Abolish the IFM and the World Bank!
Set up after World War II as a response to the world currency failures of the 1930s, the International Monetary Fund was designed to help countries meet their Bretton Woods obligations of fixed currency rates. After 1971, when the Bretton Woods accords fell apart, the IMF found itself with little to do, as currencies were now free floating, so its bureaucracy reinvented itself as the savior of developing countries' monetary crises.
While the World Bank's original goal was to make sure countries could develop through the instrument of long-term infrastructure loans, help the relatively poor private sector couldn't afford, its sister organization, the IMF, originally made short-term loans to solve short-term currency problems. Both organizations operated with little supervision, extreme secrecy, and no regulation. Certainly Congress, which voted contributions to both, had little idea of the full consequences of its spending.
By the 1990s, the bureaucracies of both IMF and the World Bank had thousands of well-off employees, entrenched in fortified bureaucracies, who spent their well-paid time performing lots of studies and funding projects in many of the wilder and more interesting spots around the world. Doubtless it's been a fascinating and lucrative way to spend a career, and it must make its employees stars at cocktail parties.
Back in the early 1990s, curious to take a hard look at the planet, I spent a couple of years circling the globe on a motorcycle, giving scores of countries the once-over from the ground, an ant's eye view of territory most of us see only on fly-overs. One thing about which I was particularly curious was the effect of Westerners' public money spent on projects mounted by developing nations. I knew thousands of projects worth tens of billions of dollars had been set up and funded by U. S. and European agencies, public and private, and I would go out of my way to see how successful these projects had been.
I visited many such sites in Latin America, Africa and Asia. In almost every case, however, I found only abandoned water projects, empty and rotting stadiums, crumbling factories, inoperable telephone systems, collapsed fertilizer plants, roads leading nowhere, and overgrown agricultural developments.
Back in the States, these memories seemed surreal as I perused the sleek annual reports of these giant agencies, particularly those of the World Bank and the IMF, which list page after page of projects costing tens of billions of dollars spent to bring water to the thirsty, work to the unemployed, electricity to the dark, and shelter to the homeless. How was it that on the ground there were few successes, while in the annual reports there were only glowing projections? How could there never have been a failure to pay back these massive development loans when so few developments were productive?
Some enlightenment dawned when I discovered the bureaucrats at the IMF and the World Bank were graded by the amount of loans they place. Some banks and commercial loan companies grade lending officers in this way, but the successful ones have a credit committee scrutinize and approve such loans, and investors grade such institutions by their loan-loss ratios. Indeed, the first commandment of banking is to make sure the loan is repaid. The more I thought about it, and the more I saw certain countries come back year after year for new loans, the more these agency loans appeared to be a gigantic Ponzi scheme.
A Ponzi scheme? The august World Bank, the ever-helpful International Monetary Fund mixed up in a Ponzi scheme?
While these developmental loans seemingly were being paid off -- the World Bank and the IMF reported 'profits' every year -- they certainly weren't being paid off with 'profits' from abandoned stadiums or collapsing waterworks. What was going on?
The key feature of a Ponzi scheme is that investors' demands for repayments and profits are paid with money from new investors, not from the profits of the project. So if a developing country borrows $50 million for a water project, making IMF consultants the favored contractors and in-country bureaucrats' nephews and local Mercedes dealers rich, it wouldn't matter much if the water project was productive or even successful as long as the loan, its interest, and expenses were repaid by yet another loan the year after.
Another key feature of a Ponzi scheme is the investment';s internal rate of return is less -- usually far less -- than its dividend or its interest payments to investors. By definition, while the scheme will appear to be the picture of health, internally its deficits are growing. To keep the scheme afloat, larger and larger loans need to be raised, and to do that larger and larger successes are declared by the schemes promoters.
In Mexico and many other countries, this is precisely what happens with every bailout, ever-larger loans are being made to cover bad old loans, with a 'profit' built in for the bureaucrats' new nephews and the sons of retired Mercedes dealers. In short, once again the Emperors clothes are made of cloth far too fine for our coarse eyes to perceive.
Where does all this wonderful new money come from? From what the IMF and the World Bank call 'contributions' from taxpayers around the world, including you and me, who are told their national treasuries are making a bulletproof loan to help the poor and homeless. Indeed, the IMF and the World Bank have become sacred cows, good things on a par with Mom and apple pie and baseball. In fact, the American taxpayer coughs up close to 20 percent of the IMF's needs.
Before I invest, I scrutinize several years of a company's annual balance sheet and profit-and-loss statements. Provided the outside auditors have done their jobs in an honest, consistent fashion, the savvy investor can see whether the payroll and inventory have grown too large for the business, if payables are outpacing receivables, and if profit margins are being sustained; in short, how healthy is the enterprise. After examining thousands of businesses over the years, I've gained a sense of when the numbers work and when they are the product of smoke and mirrors. The first hint that financials are more smoke than flesh and blood is when they're confusing to read, when a trail you're following turns into a blind alley instead of a clear boulevard, and when you can't determine who's paying what to whom. The balance sheets of well-run, profitable enterprises make no secret of their true virtues; indeed they shout them.
On the other hand, the balance sheets of the World Bank appear to be upside down, with subsidiaries displaying the assets, and the profit-and-loss statements and the balance sheets of the holding company going unreported, or reported in a singularly non-traditional fashion; that is, only cash-flow statements, no consolidated balance sheet or profit-and-loss statements. It may be public money contributed by the taxpayers of scores of countries, but it's certainly not transparent.
On Wall Street good news is reported fast, while bad news takes forever to be released. Not only do the perpetrators of bad news want to put off facing the music, they want as much time as possible to ready explanations and tweak the results. While I've been able to obtain the annual reports of the World Bank, five tries to obtain the FY1997 annual report of the IMF still haven't produced a current one after six weeks. It's no wonder some congressmen complain they have no idea of what's going on at the IMF.
All these many tens of billions of dollars spent around the globe have to come from somewhere, and the annual report of the World Bank makes it clear they came from the taxpayers of the West. Seventeen-and-a-half percent came from the U. S. taxpayer, while Germany, Japan, France, and Britain each put in about a third of our share. These two agencies borrow tens of billions of dollars, and our national treasury guarantees a portion of these loans. It all sounds so wholesome: these are loans made to developing countries so they can develop, so they can pull themselves up by their bootstraps. All the loans have been 'repaid'; indeed, the IMF and the World Bank have always reported a 'profit.' However, I can't help but wonder why these 'consistently profitable' organizations have never paid a dividend to their funders. Probably because requests for dividends -- even after 50 years -- would bring down the house of cards. Indeed, instead of sharing their profits with their 'investors,' they consistently ask for more money, precisely like all good Ponzi schemes.
But the unintended consequences of these schemes are far from wholesome. Several times over the last decades Mexico has been bailed out by IMF-led rescues. In 1994 it borrowed nearly $50 billion dollars through the IMF, several times more than its last bailout. It then reborrowed in the public markets to pay back this loan. That wasn't much of a true solution to the country's long-term structural problems, but the process made our Treasury and its chiefs look terrific. It had been Fidelity Investments and Goldman-Sachs who had loaned heavily to Mexican banks, and the former chairman of Goldman, Robert Rubin, was the U. S. Treasury chief. It made me wonder how much of a bailout the Mexicans might have received if the current head of the Treasury had been the former head of Macy's.
And if Mexico didn't let its Northern investors go broke and didn't wash out all the local banks who had over-leveraged themselves, why in heaven's name wouldn't it be back for more next time, probably a lot more? After all, if you and I could be sure we could invest at a high rate of return and have the risk of failure covered by the U.S. taxpayer, wouldn't we put in all the money we could beg, borrow, and steal? Overhung with huge debts, cronyism, and featherbedding, the Mexican system desperately needs to be cleaned out in order to become lean and truly profitable.
If over the last couple of decades the cost of Mexican bailouts has risen from $10 billion to $50 billion, what might the next one, or the one after that come to be? $100 billion? $250 billion? Do we have to wait until these crises endanger our own financial system before we insist the Mexicans handle their own problems?
Back in the 1980s the IMF bailed out South America with a program of currency loans and austerity policies -- higher taxes, lower spending, and higher interest rates -- that seemed to give the region a boost, except the country that relied on such relief the least, Chile, has in fact become the soundest economy in the Western hemisphere and that of course includes ours. Hummm...isn't this curious?
But Mexico may not be the bankbuster; Asia may beat it to the punch. Korea alone needs $60 billion, and this doesn't include the tens of billions needed by Thailand and Indonesia. Much of the turmoil in Asia was started by the devaluation of the yuan by China several years ago, which made China's goods more competitive in world markets than the Asian tigers. Back in Latin America, the major problem was government debt; the public sector couldn't repay its loans. In Asia today, it's different: we have a banking crisis where the local banks' customers can't repay their loans. As a large portion of these loans are owed in hard currencies such as dollars, marks, and yen, which become more expensive as the local currencies fall, the local banks' balance sheets are now filled with bad debt.
On the horizon looms China and its possible gigantic problems. If currency devaluations in Indonesia, Korea, and Thailand make their goods cheaper than China's, isn't China going to be tempted to devalue again? And if so, might not this then cause other Asian countries to devalue yet again? So, what will Asia need in the coming months, and does our Keystone Kops fire brigade have the water to put out that inferno, too?
More troubling yet is the lack of foresight on the part of these two august institutions. It's not as if the World Bank and the IMF -- supposedly the watchdogs of the global financial system -- weren't warned. The Bank for International Settlements (the BIS), which handles the flow of funds between countries, publishes in its annual reports who's having liquidity problems. In June 1996, a full year before the Asian crisis became acute, the BIS warned the banking world: "The unprecedented volume of [new] lending to Asia ($84.3 billion) suggests that the impact of the Mexican crisis on the region was at most marginal. Apart from its sheer size, four features characterized bank credit to Asia in 1995. First, two-thirds of the total was in the form of short interbank lines...this, together with sizeable trade-related loans, meant that by mid-1995 64 percent of the outstanding claims on the region were of less than one year. Secondly, Thailand and Korea took up $36.3 billion and $22.3 billion respectively. By year end, Thailand had become the largest bank debtor in the developing world..." Can the staffs at the World Bank and IMF read? Maybe they just don't bother since they believe crises ensure their employment.
In addition to being guided by deeply flawed policies and practices, the World Bank and the IMF have staffs of thousands, many of whom have been steeped in the esoteric economic theories cooked up in the world's most expensive graduate schools. Naturally, these staffs come complete with expensive pension plans, cafeterias, health plans, credit unions, and all the other expensive amenities of modern corporate life, which cost the 'contributors' -- you and me -- yet more hundreds of millions of dollars a year. The World Bank's financial statement for FY1997 states it has a net worth of $27 billion, and that its pension plan holds $8.698 billion, up from $4.274 billion just five years earlier. Those dedicated to helping the disadvantaged seem to have advantaged themselves very well indeed, a case of doing well by doing good.
Those retired from the World Bank have done even better: in 1992 their plan held $230 million in assets but by 1997, it had grown five fold to $1,177 million. The IMF tops all this, however: its pension plan is larger than its Special Disbursement Account, that part of their balance sheet you and I would call its net worth. You guessed it, the United States pays a substantial portion of all this largess, three times as much as any other nation.
However, the situation is yet worse than failed projects and enriched bureaucrats: these loans have now become an elaborate means of having the American taxpayer -- once more you and me -- guarantee the loans that Chase, Morgan, Goldman-Sachs, and Fidelity make to banks in developing countries. Of course, all this is gussied up in the most sanctimonious of prose about aiding the poor and raising the living standards of the Third World when in reality, these bailouts are little more than rescuing our own and Europe's huge domestic lenders from overseas loans they never should have made. If Chase Bank came to Congress or to you and I directly and said 'we've made a bad loan to Korean and Thai banks and we want you to bail us out,' what would be our response? I can guess the answer. But if the IMF is going to give the Korean government a loan, which in turn will use the money to guarantee Korean banks' new loans, which these banks then use to repay Chase, does this rope-a-dope make it any the less your pocketbook?
For what it's worth, any reform these countries promise to enact in order to obtain these loans is short-lived. Typically, such countries say they will follow the IMF edicts to raise taxes, raise interest rates, and cut government spending, but they often engineer work-arounds to keep from having to endure such political pain. As well, many people here and in the borrowing countries say IMF policies are wrong, that they do more harm than good, and thus many are all too ready to abandon such policies. There's no argument inside or outside of the IMF that certain previous IMF policies -- such as exchange controls -- were damaging to client countries. In Mexico after the last bailout, yes, interest rates went to 30 percent, but a Mexican-government subsidy gave back about half of this so Mexicans were let off the hook of austerity. After all, the IMF has no tanks to enforce its agreements. In my experience, the only discipline that makes any of us learn financial lessons are the hard consequences of our foolish actions, our mistakes, not someone else's pious sermons about what works and doesn't work.
More troubling yet was the admission by IMF managing director Michael Camdessus in 1996 that IMF loans were being used to finance the war in Chechnya. As a taxpayer, were you prepared to back Russia's attempt to put down this Islamic rebellion?
The hard discipline needed to make currencies sound is to clean out the many current corrupt and soggy national systems; that is, to allow the over-extended and unprofitable enterprises to collapse and begin anew. Yes, it hurts, and no, no one wants to go through it. But it's better pain now that is short and shallow than that later when the problem has become 10 to 30 times as large and threatens the entire structure of world finance.
An illustrative comparison is one between Chile and Mexico. Back in the 1970s, Chile had to reform its statist mess or collapse, and it turned to market reforms, setting up policies from micro-loans so its poor could start businesses to a transfer of its pension plans from the public to the private sector. Today Chile has the soundest economy in the Western hemisphere, and that includes ours. Mexico has received bailout after bailout, but because it has reformed nothing, it has only papered over its carloads of bad loans -- that is, loans made to unprofitable facilities -- and it will require yet another bailout in a few years. The pity is that with its huge population and proximity to our giant markets, Mexico could have been placed on a sound footing many years ago and might well have become an economic miracle in its own right.
Today's global monetary system is far more complex and interlocked than in 1944 when the Bretton Woods agreement was signed or in 1971 when it fell apart. Today, more than a trillion dollars in currencies a day are traded around the world versus nothing just after World War II. The bailouts of parts of our global system are becoming larger and larger, and will only grow. If this continues, the day must come when the crack is too wide to paper over. Korea or Italy or China will fail to obtain enough emergency infusions, and they will then fail to pay Chase and Morgan, who will fail to pay banks in Germany and Japan, who will fail to pay...
The dominoes could fall, and probably fall rapidly, almost overnight, as these days no institution has its capital in any instrument as simple as Treasury bills. Every financial house has assets -- i. e., loans and receivables -- from other financial houses, and its capital base, its net worth, is a fraction of those assets. One difference between a 'sound' bank and a household or a business is the bank has leveraged its net capital& -- its net worth -- 20- or even 30-to-1 but when that same bank lends to businesses, it typically insists on no more than a three-to-one debt-to-equity ratio.
Such highly leveraged practices have worked for banks for decades, if not centuries, but banks taking such risks haven't been subjected to much of the stress of today's hyper-speed markets. Today many banks have huge loans to other banks on their books, loans made against other banks' debt-to-equity ratios only tolerated because the borrower is a bank. At such super-charged ratios, a bank has only to lose 5 percent of its assets to have its net capital wiped out, and in the time of crisis toward which we might be heading, 5percent can be wiped out in hours. And each loss will trigger another huge loss on yet another bank's balance sheet.
Banks always have loans involved in these periodic crises; they are big boys and resourceful. If no international bailout exists to rescue them, they'll have all the more incentive to figure out how to save not only their customers' situation but also their own hides. They will certainly have more of such expertise than the IMF.
Today thousands of MBAs are on planes seeking out investments for private investors all over the world, a far cry from the limited private money that existed after World War II. The World Bank might have been needed then, but today it is providing a service the private sector performs far, far better and with more accountability. Bureaucrats cannot figure out the best place to put a water plant, a new road, a telephone line, or an airport. Private capital can and will, for it must obtain a return on its capital or cease to exist, a discipline which holds the investment to strict accountability. That's what we mean by the old tautology, 'A fool and his money are soon parted.'
If we taxpayers don't insist on full accountability for our investments, sooner or later we're going to be like the outraged investors standing in a line outside Mr. Ponzi's Boston office, broke and disappointed. The world has changed dramatically in the 54 years since the IMF and the World Bank were created and now that the crisis of the Second World War is long since over, it can get along without them.
Updates are available at www.jimrogers.com.