A world in economic crisis

More on the der Spiegel’s article on the IMF

Posted in G20, Greece, Hungary, International Monetary Fund, USA by Aussie on October 7, 2010

Despite the rather flowery language of the author, this article on the IMF and where it wants to head is worth reading. It takes time to digest because it becomes necessary to remove all of the flowery language to get down to the nuts and bolts.

There are several European countries that are in danger of collapse: Spain, Greece, the U.K., Ireland, Turkey, Italy and a new one to add to the list Hungary.  The IMF seems intent upon interfering in the economies of these countries by providing loans coupled with austerity measures. This is certainly the prescription that was given to Greece. (I have already covered the issue of the laziness of the Greeks).  The question though, is whether or not this interference is justified, especially when these Socialist countries do not seem to want to reform, let alone grasp the reality that their Socialist policies might be to blame for the imminent collapse of their respective economies.

Hungary had been on the brink many times since the fall of the Berlin Wall, and it had been borrowing from the IMF on and off for several years, until the negotiations were broken off. Any country borrowing from the IMF must be prepared to make certain necessary reforms including: a reduction in the civil service employees and employee pensions.  Here is an outline of Hungary’s interaction with the IMF and the results for that country (not all that encouraging):

Hungary has been an IMF member since 1982. The country embarked on economic reforms early on, and to do so it needed IMF loans — to the tune of $520 million in the first year of its accession to the Fund. Hungary, a model student when it came to developing a market economy, relaxed its import policies in 1984. Subsidies were cut and the Hungarian forint was devalued, all at the request, urging or instruction of the IMF.

The country received six more loans by 1996, one for $365 million, another for $480 million, and in 1991 the Fund approved a loan worth $1.6 billion. In all those years, Hungary was reinventing itself. The banking system was restructured to satisfy free-market requirements, and a value-added tax was introduced. In 1990, the government passed laws to allow foreign investment, removed customs barriers, reduced government bureaucracy and lifted controls on prices and wages.

But there was a dark side to the policies, even though they pleased Washington, attracted investors and were rewarded by the financial markets. The real wages of Hungarians — those who even had a job — declined by 22 percent between 1989 and 1996. When the Berlin Wall fell and the country opened up to global markets, Hungarian industrial production declined by more than a third, unemployment rose and inflation reached 30 percent. In other words, workers, retirees and the overwhelming majority of Hungarians had less in their pockets from one year to the next, they had to work longer for a pension that was smaller than expected, and when they became welfare cases, the state no longer felt responsible for them — because the very nature of the state had changed.

Hungary’s accession to the EU in 2004 brought a new round of so-called adjustments. And then came the global economic crisis. By 2008 Hungary was on the verge of default. To avert a disaster, the IMF, the World Bank and the EU joined forces to provide Budapest with $25 billion. The IMF, which put up $15.7 billion of the total, dictated the conditions: pension cuts and a freeze on civil servants’ salaries. It was back to square one for Hungary.

The real gems in this article come from the economist Rogoff from Harvard University.  These gems includes not very flattering assessment of the new financial reform legislation, as well as some not very flattering comments about the way in which the IMF and the G-20 handled the GFC.  Here are some of the statements and assessments by Rogoff:

“A Greek bankruptcy is unavoidable. There is a 95 percent chance that Spain will go bankrupt. Hungary is on the brink. Things will get much worse in Eastern Europe. We will have a certain number of countries that will go bankrupt. We will have a number of euro zone countries that would be well advised to take a sabbatical from the euro for a year. The situation in the United States is very worrisome. The markets will refuse to tolerate this level of debt.”

and on the Wall Street reform legislation:

The government asked him to comment on a draft bill on the regulation of the financial sector. “The draft had 2,000 pages,” says Rogoff. “I don’t know what to say to that. I suspect that those 2,000 pages are filled with enough loopholes that Wall Street will discover and exploit to come up with new business models.”

A real reform of the banking and finance sector would have to drastically shrink the system to a business volume that existed 30 years ago. Rogoff says: “The financial market, with all of its products, adds up to $200 trillion, $120 trillion of which represents trading in debt securities. I remember a speech given by Angela Merkel. She said that the Americans make the profits while distributing the risks, with all those debt securities, worldwide. That’s true. This could be curbed.”

On the IMF and crisis management efforts:

“We are fundamentally too quick with bailout packages and too hesitant with default,” he says. Rogoff believes that the G-20 and the IMF, with their protective mechanisms, have already pre-programmed future misconduct. Experts call this a “moral hazard,” the notion that bailout packages, instead of preventing crises, simply create new ones. “It boils down to the banks ultimately speculating with taxpayer money,”

The final gem in this piece comes from the Chinese IMF worker Min Zhu. It is actually a sage piece of advice, and I might add here that it is quite obvious that this is the remedy that Europe should be seeking (rather than agreeing to follow the Watermelons to the precipice of destruction):

. “There is the issue of social welfare, and demographic change. Everybody has longevity, so the cost for the pension and health insurance is very different today than, say, 20 years ago. The model, of course, does not fit today’s needs. It would not survive tomorrow.” Besides, he adds, Europe needs a growth strategy, an industrial strategy. Europe must invent new products and sectors that meet the demands of the world — otherwise, with labor costs of $30 an hour, they won’t prevail “against a country that pays $3.”

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