Mr. Shultz: Thank you, Mr. Chairman, Senator Biden, Senator Lugar. I am honored to respond to your invitation. Although I have not been here in well over a decade, I have spent so much time here in the past that it almost feels like a homecoming.
You asked me to focus on the IMF, which I will do. I have three points of criticism, each of which I will illustrate with an example. And I have eight suggestions about what should be done, or what should be kept in mind, as you consider the international economic scene.
My principal points can be stated as follows. The IMF encourages bailout expectations and, thereby, weakens the resolve of lenders to perform the due diligence that is critical to the healthy functioning of the international economy. I think that is a very important point. Basically it started with Mexico in the mid-1990s, when the Treasury and the IMF put together a package of over $40 billion to meet the Mexican crisis. I might add that this was done after putting it to Congress and failing to get Congress’s approval.
What was done with that money? The short-term loans that had been made to the Mexican government, mostly by U.S. investors, were immediately paid off. Those lenders got high rates of interest on risky short-term money. The Mexican government was not able to pay off the loans or roll them over, so the lenders literally got bailed out.
The evidence is that the IMF’s economic programs have often been wrong.
The Mexican government then did the same thing with its own banks. It was a gigantic bailout. The financial people made out fine. The money did get paid back, but it was a bailout pure and simple, and that had a big impact on potential investors.
As an aside, but to emphasize that point, some time after the Russian default a banker friend of mine said to me, "After you bailed out investors in Mexico because Mexico is your neighbor, I believed that you would bail me out in Russia because Russia has all those nuclear weapons." (It seems that once you have held office, you are held responsible forever for anything that happens.) But that is how the bailout mentality spreads and why it is such a big problem.
My second point is that the IMF has, almost as a matter of logical development, created programs that are increasingly intrusive in the economic policies of the countries where it is involved. And I think it is almost axiomatic that the more you intrude into economic policies, the more you get involved in the politics of those countries.
The evidence is that the IMF’s economic programs have often been wrong, so their competence in economics, their presumed area of expertise, must be questioned. But when they get into the business of prescribing policies that infringe on the politics of countries, they really don’t know what they’re doing. Let me take the example of Indonesia.
Indonesia had an authoritarian government, and, as we all know, there was a great deal of favoritism toward President Suharto’s family and cronies. So, obviously, there were a lot of corrupt practices there. However, over a 20-year period, Indonesia also had something like a 7 percent sustained real growth rate, the fruits of which were widely disbursed. The income per capita in Indonesia rose very, very rapidly. The Indonesians did very well.
In addition, a tradition of religious tolerance was fostered. Indonesia is the largest Muslim country in the world—90 percent are Muslim—but they had a tradition of tolerance of other religions of which they were rather proud. There was also a small but very important ethnic Chinese community that brought lots of money and commercial enterprise to Indonesia.
Nevertheless, because Indonesia was part of the Asian crisis, the IMF and the Treasury moved in. One of their first acts was to call for the closing of 16 banks. I do not know how anyone could fail to foresee that, if you close 16 banks, you are going to cause a crisis in the banking system and runs on banks are sure to follow. It is as simple as ABC. I don’t want to say that the IMF deliberately set out to destabilize Indonesia, but it is hard to imagine such a level of incompetence.
The intrusiveness of the IMF programs in Indonesia—with their big, thick documents, telling the Indonesians in great detail how they should manage their economic policies—were all part of a great act of destabilization.
Lots of things were wrong in Indonesia, but also lots were right. The intrusiveness of the IMF programs—with their big, thick documents, telling the Indonesians in great detail how they should manage their economic policies and requiring things that were impossible—were all part of a great act of destabilization.
I have heard people from the IMF say, well, we helped get rid of Suharto. I don’t think that is a legitimate function of the IMF. I do know, however, that the management of moving countries from autocratic regimes to democratic ones is a very tricky business. I’m sure you remember, Mr. Chairman, in the 1980s we had quite a few: Argentina, Brazil, Chile, South Korea, the Philippines, and Taiwan. And we had lots of discussions in this committee about how to do it. On the whole those transitions came about all right, but in every case you have to go from something to something else. Otherwise you will have serious problems. Look at what happened in Indonesia: income per capita cut in half, widespread poverty, religious intolerance on the rise, fights between Muslims and Christians, and many ethnic Chinese driven out. I am told that at least $100 billion of ethnic Chinese money is parked outside Indonesia right now. If you want to do something about the Indonesian economy, you need to figure out how to get the Chinese back. It is a big problem, and I think it illustrates the difficulties that arise when the IMF finds itself enmeshed in the politics of a country that it knows very little about.
My third point has to do with the IMF’s loosely worded charter and the very large amounts of money available for use at the discretion of the U.S. president and his G-7 counterparts. It is an enormous amount of money now. It’s hard to estimate how much, but it is certainly on the order of $200 billion. As we have seen by the IMF’s past performance, there is virtually no limit on how the money can be used. That is a temptation to a U.S. president that is very hard to resist.
In the case of Russia, a misconceived policy was implemented that had as its foundation the idea that we would provide large amounts of money and the Russians would reform. That is, it would become a democratic and economically open country. The funds were provided and conditions were laid down. Of course, the temptation to take the money was enormous because it’s like a gift in the sense that the interest rates charged were way below any reasonable market rate of interest. In fact, it really was aid. The IMF is the only consultant in the world that pays you to take their advice.
At any rate, the IMF poured lots of money into Russia, and I think it was misguided. In the meantime, the Russians were taking money out. I do not personally have any way of verifying this, but I have seen very credible estimates that between $150 and $350 billion was taken out of Russia, that is, Russian money out of Russia. If they are taking it out while we are putting it in, that must tell you something. It tells me that some very bad policies were followed. And, of course, when the money we put in goes to general budget support, it supports whatever the government is doing, including the war in Chechnya. There is no way around that.
It seems to me that, in a more subtle way, these misconceived policies have an almost psychological effect on the creators of the policies. They have made these loans to bring about a particular set of results that they want to occur. So they allow themselves to think that the desired results are always just around the corner. And if you have your hopes pinned on an individual like Mr. Yeltsin, you may tend to overlook things that are wrong and tend to take his line. In the process, you distort the reality of the situation and what is really going on in the country with which you are dealing.
In that connection, I would like to read a couple of things to you. Here is a description of Russia today. I am reading this: "A pluralist political system and civil society, competing in the world markets and plugged into the Internet." Does that bear any resemblance to the Russia that you—
Senator Biden: Whose description is that, Mr. Secretary?
Mr. Shultz: The president of the United States writing recently in the January 1, 2000, issue of Time magazine.
Now, here is his description of Chechnya. He says, "We have a profound disagreement on the treatment of refugees." That’s all—the treatment of refugees. He says that we understand that they have to "liberate Grozny"—that is the way the Russian government puts it—and goes on to talk about this being a model for how to deal with other problems involving terrorists.
I think this is what happens when you get so involved in another country’s operations, and you put so much money and so much of your own credibility on the line to obtain results that are not happening.
I don’t think this happens only because of the huge amounts of money involved, but it helps. I call it the honey pot problem. When you have a big pot of money that can be used for any purpose, it is an invitation to a president to think, all right, we have a problem so I will get together with my friends in other countries and we will use that money to solve this problem. I think the resulting profligacy with IMF money has had a bad result—and that is unfortunate.
I could give lots of other examples, but I especially want to call those three to your attention. First, the enormous amount of money available for bailouts creates an expectation mentality in the international lending community that it is likely to get bailed out. Because of this expectation, the private lenders fail to perform the due diligence they should always perform.
Second, you get driven, almost by the size of these programs, to become very intrusive, very detailed in what you want, and when you do that you are not talking economics, you’re talking about the politics of a country. It would be like the IMF coming to the United States and saying, you have problems with Social Security and Medicare and here is the way to fix them, without realizing that these are very delicate political issues in this country. Not primarily economic issues.
The third problem is this gigantic honey pot of money that can be dipped into for almost any purpose.
Mr. Chairman, as you know, I have said that it seems to me it is time to close the book on the IMF and go about its functions in another way. I have been saying that for quite a long time, beginning with a lengthy address to the American Economics Association about five or six years ago. Last year when I said it again, Congress proceeded to provide about $18 billion for the IMF. With contributions from other countries, the total came to some $80 billion of additional money for the IMF. Today I say, all right, I recognize I may not get my way, and if I don’t, here are my suggestions for what should be done.
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First of all, tighten the charter. I welcomed the statement by Treasury secretary Summers that the IMF should return to its core function, namely, dealing with critical problems in exchange rates and balance-of-payment problems in countries around the world. That is what the IMF started out to do and if that is its function, it seems to me, the charter should clearly say so. Then you have a limited-purpose organization. The money is there, but it is there for a clearly defined purpose.
As I can vividly recall, that is the way you go about appropriations. During my various cabinet posts, money was provided to me for certain purposes. For example, when I was secretary of labor, money was appropriated for manpower training programs. I could not decide to use it for something else. You simply can’t do that. You must use it for the purpose for which it is prescribed.
Therefore, my number one suggestion is to tighten the charter and focus on what Secretary Summers called core function.
I do think there is a need for an international economic organization with some stature to play a convener role. That is, when there is a problem, it is important to have an organization that can convene the parties, bringing together the lenders and the borrowers. An individual bank usually cannot do it, and an individual country has a hard time doing it. So an international organization that can serve as a convener would be useful, and it is probably best if it does not have much money.
Which leads me to my second recommendation. I believe that the amount of money in the fund should be drastically reduced. Obviously, if that happens, there has to be a period of transition. You cannot just pull the plug on existing programs and commitments. They have to be carried forward, but if the object is clear, the amount of money in the fund can be brought way down. By reducing the amount of money available, you take away the honey pot and you take away a lot of the problems associated with bailouts. And I don’t think that you would miss it.
The IMF believed that if it provided Russia with large amounts of money, then the Russians would reform, becoming democratic and open. The IMF was wrong.
Third, insist on transparency. There has been a lot of talk about that and no doubt some progress has been made. Because transparency is the counterpoint of accountability, it should be an integral part of the IMF’s internal operations and it should apply equally with respect to an individual country’s programs. If a country seeks help from the IMF, but balks at transparency, that is its choice, and the IMF should not get involved. We need to know what is going on.
Fourth, I think the interest rates on loans should be raised up or close to the market. It’s not a gift. It’s a loan to help a country during a time of transition. So the interest rate policy needs to be revised.
Fifth, I think it is increasingly apparent that countries should be willing to have financial institutions from outside their own country operate in their country. Obviously, this is not something we can mandate. The sovereign countries have to decide for themselves, but the presence of foreign financial institutions helps with transparency, with diversification—which is especially important for small countries—by virtue of competition in the financial realm. This could be a key element in developing workable economic policies.
Sixth, I must mention but do not want to belabor the issue of exchange rates. It’s clearly a very important issue but a complicated one. I will simply say for the record that a stable and strong currency is very, very important for any country and that the way to achieve that is to have a fundamentally strong, stable economy on which to base your currency.
Seventh, I think it is essential to have a clear understanding of what is taking place. The IMF’s prescriptions in Asia for more austerity were misguided, and it had to change them. I think the Asia situation was not so much about hot money and the new information age, which are, of course, very important, but about classic mistakes that were made: that is, too much debt in relation to equity; borrowing short, lending long, and into illiquid assets; borrowing hard currency, lending in a softly pegged currency. Put those things together and you have all the ingredients for a crisis. It doesn’t have anything to do with the new economy. It has to do with errors in basic economics.
I think it’s ridiculous when people say Russia caught the Asian flu. The crisis in Russia was caused by the misguided policies pursued internally by the Russians and had nothing to do with Asian flu. But it is another good example of why it is so important to get the analysis right.
My eighth and final point concerns the importance of sovereign responsibilities. One of the most important of those responsibilities is for a country to run its economy in a way that is healthy, noninflationary, and open. There is nothing that the IMF or any other organization can do that comes anywhere near the importance of the United States having an expanding, noninflationary, open economy. And if you put that alongside similar economies in Europe and Japan, the problems will fundamentally work themselves through. The proper exercise of sovereign responsibilities is very important to this country and every country.
Thank you, Mr. Chairman.