Benefits and challenges of the International Monetary System

¶ … International Monetary Fund (IMF) was established to foster international monetary cooperation and secure financial stability between nations (Stephey, 2008). Over time, the fund has also served to facilitate international trade, contributed to the overall employment situation and economic growth. Many financial experts argue that the operation of the IMF has served to reduce worldwide poverty and its existence contributes significantly to the overall health of the world's economy (Chossudovsky, 1991).

One of the primary responsibilities of the IMF is to monitor the various economies throughout the world. Made up of 185 member countries the IMF is available for advice in an attempt to maintain economic stability throughout the world and to avoid any situation that might lead to economic crisis. It provides its members with a convenient forum for discussing issues that might impact economies on a local, regional, and international scale.

One of the least understood functions of the IMF but one of its most important functions is to provide its member countries with the opportunity to obtain temporary financing (International Monetary Fund). Due to the fact that international trading has increased substantially in these days of globalization member countries often find themselves with severe balance of payment problems. Such problems occur when nations find themselves short of foreign currency to meet their financial obligations to other countries. The availability of these options afford member nations with a stop gap solution to their particular financial problems in an effort to alleviate international conflicts arising from temporary cash flow difficulties.

The IMF was founded in the days following the Second World War. The War had placed the difficulties of the Great Depression on the back burner but, once the War began to wind down, the various world governments and representatives from their financial institutions gathered at Bretton Woods, New Hampshire to discuss how to best avoid the situations that resulted prior to the War. At said conference only 44 nations were represented but the world's major economic powers, except those associated with the Axis powers, were present (Eichengreen, 2008).

The IMF provided stability in the international money market in the difficult days following the Second World War. The belief following the Great Depression was that financial institutions and markets often times become too powerful and that allowing them to become too powerful had the potential of destabilizing financial systems and, thereby, undermining individual economies. The turbulent times were lessened through the reliance on the U.S. dollar but in the 1960s the United States found itself embroiled in a costly war in Vietnam and facing the high costs of President Lyndon Johnson's Great Society programs. The combination caused the dollar to become vastly overvalued. As a result, the system of fixing the U.S. dollar against gold as dictated by the Bretton Woods agreement was abandoned (You, 2000). The world monetary system endured a period where the major currencies floated against each other. During this time, the members of the IMF were allowed to choose any exchange arrangement among five different styles: 1) allowing their currency to float freely; 2) pegging it to another nation's currency; 3) adopting the currency of another nation; 4) participating in a currency bloc; and, 5) forming a monetary union.

There were fears when the Bretton Woods system collapsed that it would have adverse effects on the world monetary system. Fortunately, the world monetary system did not collapse subsequent to the abandonment of the Bretton Woods system. Instead, the flexible exchange rates that developed after Bretton Woods as detailed in the 1972 Smithsonian Agreement (Solomon, 1977) seemed to allow the world's various money markets to adjust more easily to the higher oil prices that occurred in the early 1970s as a result of the actions of OPEC (Organization of the Petroleum Exporting Countries). The floating rate system has continued to the present but it does so subject to a great deal of criticism.

For a number of years now, international markets have suffered through worldwide stagnation. This stagnation has increased the need for many developing countries to request assistance from the IMF and for the IMF to involve itself more aggressively in the stabilization of exchanges rates in developed countries. Unfortunately, the IMF has failed both developing and developed nations and, in this period of increased globalization, the involvement of the IMF is more important than ever and yet, it is not forthcoming.

To examine how the IMF has failed in recent years it is important to understand how the IMF operates. The basic funding for the IMF is derived by requiring every member country to pay based upon the size of the country's economy and its corresponding influence in world trade and finance. Typically newly enrolled members are expected to pay at least 25% of their membership quota in either U.S. dollars, euros, yen or pound sterling. These currencies are considered among the world's most stable and, therefore, the most universally acceptable form or trade. The balance of the membership is payable in the new membership's currency. The monies generated from membership quotas are then used to provide loans to member countries on a short-term basis to cover balance of trade deficiencies.

Beyond its capacity to make short-term loans the IMF is also shouldered with the responsibility of monitoring the economic and financial affairs of its member nations. Historically, this service has been limited to assisting developing countries but is available to any nation requesting its assistance. This assistance is intended to help nations avoid or correct problems that might occur in a nation's economic, tax, or monetary policy. On occasion, the IMF is also available to provide advice and assistance in matters involving a country's exchange rate system or its basic financial stability.

As in any organization there are levels of influence. With 185 members it would be unreasonable to expect that every member would exercise the same level of power and influence but one of the primary criticisms leveled against the IMF is that the United States, as the organization's largest voting member, has used its power within the organization to promote its own political agenda. In essence, many members feel that the United States unfairly directs its power and influence with the IMF to direct funds in the direction of nations that fulfill a need in American foreign policy or who occupy a strategic position. These same members argue that they should enjoy a greater say in how matters are decided within the IMF.

Similar concerns have been expressed regarding the power and influence of the European nations. Although no one European nation enjoys the voting power of the United States, as a group, Europe's power is considerable. As evidence of Europe's power within the IMF is the fact that since its inception nearly every managing director of the organization has been European. Newly emerging economic powers like India and China are demanding that their roles within the IMF be increased and that the corresponding roles of the United States and the European nations be cut back.

Critics also argue that the IMF has seemingly lost sight of its original mission. When it was founded in the waning hours of the Second World War, the IMF was intended to provide guidance to the world's economy so that it could be stabilized prior to any major crisis developing such as the Great Depression. Now some critics argue that IMF has adopted a policy of leaving markets alone and of providing little or no direction or intervention. Historically, the IMF offered assistance to countries facing financial crisis by encouraging the use of expansionary economic strategies such as increasing expenditures, decreasing taxes, and lowering interest rates. The theory in the early years of the IMF was that such measures would stimulate the nation's economy. More available money meant a stimulated economy. Unfortunately, many critics now argue that the IMF has adopted an opposite approach and will now only lend struggling nations with loans if they cut their deficits, increase their taxes, and raise interest rates. By doing so, IMF critics feel that it has failed in its mission and become the pawn of the developed nations that dominate its executive board (Wessel, 1997).

Criticism of the IMF is not limited to the dominance of the United States and Europe as individual member nations but also at the financial institutions contained in those nations. Because a country's membership position with the IMF is determined by its overall economic influence in the international market the power and influence of its financial institutions are also enhanced. That is, banks and financial organizations within the United States and Europe enjoy for more influence on the decisions of the IMF and better far more from those decisions than do similar organizations in smaller countries. Critics argue that the result of this scenario is that the interests of developing and poorer developed countries are too often overlooked in favor of the United States and European commercial interests.

As one might expect there are also critics on the other side of the ledger as well. These critics argue that the United States and Europe have been the principal financial support for the IMF for over fifty years and that, but for, such support the IMF would long ago ceased to function as a viable organization. Those supporting this view, however, also argue that the IMF has lost sight of its original goal and ventured into new areas that might be best left for others to address. Debates have repeatedly occurred in the halls of the U.S. Congress relative to the United States' continued financial support of the IMF. These debates center on the fact that the IMF has ceased to exist as an organization whose function was to finance temporary balance of payment problems and transcended into an organization whose principal function is to provide "microeconomic bailouts that restore the solvency of clearly insolvent financial institutions" (Calomiris, 1998).

In a similar vein, critics argue that the IMF is providing assistance to countries and commercial interests within those countries tha are imprudent and exposing U.S. funds to unnecessary and dangerous risks. These critics argue that the IMF operates largely in secret and that the American taxpayers who are largely providing bailouts for other nations throughout the world have no say in the conditions under which these bailouts are occurring. Those individuals offering these criticisms argue that the IMF should adopt more transparent lending policies that allow the nations providing the bulk of the financial support the opportunity to understand and object, if necessary, to the loans being offered nations that have little or no chance of paying back the loans.

A third group of critics relative to the IMF comes from the nations most dependent on the IMF for financial support. This group would be the developing nations of the world who find themselves having to approach the IMF for loans. These nations argue that the IMF uses a heavy handed approach relative to not only the granting of loans but also as the conditions attached to those loans. The governmental officials and business leaders in these countries complain that the IMF is inflexible and slow to provide debt relief and that its policies contribute to the poverty found in many nations (Bandow, 1993).

Like all large organizations, the IMF has critics on all sides (Global Exchange, 2007). The examples offered are only the tip of the iceberg but are representative of the viewpoints expressed by the various groups affected by the IMF. Quite simply, the IMF is facing a potential crisis that might threaten its very existence. The IMF has creditibility problems across the board and must begin to face these problems (Bucharest Herald, 2011). The legitimacy of its policies, its effectiveness in handling financial crises, and its loan strategy are all under attack. Despite the IMF's increased role in granting loans and other financial assistance to recipient countries, these loans have too often not resulted in recovery or growth, but rather, they have resulted in economic stagnation or worse. The result has been dissatisfaction by the recipient nations and outrage by the countries providing the bulk of the support for these loans.

Althought it has already been stated, the fact that the IMF has ventured so far away from its original purpose cannot be stated enough. The original function of the IMF was to provide stabilization and this stabilization was dependent on the strength and dependability of the U.S. dollar. This system worked effectively for nearly thirty years but it all ended with the Smithsonian Agreement. The Smithsonian Agreement ushered in the era of floating exchange rates that the world uses today and it brought with it financial deregulation and a liberalism that has fueled financial speculation activity and currency instability. In the process, the role of the IMF in maintaining a stable financial network has been lost.

In order for the IMF to regain the respect of the international community it needs to work itself back toward its original goal of providing stability to the financial markets. This requires that the IMF work to begin stronger regulation of capital flows and markets and to establish a stable system of exchange rates. This goal is particularly difficult in light of the fact that there are so many developing nations whose currency borders on being worthless but in order for the world's major currencies to remain stable these lesser currencies must be afforded some measure of stability as well. This was the original role of the IMF and it must direct its attention in this direction again.

The IMF's track record in managing financial crises as they develop throughout the world has not been good. The policies utilized by the IMF place debtor nations in a weakened position relative to the creditor nations. The debtor nations are unsophisticated and lack the capacity to organize themselves against the creditor nations who possess the benefit from their experience and ability to organize among themselves. As a result, debtor nations find themselves being forced to pay high interest rates and being made to suffer from unreasonable demands in exchange for procuring loans. What is needed is a fair system where loan repayment disputes and loan forgiveness programs can be arbitrated where debtors and creditors can negotiate on a somewhat level playing field. At the present time, the IMF is viewed by most debtor nations as a partner with the creditor nations. A condition that undermines the actual position of the IMF and one that is counter-productive to economic stability in the debtor nations.

The IMF must work diligently to increase its level of expertise in many of the areas that it is presently offering advice. In recent crises such as those that occurred in Malaysia and other parts of Asia, information after the fact established that the IMF may have incorrectly advised the principles relative to several factors that contributed to the events there. The IMF managing director admitted that the his staff failed to adequately understand the capital markets involved in the crisis and that they provided incorrect information to the involved nations when they asked for assistance on the issue. For an agency that is supposed to be a source of expertise on such matters an admission of this nature is remarkable and indicative of the changes that the IMF must make.