Newsweek
July 11, 2011
The International Monetary Fund’s new managing director, Christine Lagarde, has inherited an IMF that has outlived its purpose. It takes just a bit of history to explain why. The IMF was created under the 1944 Bretton Woods agreement, a plan to promote open markets through exchange rates tied to the U.S. dollar. If a country couldn’t cover its trade deficits, the IMF was to step in and lend it the needed dollars—on certain conditions. To ensure that the emergency loan would be repaid, and to clear the way for other financial institutions to make or renew longer-term loans in safety, the recipient nation had to adopt a program of strict austerity.
When the fixed-rate regime of Bretton Woods ended in 1971, economists imagined at first that a new era of freely floating exchange rates would keep imports and exports roughly in balance, thus eliminating large trade deficits and the need to borrow abroad to cover them. But many governments were loath to let exchange rates float freely. To hold down prices for imported food and energy, they kept their currencies at overvalued levels—and so their foreign debts mounted. They borrowed abroad for other reasons, too: for grandiose public-works projects; to keep state-owned industries afloat; and, not least, because it suited sticky-fingered ruling families.
Foreign lenders were untroubled; as former Citibank head Walter Wriston famously declared, countries don’t go bust. Still, governments cannot borrow without limit. When the pretense that a country was creditworthy became impossible to sustain, the IMF was wheeled in to do the dirty work and make the country safe to lend to again—until the next crisis.
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