as crisis spreads The International Monetary Fund may soon lack the money to bail out an ever growing list of countries crumbling across Eastern Europe, Latin America, Africa, and parts of Asia, raising concerns that it will have to tap taxpayers in Western countries for a capital infusion or resort to the nuclear option of printing its own money.
By Ambrose Evans-Pritchard
Last Updated: 10:46PM GMT 27 Oct 2008
IMF's work in countries such as Turkey is only just beginning
The Fund is already close to committing a quarter of its $200bn (£130bn) reserve chest, with a loans to Iceland ($2bn), Ukraine ($16.5bn), and talks underway with Pakistan ($14.5bn), Hungary ($10bn), as well as Belarus and Serbia.
Neil Schering, emerging market strategist at Capital Economics, said the IMF's work in the great arc of countries from the Baltic states to Turkey is only just beginning.
"When you tot up the countries across the region with external funding needs, you get to $500bn or $600bn very quickly, and that blows the IMF out of the water. The Fund may soon have to start calling on the West for additional funds," he said.
Brad Setser, an expert on capital flows at the Council for Foreign Relations, said Russia, Mexico, Brazil and India have together spent $75bn of their reserves defending their currencies this month, and South Korea is grappling with a serious banking crisis.
"Right now the IMF is too small to meet the foreign currency liquidity needs of the larger emerging economies. We're in a dangerous situation and there is the risk of extreme moves in the markets, as we have seen with the Brazilian real. I hope policy-makers understand how serious this is," he said.
The IMF, led by Dominique Strauss-Kahn, has the power to raise money on the capital markets by issuing `AAA' bonds under its own name. It has never resorted to this option, preferring to tap members states for deposits.
The nuclear option is to print money by issuing Special Drawing Rights, in effect acting as if it were the world's central bank. This was done briefly after the fall of the Soviet Union but has never been used as systematic tool of policy to head off a global financial crisis.
"The IMF can in theory create liquidity like a central bank," said an informed source. "There are a lot of ideas kicking around."
For now, Eastern Europe is the epicentre of the crisis. Lars Christensen, a strategist at Danske Bank, said the lighting speed and size of Ukraine's bail-out suggest the IMF is worried about the geo-strategic risk in the Black Sea region, as well as the imminent risk a financial pandemic. "The IMF clearly fears a domino effect in Eastern Europe where a collapse in one country automatically leads to a collapse in another," he said.
Mr Christensen said investor sentiment towards the region has reached the point of revulsion. The Budapest bourse plunged 10pc yesterday despite the proximity of an IMF deal Meanwhile, Standard & Poor's issued a blitz of fresh warnings, downgrading Romania's debt to junk status, and axing the ratings Poland, Latvia, Lithuania, and Croatia.
The agency said Romania was "vulnerable to a sudden-stop scenario where capital inflows dry up or even reverese", leaving the country unable to cover a current account deficit of 14pc of GDP.
Romania's central bank has taken drastic steps to defend the leu, squeezing liquidity so violently that overnight rates shot up to 900pc. But there are growing doubts whether this sort of shock therapy can obscure the fact that economic booms are now turning to bust across the region.
Merrill Lynch has advised to clients to take "short" positions against the leu. "The fundamental picture suggests that Romania may face a currency crisis in the near term, similar to what Hungary has gone through over the last week," it said. The bank also warned that Turkey and the Philippines are vulnerable.
Hungary was forced to raise interest rates last week by 3 percentage points to 11.5pc to defend its currency peg in Europe's Exchange Rate Mechanism. Even Denmark has had to tighten by a half point, raising fears that every country on the fringes of the eurozone will have resort to a deflationary squeeze.
The root problem is that Eastern Europe and Russia have together borrowed $1,600bn from foreign banks in euros and dollars to fund their catch-up growth spurt over the last five years, according to data from the Bank for International Settlements. These loans are now coming due at an alarming pace. Even rock-solid companies are having trouble rolling over debts.
Mr Schering said Turkey was likely to join the queue for bail-outs very soon. "Their external liabilities have reached $186bn, and a lot of this is short-term debt that has to be rolled over in coming months," he said.
Turkey's prime minister Recep Tayyip Erdogan said over the weekend that his country would not "darken its future by bowing to the wishes of the IMF", but it is unclear how long Ankara can maintain its defiant stand as capital flight drains reserves.
Pakistan - now facing imminent bankruptcy - has also raised political hackles, balking at IMF demands for deep cuts in military spending as a condition for a standby loan. Diplomats say it is unlikely that the West will let the nuclear-armed Islamic state slip into chaos.
Jeremy Warner: IMF must not be too hard on developing world
Tuesday, 28 October 2008
Outlook: After 10 years of doing little, other than produce worthy reports and forecasts, the IMF finds itself back in business playing the role for which it was created – to act as lender of last resort to distressed countries. Already, outline packages have been announced for three countries – Iceland, Ukraine and Hungary. It is certain there will be many more emergency calls for international rescue before the crisis plays out.
The financial storm started with banks. Now it is whole countries which are being afflicted by the flight of capital back to perceived safe havens. The run on banks is being replaced by a run on national economies as investors reacquaint themselves with the meaning of risk.
Perhaps oddly, the developing world had, until a month or two back, managed to escape the worst consequences of the credit crunch. These fast-growing economies were said to have decoupled from their Western counterparts and were widely thought to be capable of motoring on, a world unto themselves, as the developed world went to hell in a handcart.
This thinking has turned out to be flawed. Many of these economies were as much living on borrowed money as the rest of us, and even those, such as China, which have been built on export success, are suffering as demand in America and Europe plummets. The definition of an emerging market, it used to be said, was one from which it was impossible to emerge in an emergency. Once again, this old truism is reasserting itself.
Almost everywhere, assets thought risky are being liquidated as loans are called in and credit becomes contracted. One consequence of this process is the unwinding of the so-called "yen carry trade", under which hedge funds and others would borrow cheaply in yen and lend at higher rates in riskier currencies.
As hedge funds retreat from these positions, they sell the risky assets they have bought in emerging and other high-interest rate markets and buy yen to pay back the money they have borrowed. This is causing the yen to appreciate in value, undermining the competitiveness of Japanese industries already hit by the fall-off in export demand. The capital markets seem to have become like a doomsday machine, decimating everything in their path.
The last time the IMF was tapped on the scale now envisaged was during the emerging-markets crisis of the late 1990s. Back then, it was judged to have done a thoroughly bad, even counter-productive job. By imposing austerity measures on countries as a condition of its lending, the IMF greatly added to the economic and social pain that recipient countries suffered.
One country, Malaysia, resisted the IMF's embrace and, to almost universal international condemnation, instead imposed its own controls to halt the flight of capital. To the bewilderment of the IMF's free-market thinkers, it seemed to work much better than the medicine the IMF was imposing on others. There is indeed a perfectly respectable, though not wholly convincing, school of thought which traces the entire credit crunch back to the IMF's actions at that time.
So shocked were the Asian economies by the deep recessions which the IMF's austerity packages helped bring about that they vowed never again to get themselves into a position where they needed to be bailed out with Western money. Instead, they began to save with a vengeance in an attempt to build up unassailable reserves of foreign currency. These capital surpluses had to go somewhere, and in no small measure, they helped to fuel the Western credit binge.
It is to be hoped that, this time around, the IMF has learnt its lesson. Little is yet known except in outline about the conditions being attached to the present round of lending. For the Ukraine, the IMF wants a more flexible exchange rate, more privatisation, and a smaller current account deficit. More ominously, it wants progress towards a balanced budget, this to be achieved by paring down on social spending.
It scarcely needs saying that this latter demand is the exact opposite of what Western nations, including Britain, propose for themselves in their efforts to mitigate the downturn. Yesterday, Gordon Brown, the Prime Minister, vowed to spend his way out of recession, a quite high-risk strategy for an economy with its own currency. To be further adding to public borrowing in the hope of addressing the contraction in private debt may not seem entirely wise.
If there is a fully blown sterling crisis, and he's eventually forced to go cap in hand to the IMF, like Denis Healey in the 1970s, he would be dismayed by the sort of medicine the IMF likes to impose. Tempting though it is for reasons of moral hazard to impose austerity on countries that have borrowed too much, it is not the answer.
If the conditions are too harsh, countries will retreat into capital controls, a form of beggar-thy-neighbour protectionism which would set the cause of globalisation back decades and might tip what already promises to be a severe global recession into an outright slump.
Brown says IMF needs more cash
Embarking on a diplomatic offensive to secure hundreds of billions of dollars in additional financial support for the IMF, the Prime Minister called for immediate action.
His intervention came after Hungary and Ukraine accepted IMF assistance to prop up their battered economies as the financial crisis has torn through Eastern Europe.
He said the 250 billion dollar fund currently available to the IMF to lend to financially stricken states "may not be enough".
"It is becoming increasingly clear to me that we cannot delay and that we now need substantial additional resources in addition to the 250 billion dollars the IMF already has available," he said.
Aides later refused to set a figure but said the required cash was likely to run into hundreds of billions.
The premier did not rule out a British contribution to the enhanced fund, but made clear he believed the bulk of any additional money should come from China and the oil rich states of the Gulf. "Yes, we will play our part, but the biggest part can be played by countries that have got the biggest surpluses," he said.
Mr Brown, who was in Paris holding talks with French president Nicolas Sarkozy, said he would be raising the issue during a four-day trip to the Gulf starting on Saturday. He is due to visit the leaders of Saudi Arabia, Qatar and the United Arab Emirates, which have all seen multi-billion dollar boosts to their income from oil due to the recent price spike.
He is also planning to speak by phone with Chinese premier Wen Jiabao, whose country is sitting on a large capital reserve after a decade of expanding exports of consumer goods to the West.
"I believe it is possible in a very short period of time to create an international fund that is strong enough to help withstand the difficulties," Mr Brown said. "It is in every nation's interest and in the interests of hard-working families in our country and every country that financial contagion does not spread."