A Level Economics 77: Macroeconomic Objectives

 Government policy objectives are the goals and targets set by the government to guide their actions and influence the direction of the economy. These objectives typically focus on achieving stable and sustainable economic growth, low inflation, low unemployment, equilibrium in the current account, and promoting social objectives such as reducing inequality and enhancing competitiveness.

Main Macroeconomic Objectives:

1. Low Inflation: Inflation is the rate at which the general price level of goods and services in an economy rises over time. Low inflation is a primary objective for governments as it helps maintain price stability and the purchasing power of money. Moderate inflation encourages spending and investment, but high and volatile inflation erodes consumer and business confidence and can lead to economic instability.

2. Low Levels of Unemployment: Governments aim to achieve full employment or the lowest possible level of unemployment in the economy. Low unemployment not only improves the well-being of citizens but also contributes to economic growth by increasing consumer spending and boosting overall productivity.

3. Sustainable Economic Growth: Sustainable economic growth is an essential objective to ensure long-term prosperity and improved living standards. Steady economic growth allows for more job opportunities, higher incomes, and increased tax revenues for the government. Sustainable growth is typically measured by the annual percentage change in Gross Domestic Product (GDP).

4. Equilibrium in the Current Account of the Balance of Payments: The balance of payments reflects a country's economic transactions with the rest of the world. Equilibrium in the current account means that the value of exports is equal to the value of imports, indicating a healthy and balanced trade position. Achieving balance in the current account is essential to prevent excessive reliance on foreign borrowing and maintain stability in the economy.

Promoting Social Objectives:

1. Reducing Inequality: Governments often aim to reduce income and wealth inequality within their societies. Policymakers use progressive taxation, social welfare programs, education and training initiatives, and labor market reforms to address income disparities and create a more equitable distribution of resources.

2. Enhancing Competitiveness: Competitiveness is crucial for the long-term growth and success of an economy. Governments work to create a conducive business environment, invest in infrastructure, promote innovation, and foster a skilled workforce to enhance the competitiveness of domestic industries in the global market.

Possible Conflicts and Trade-offs:

1. Inflation-Unemployment Trade-off: There can be a short-run trade-off between inflation and unemployment, as described by the Phillips curve. Policymakers may face the challenge of choosing between policies that aim to reduce inflation and those that aim to reduce unemployment in the short term. However, in the long run, this trade-off disappears, as attempting to keep unemployment below its natural rate may lead to accelerating inflation.

2. Growth-Inflation Trade-off: Policies aimed at stimulating economic growth, such as expansionary fiscal or monetary policies, may lead to higher inflation. Controlling inflation might require contractionary policies that could potentially slow down economic growth.

3. External Imbalance and Domestic Goals: Pursuing domestic objectives, such as high economic growth, could lead to imbalances in the balance of payments. For example, strong domestic demand might increase imports and lead to a trade deficit, affecting the equilibrium in the current account.

4. Competitiveness-Inequality Trade-off: Some policies aimed at enhancing competitiveness may lead to increased income inequality. For instance, labor market reforms that encourage flexibility and wage moderation may result in higher profits for businesses but could lead to stagnant wages for workers.

Government Efforts to Achieve Objectives:

Governments use a mix of policy tools to pursue their objectives:

1. Monetary Policy: Central banks use monetary policy to control the money supply and influence interest rates, aiming to achieve price stability and economic growth.

2. Fiscal Policy: Governments use fiscal policy to influence the economy through changes in taxation and government spending. Fiscal policy can be expansionary or contractionary, depending on the economic conditions and policy objectives.

3. Exchange Rate Policy: Governments may use exchange rate policies to manage their external trade position and support domestic industries' competitiveness.

4. Social Welfare Programs: Governments implement various social welfare programs, such as unemployment benefits, education subsidies, and healthcare services, to address inequality and improve social well-being.

Conclusion:

Government policy objectives encompass macroeconomic goals such as stable economic growth, low inflation, low unemployment, and equilibrium in the balance of payments. Additionally, they include social objectives like reducing inequality and enhancing competitiveness. Policymakers face trade-offs and challenges when pursuing these objectives, and they must carefully balance their policy choices to achieve overall economic stability, growth, and social well-being. Effective coordination of various policy instruments is crucial to ensure that both macroeconomic and social objectives are achieved harmoniously.

Economics Essay 58: Terms of Trade

 To what extent would an improvement in the terms of trade improve the balance of trade?

Before addressing the question, let's define the key terms:

1. Terms of Trade: The terms of trade refer to the ratio at which a country's exports are exchanged for its imports. It represents the purchasing power of a country's exports in relation to its imports. The terms of trade are calculated by dividing the price index of a country's exports by the price index of its imports.

2. Balance of Trade: The balance of trade, also known as the trade balance, is the difference between the value of a country's exports and the value of its imports over a specific period, usually a year. A positive balance of trade, or trade surplus, occurs when the value of exports exceeds the value of imports. A negative balance of trade, or trade deficit, occurs when the value of imports exceeds the value of exports.

Now, let's evaluate the extent to which an improvement in the terms of trade can affect the balance of trade:

An improvement in the terms of trade means that a country can obtain a higher quantity of imports for a given quantity of exports. This occurs when the prices of a country's exports increase relative to the prices of its imports. Here's how an improvement in the terms of trade can influence the balance of trade:

1. Increase in Export Revenue: If the terms of trade improve, a country receives a higher price for its exports. This leads to an increase in export revenue, as the country can sell its goods and services at higher prices. The increased export revenue can contribute to a positive impact on the balance of trade, as it enhances the country's ability to pay for imports.

2. Cost of Imports: When the terms of trade improve, the prices of imports may also decrease or increase at a slower rate compared to exports. This means that a country can import goods and services at lower prices or experience slower price growth for imports. It can result in cost savings for businesses and consumers, potentially leading to increased imports. The affordability of imports can help address domestic demand and improve the availability of goods and services within the country.

However, it is essential to consider other factors that can influence the balance of trade apart from the terms of trade. Factors such as exchange rates, domestic demand, competitiveness, productivity, trade policies, and global economic conditions can also significantly impact the balance of trade.

In conclusion, while an improvement in the terms of trade can contribute to a more favorable balance of trade by increasing export revenue and potentially reducing import costs, it is not the sole determinant. Various other factors interact to shape a country's trade balance, and their combined effects must be considered to assess the overall impact on the balance of trade.

A Level Economics Essay 11: Current Account

"Germany runs permanent current account surplus" - Explain why some countries have long-term current account surpluses on their balance of payments.

In simple terms, the balance of payments is a record of all economic transactions between a country and the rest of the world over a specific period. It consists of two main components: the current account and the capital account.

The current account is one of the main components of the balance of payments. It records the flows of goods, services, income, and transfers between a country and the rest of the world.

1. Goods: The current account includes the balance of trade, which represents the exports and imports of goods. For example, Germany's current account includes the value of goods it exports, such as automobiles, machinery, and chemicals, as well as the value of goods it imports, such as raw materials or consumer products.

2. Services: The current account also incorporates the balance of services, which includes income generated from services provided internationally. This includes items such as transportation, tourism, financial services, and consulting. For example, Germany's current account considers the income it earns from providing services like engineering consulting or financial services to other countries.

3. Income: The income component of the current account accounts for the net income earned from investments abroad and investments made by foreigners within the country. It includes items like dividends, interest payments, and profits. For example, if German companies have investments in foreign countries and receive income from those investments, it contributes to Germany's current account surplus.

4. Transfers: The current account also incorporates net transfers, which involve flows of money between countries that are not directly linked to the exchange of goods, services, or income. Transfers can include items like foreign aid, remittances from overseas workers, and grants. These transfers can either contribute to or reduce the current account balance.

The current account balance is determined by the sum of these components. When a country's exports and income from abroad exceed its imports and outward income flows, it results in a current account surplus. This surplus represents a net inflow of funds into the country and indicates that the country is a net lender to the rest of the world.

Germany is known for consistently running a current account surplus, which means its exports and income from abroad exceed its imports and outward income flows. There are several reasons why Germany has been able to maintain this long-term current account surplus:

1. Export-oriented economy: Germany has a strong export sector and is known for its high-quality manufactured goods, such as automobiles, machinery, and chemicals. Its products are in high demand globally, allowing Germany to generate significant export revenue.

2. Competitive advantage: Germany has a competitive advantage in various industries. It has a highly skilled labor force, advanced technology, and a reputation for precision engineering, which makes its products highly sought after. This competitive advantage enables Germany to maintain a strong position in international markets and contribute to its current account surplus.

3. Savings and investment patterns: Germany has a culture of high savings and a focus on investment. Germans tend to have a high savings rate and exhibit a preference for financial security. This leads to lower domestic consumption and a surplus of savings available for investment, both domestically and abroad. The returns on these investments, such as profits and interest payments from foreign assets, contribute to Germany's current account surplus.

4. Strong industrial base: Germany has a well-developed industrial base that supports its export-oriented economy. It has a diverse range of industries, including automotive, machinery, chemicals, and pharmaceuticals, which provide a solid foundation for sustained export performance.

The current account surplus of Germany indicates its success in exporting goods and services, generating income from abroad, and maintaining a competitive position in the global market. However, it is important to note that persistent surpluses can have implications, such as currency appreciation, which can make German exports relatively more expensive and affect the competitiveness of other countries' exports.

Deficits can matter, sometimes

Philip Coggan in The FT

Deficits don’t matter. This quote comes not from some spendthrift European socialist but reputedly from the distinctly conservative Dick Cheney, vice-president of the US from 2001 to 2009. 

According to an account by former Treasury secretary Paul O’Neill, in 2002 Cheney cited the Reagan administration as evidence for his thesis; the national debt tripled on the Republican’s watch in the 1980s but the US economy boomed and bond yields fell sharply. 

In the 20 years since Cheney’s remark, US federal debt has roughly doubled as a proportion of GDP. But 10-year Treasury bond yields are no higher than they were two decades ago; indeed they have spent much of the intervening period at much lower levels, even as debt has soared. The continuing brouhaha over the US debt ceiling has nothing to do with the willingness of markets to buy American debt; any everything to do with the willingness of politicians to honour their government’s commitments. 

However, Cheney’s sentiments have not always been borne out elsewhere. Over the past nine months the British government has discovered the problems that can occur when funding costs suddenly increase. And that has rekindled the debate over the ability of governments to run prolonged deficits. 

In one camp are the spiritual descendants of Margaret Thatcher, the former British prime minister who sought to balance budgets, arguing that “good Conservatives always pay their bills”. Modern budget hawks often say that governments should not pass on the burden of debt repayment to the next generation. Many also argue that budget deficits are caused by excessive government spending and that reducing this spending is not only prudent but will fuel economic growth. In the other camp are the majority of economists, who argue that unlike individuals, governments are in effect immortal and can rely on inflation, or future generations, to pay down their debts. 

They point out that government debt, as a proportion of gross domestic product, was very high (in both the US and the UK) in the aftermath of the second world war. That debt proved no barrier to rapid economic growth. Furthermore, ageing populations in the developed world mean there has been a “savings glut” as citizens put aside money for their retirements, making it easy to fund deficits. 

But the freedom of governments to issue debt comes with a couple of caveats. First, a country must be able to issue debt in its own currency. Many a developing country has discovered the dangers of issuing debt in dollars. If that country is forced to devalue its currency, then the cost of servicing the dollar debt soars. Secondly, countries need a central bank that is willing to support its government by buying its debt. The quantitative easing programmes of such buying has undoubtedly made it easier for governments to run deficits. 

In the eurozone crisis of 2010-12, deficits did matter for countries like Greece and Italy. Their bond yields soared as investors feared that the indebted countries might be forced to leave the eurozone. This would have either forced governments to default, or attempt to re-denominate the debt into their local currency. Greece turned to neighbours for help but found that other countries were unwilling to provide required support that unless Athens reined in its budget deficits. 

To many Eurosceptics, that proved the folly of joining the single currency. Britain was free of such constraints since it issued debt in its own currency and had a central bank that would undertake QE. Given those freedoms, the financial crisis of last autumn, which followed the mini-Budget proposed by the shortlived Liz Truss administration, was even more of a shock. 

While Truss tried to echo Thatcher’s imagery, she rejected the budgetary prudence of the Treasury as “abacus economics”. She argued that slashing taxes would lead to faster economic growth so that the deficit would disappear of its own accord as government revenues rose.  

However, the markets did not swallow the argument. The mini-Budget was followed by a spectacular sell-off in sterling and UK government bonds. The latter may have stemmed from the leveraged bets made by British pension funds on bonds. Still, the Truss team’s economic analysis failed to account for this possibility. 

Investor confidence in British economic policy had already been dented by the Brexit vote and by the rapid turnover of prime ministers and chancellors. The problem has not gone away. Data released this week showed that Britain was still struggling to contain inflation and gilt yields jumped back towards the levels reached after the mini-Budget. 

So Cheney’s aphorism needs amending. Deficits don’t matter if the government borrows in its own currency, and also has a friendly central bank, a steady inflation rate and the confidence of the financial markets. It also requires a continuation of the global savings glut. Those conditions mean there is plenty of scope for future governments to get into trouble.

Is the IMF fit for purpose?

As the world faces the worst debt crisis in decades, the need for a global lender of last resort is clearer than ever. But many nations view the IMF as overbearing, or even neocolonial – and are now looking elsewhere for help writes Jamie Martin in The Guardian

 
Last summer, after months of unusually heavy monsoon rains, and temperatures that approached the limits of human survivability, Pakistan – home to thousands of melting Himalayan glaciers – experienced some of the worst floods in its history. The most extensive destruction was in the provinces of Sindh and Balochistan, but some estimated that up to a third of the country was submerged. The floods killed more than 1,700 people and displaced a further 32 million – more than the entire population of Australia. Some of the country’s most fertile agricultural areas became giant lakes, drowning livestock and destroying crops and infrastructure. The cost of the disaster now runs to tens of billions of dollars.

In late August, as the scale of this catastrophe was becoming clear, the Pakistani government was trying to avert a second disaster. It was finally reaching a deal with the International Monetary Fund (IMF) to avoid missing payment on its foreign debt. Without this agreement, Pakistan would likely have been declared in default – an event that can spark a recession, weaken a country’s long-term growth, and make it more difficult to borrow at affordable rates in the future. The terms of the deal were painful: the government was offered a $1.17bn IMF bailout only after it demonstrated a real commitment to undertaking unpopular austerity policies, such as slashing energy subsidies. But the recent fate of another south Asian country appeared to show what happens if you put off the IMF for too long. Only weeks before, the Sri Lankan government, shortly after its own default – and after months of refusing to implement IMF-demanded reforms – was overthrown in a popular uprising.

The correlation of Pakistan’s crises – exceptionally devastating floods and the threat of economic meltdown – was partly bad luck. But it was also emblematic of a challenge faced by many countries at the forefront of the climate crisis: how can they afford to deal with extreme weather events and prepare themselves for the coming disasters, while suffering under crippling debt loads and facing demands for austerity as the price of relief?

Pakistan and Sri Lanka are only two of the many countries currently facing conditions of severe debt distress. Covid-19 delivered a major blow to many low- and middle-income countries that had borrowed heavily during the era of low interest rates beginning with the 2008 financial crisis. As the costs of public health and welfare rocketed, economies were locked down and tourism collapsed, which meant that tax revenues plummeted. The pandemic also disrupted global supply chains, leading to shortages of many goods and higher prices. These inflationary pressures were then exacerbated by Russia’s invasion of Ukraine. Meanwhile, the decision of the US Federal Reserve to raise interest rates to reduce US inflation has pushed the value of the dollar to its highest level in 20 years. This has made the debt of countries that borrowed in dollars – many do – more expensive since their currencies are worth less, while further increasing the cost of their imports. Rising US interest rates have also encouraged investors to pull capital out of riskier emerging markets at a historic rate, since safer dollar investments now produce higher returns.

The result is that the world economy faces the possibility of one of the worst debt crises in decades, threatening deep recessions, political instability, and years of lost growth. At the same time, the increase in extreme weather events – stronger hurricanes, recurring droughts – makes life even harder for states that already dedicate a large portion of their revenues to servicing foreign debt. In the midst of this turmoil, the IMF has become more involved in bailing out countries than it has in years. Over the last few months, the value of its emergency loans reached a record level, as a growing number of states turned to it for help, including Bangladesh, Egypt, Ghana and Tunisia.

Broadly speaking, the way the IMF works is by collecting financial resources from members and then offering them short-term assistance in the case of financial hardship. Based in Washington DC, the institution is staffed by representatives of ministers of finance and central bank governors from around the world. Because voting power is weighted by each state’s financial contribution, the US, as the IMF’s largest shareholder, exercises outsized influence over its major decisions and can veto proposed reforms to its governance. But as an international body that counts nearly every sovereign state as member, the IMF plays a unique role in the world economy. It’s the only institution with the resources, mandate and global reach to help almost any country facing severe economic distress.

But in exchange for its help, the IMF typically insists governments do what they find most difficult: reduce public spending, raise taxes and implement reforms designed to lower their debt-to-GDP ratios, such as cutting subsidies for fuel or food. Unsurprisingly, politicians are often reluctant to undertake these measures. It’s not just that the reforms often leave voters worse off and make politicians less popular. National pride is also at stake. Bowing to demands from an institution dominated by foreign governments can be seen as humiliating, and an admission of domestic dysfunction and misgovernance.

 

On the rare occasions that the IMF criticises the policies of a wealthy European state, this too can embroil the institution in domestic political conflicts. In September, the IMF’s criticism of Liz Truss’s proposed tax cuts provided ammunition to her political opponents and contributed to a slump in the pound’s value. The decision to sack chancellor Kwasi Kwarteng was taken while he was attending the IMF’s annual meeting in Washington DC, where the institution’s leading officials did little to mask their disapproval of his policies. In future histories of the fall of Truss, the IMF is likely to play a not insignificant role.

Despite all this, the IMF is not the kingmaker it once was. After reaching the height of its powers in the 90s, when its name became synonymous with the excesses of neoliberal globalisation and US overreach, the IMF has faced increasing resistance. It’s still the only institution that can guarantee assistance to nearly any country experiencing extreme financial stress. But the decline of US power, emergence of alternative lenders, and the IMF’s reputation as a domineering taskmaster has left it an anomalous position. It is much needed and little loved, enormously powerful and often ineffectual in getting states to agree to its terms. If predictions are correct that the world is entering an extended period of economic turmoil, this will only increase the need for some kind of global lender of last resort. Whether the IMF is up to the task depends on whether it has learned from its chequered history.

One of the most remarkable aspects of the IMF was what, in theory, it was supposed to accomplish when it was established – and how quickly it departed from this initial vision. The creation of the IMF was agreed at the Bretton Woods Conference of July 1944, when representatives from more than 40 countries met to rewrite the rules of the world economy. Led by the world-famous British economist John Maynard Keynes and his US counterpart Harry Dexter White, their aim was to create an international monetary system that stabilised currencies and facilitated a return to freer trade. National currencies would be set at fixed but adjustable rates to the dollar, which was in turn convertible to gold at a fixed rate of $35 per ounce.

The role of the IMF in this system was to help member states suffering from short-term balance-of-payments problems, while its partner organisation, the World Bank, made long-term loans for reconstruction and development. Crucially, in this original vision, the IMF would help members weather financial instability without browbeating them into undertaking painful policies such as cutting budgets or raising interest rates in the middle of a recession. This marked a break with the previous gold standard system, which from the late 19th century had provided predictable and stable exchange rates for countries that kept the value of their currencies fixed to a specific quantity of gold. This stability had come at the cost of being able to implement expansive national economic policies during a crisis. By contrast, officials involved in the creation of the IMF insisted that it avoid developing what Keynes referred to as “grandmotherly powers”, meaning finger-wagging, moralising strictures that unduly curtailed the freedom of member states.

Shortly after the end of the second world war, however, European representatives in the IMF’s executive board discovered that – despite an apparent wartime consensus shared by their more powerful US counterparts – the IMF was going to readopt an unpopular practice associated with earlier periods of financial imperialism: attaching policy conditions to its loans. To their chagrin, the institution would be authorised to intervene in sensitive domestic matters concerning fiscal and monetary decisions. US representatives were wary of allowing members access to the dollar without strings attached. And because the IMF had been designed in ways that gave the US unparalleled control over its activities, their prerogatives held sway. It was not in Europe that the IMF first deployed these interventionist powers, though; it was in the so-called third world, beginning in South American states such as Chile, Paraguay and Bolivia in the 50s.

After the collapse of the Bretton Woods system in the early 70s, when Richard Nixon removed the US dollar’s peg to gold, the IMF appeared to be out of a job. But it quickly took on new prominence in making bailout loans to financially unstable states. These loans came with demands for major structural reforms (privatisation, deregulation, the removal of tariffs) in addition to fiscal and monetary restraint. What made the IMF so mighty was that other creditors – whether commercial banks such as Citibank, or foreign governments – often considered a prior arrangement with the institution as a sign of a country’s creditworthiness. When the Soviet Union collapsed in the early 90s, the IMF undertook its most ambitious task yet, overseeing the transition of nearly-formerly Soviet republics to capitalism. In the process, it became, as the political scientist Randall Stone put it, the “most powerful international institution in history”.

As the IMF reached the height of its influence in the 90s, however, it sparked a global backlash that continues to this day. And the place where that backlash began was in Asia.

The Asian financial crisis is poorly remembered in the west, having been overshadowed by the 9/11 terrorist attacks and the “war on terror”. But it was an enormously consequential event, and its impact would reshape the global economy over the next 25 years. It began in the summer of 1997, when the collapse of the Thai baht sparked a financial panic that spread quickly throughout the region. As investors dumped one shaky currency after another, the panic became self-perpetuating, wreaking havoc from Indonesia to South Korea, and to countries as far off as Russia and Brazil.

The IMF quickly stepped in to offer rescue loans to the worst-hit countries, including Thailand, Indonesia and South Korea. The conditions of these loans included the institution’s perennial demands for austerity and tighter monetary policies – even though none of these governments had run significant deficits, nor seen much inflation in their economies in the run-up to the crisis. The IMF also insisted on a long list of reforms designed to liberalise their economies and, in particular, to dismantle practices and institutions derided as corrupt and inefficient forms of “crony capitalism”. In South Korea, the IMF set its sights on the country’s huge conglomerates, or chaebol, such as Hyundai, which enjoyed close ties to the state and domestic banks. In Indonesia, the IMF called for uprooting the vast system of patronage that enriched the family of long-ruling autocrat Suharto, such as the lucrative national clove monopoly, which produced a key ingredient of the kretek cigarettes popular in Indonesia, and was controlled by one of Suharto’s sons.

By intervening in sectors that had little to do with the currency crisis, the IMF appeared to be announcing the scale of its ambition. It wanted to transform what had, until then, been widely considered well-run economies. In particular, it seemed dead set on overturning what was known as the “Asian Model” of economic management, characterised by state-led investment in specific industries and firms. This approach had yielded impressive results in several countries, not least Japan, which then boasted the world’s second-largest economy. But it was widely seen by western officials and investors as anachronistic. To them, the crisis had rung the death knell for this Asian statist alternative to the Anglo-American laissez-faire approach.

This reformist zeal made the IMF unpopular across much of Asia. People were especially infuriated by demands to lift restrictions on foreign ownership of domestic firms. As US and European corporations swooped in to buy up financial institutions in Thailand and South Korea at steep discounts, many denounced the IMF as neo-colonial. In China, which was spared from the worst of the crisis, the state-owned People’s Daily newspaper accused the US of “forcing east Asia into submission”. Even Raghuram Rajan, who became the IMF’s chief economist in 2003, later admitted that the institution’s handling of the crisis had left it vulnerable to charges of financial colonialism.

Meanwhile, austerity measures such as cutting subsidies to fuel and foodstuffs like rice and flour, in countries undergoing severe cost of living and unemployment crises, fed growing political turmoil. The crisis was especially dire in Indonesia. As the rupiah continued to plunge into 1998, the country was gripped by political discontent and violence, as mob attacks on the ethnic Chinese minority led to scores of deaths. In Jakarta, the military fired on student protesters at Trisakti University, killing four and fanning the flames of riots spreading across the country. When Suharto raised fuel prices to fulfil IMF demands to produce a budget surplus, opposition intensified. In May 1998, he was forced from office.

At the time, defenders of the IMF insisted Suharto had been the author of his own downfall, claiming he had refused to implement reforms quickly enough to halt a crisis caused by his own corruption. But other contemporaries recognised that insisting he instantly uproot the entire system of patronage on which his regime relied was an impossible demand. “It’s crazy to ask people to commit suicide,” one diplomat remarked at the time.

Looking at images of Suharto signing the terms of an agreement with the IMF in January 1998, as the institution’s managing director, the French economist Michel Camdessus, loomed over him, it wasn’t hard to see this as a humiliating surrender of sovereignty. And it did not take conspiracists to recognise that the US Treasury and many western investors wanted Suharto gone, despite the opposition of the state department and Pentagon to anything that threatened the stability of a US strategic partner in the Asia-Pacific region. While the IMF didn’t plot Suharto’s removal, there was little question that US Treasury officials had come to see regime change as the only salvation for the Indonesian economy. As Camdessus himself later admitted: “We created the conditions that obliged Suharto to leave his job.”

To some American observers, Indonesia had proven an iron law of history: that the growing material prosperity of a citizenry would inevitably cause them to reject autocratic rule. What happened to Suharto, they said, would eventually happen to the Chinese Communist party. (Some predicted the exact year – 2015 – that China would see its equivalent popular uprising.)

What went less commented on was the obvious wakeup call the crisis and its political effects delivered to other governments. The lesson was clear: make yourself able to resist a crisis of financial globalisation and, if it comes, be sure you can deal with it on your own. 

For many states, the Asian crisis was a warning. In the event of a future financial crisis, they wanted to avoid calling in any institutions that might interfere in their domestic affairs. One way to do this was to build up huge stockpiles of foreign currency reserves. At a moment of crisis, these reserves can be used to defend a currency’s value, pay off foreign debts and import necessities. China led the way, but South Korea, Brazil, Mexico and others followed. From 2000 to 2009, the total value of China’s reserve assets grew by nearly $1.8tn. Today, it’s well over $3tn – a figure higher than the total GDP of the entire African continent.

For some countries, accumulating these reserves has been key to a strategy of export-led development, since doing so can help hold down the value of a national currency and thus make exports more competitive. But for most states, the aim has been insurance against financial turmoil. And in some cases, it’s worked remarkably well. The accumulation of currency reserves helped many emerging market economies escape the worst of the global financial crisis that began in 2008. While the IMF played a major role in bailing out Greece in the 2010s, it did comparatively little elsewhere. It was not invited back to countries where it had become so controversially involved in the 90s, such as South Korea and Russia.

One striking consequence of this currency stockpiling is that capital now moves in huge quantities from poorer countries to wealthier ones, rather than vice versa. This is because much of the world’s supply of reserves are held in US dollars, which countries tend to invest back into the safe haven of US treasury bills. Doing so guarantees a nearly bottomless global demand for US government debt and helps ensure the continued centrality of the US dollar to the global economy. The fact that China sits on such a huge stockpile of US treasuries has long generated anxiety about the political leverage this might give Beijing over Washington, since a sell-off would be catastrophic to the value of the dollar. But because it would also be catastrophic to the Chinese economy, the threat has never been close to realisation.

Not all states can afford to pile up currency in this way. For those that can, it is not painless, since it diverts resources away from public investment. Some economists have wondered why governments opt for it, suggesting that the opportunity cost of reducing public investment may outweigh the possible savings of averting a financial crisis. But hoarding these assets is not just a matter of economics. It’s also political and strategic policy designed to guarantee states the kind of autonomy that Indonesia, Thailand and South Korea bargained away during the 1997-98 crisis. Seen in this way, there’s little price that’s not worth paying for full sovereignty. The historian Adam Tooze has aptly referred to the strategies pursued by emerging market economies since the 90s as programmes of “self-strengthening” – a term originally used to describe the efforts of states like China and Japan in the late 19th century to reform their government administrations, militaries and economies to resist the incursion of powerful western empires.
 

Take Russia, a country that experienced a long and painful engagement with the IMF in the 90s. After defaulting on its sovereign debt in 1998, Russia, under its new president Vladimir Putin, began to amass a stockpile of reserves in the 2000s, facilitated by rising oil prices. By 2008, it sat on such a huge war chest that it could spark an aggressive war with Georgia without much concern for the financial repercussions. Russia appeared to have won new strategic independence.

A similar calculus was likely at play with Putin’s decision to invade Ukraine this year. But in one of the most far-reaching countermoves of Putin’s enemies, the US and its G7 partners targeted the foreign assets that were owned by the Russian central bank, but which they ultimately controlled. In late February, more than $300bn of Russian assets were immobilised in a move designed to paralyse Russia. The same tactic had been used just a few months earlier, when the dollar assets of the Afghan central bank had been frozen to hobble the Taliban in the wake of Kabul’s fall.

In Russia’s case, this strategy failed to end the war. And some worry it will backfire, encouraging states to rethink holding US dollars as a guarantee of economic stability. If the Asian financial crisis had the effect of turning countries away from the IMF and towards stockpiling reserves, the war in Ukraine may similarly push them away from the dollar as the reserve currency of choice. Were this to happen, the impact would be seismic. The dollar would be dethroned, losing its status as the world’s principal safe haven-asset. More likely, others argue, is further diversification away from dollars to other currencies. The ambitious US and European financial sanctions against Russia may prove, over time, to have similar effects to the IMF’s response to the Asian financial crisis: encouraging states to reconsider how they guarantee their autonomy in a global economy whose infrastructures they do not control.

Over the past decade, the IMF has made significant efforts to repair its reputation. In the wake of the global financial crisis, it became routine for IMF officials to publicly acknowledge that austerity could be counterproductive and that tackling inequality had become one of the institution’s central concerns. The selective use of once-taboo policies such as capital controls to restrict the flow of foreign capital into and out of a national economy was reconsidered, while demands for far-reaching domestic structural reforms were supposedly a thing of the past. When the official IMF publication Finance and Development ran an article in 2016 with the provocative headline Neoliberalism: Oversold?, many media outlets reported it as a sign of the institution undergoing a significant transformation. “What the hell is going on?” was how one longtime critic of neoliberalism, the Harvard economist Dani Rodrik, greeted news of its publication.

But in practice, the IMF’s transformation has itself been oversold. As the scholars Alexander Kentikelenis, Thomas Stubbs and Lawrence King showed in an article from the same year, the IMF, despite these rhetorical shifts, continued to insist on just as many, if not more, of the same structural reforms of borrowers as ever – sacking civil servants, cutting pensions, lowering minimum wages. A 2020 study by the Global Development Policy Center at Boston University found something similar. Today’s IMF, it noted, recognises that austerity constrains growth – while continuing to demand austerity from states in receipt of its aid.

Yet the Boston University study also reached another conclusion – one that shows how, despite itself, the institution may be undergoing real changes, not from ideological shifts alone, but from competition for its business. Researchers found that borrowers that had prior loan arrangements with China tended to get more lenient treatment from the IMF. Why? Probably because China does not make austerity or domestic reforms the price of its loans, which pushes the IMF to moderate its terms with clients that have access to this unconditional financing. Other studies have found a similar phenomenon at work at the World Bank.

China is now the world’s largest bilateral lender, a fact that has generated considerable anxiety in the west. Lending without policy strings attached is sometimes seen as Beijing’s way of buying goodwill with corrupt autocrats. China is also accused of “dept trap” diplomacy, by making loans to states to invest in unaffordable “white elephant” infrastructure projects. When these states can’t repay their debts, Chinese officials insist they give up valuable assets, like a 99-year lease over a strategic port, such as happened in Sri Lanka in 2017.

Critics of China have described Sri Lanka’s descent into financial and political turmoil as the logical end point of Beijing’s predatory lending. It’s true that the Rajapaksa brothers, who traded off ruling Sri Lanka from the mid-00s until this summer, pursued an extravagant programme of Chinese-financed infrastructure building. But when the Sri Lankan economy collapsed earlier this year, the government actually owed more money to private bondholders in Europe and the US than to China – despite the role Beijing had played in financing the country’s infrastructure boom. It’s too simple to see Sri Lanka solely as the victim of Chinese debt diplomacy.

Today, many are looking for clues on the nature of China’s role as lender in how it navigates its first global debt crisis. Over the last few years, it’s started making more emergency bailouts, setting itself up even more as a direct alternative to the IMF. But even critics of the IMF see the institution – with its broad membership, global reach and public aims – as playing a meaningfully different role in the world economy from a state actor like China, which – like all states – will make loans largely for the sake of its strategic aims and national interests. This is why many reformers calling for changes to the international financial system – such as Mia Mottley, the prime minister of Barbados – still focus on the IMF. Despite its history of missteps, and close ties to US foreign policy objectives, the institution is still seen as being uniquely able to provide something approximating a global financial safety net.

Given its continued dominance of the IMF, it is from the US that the greatest pressure to actually reshape the institution will have to come. There are signs that the current global crisis is forcing political change. In October, just before the annual meeting of the IMF and World Bank, the former Treasury secretary Lawrence Summers called on the institution to develop new, unconditional ways of providing financial assistance to states facing extreme pressures, as central banks raised interest rates. The political stigma involved in traditional IMF forms of lending, Summers suggested, was pushing states away from the institution when they needed it most. 

It was extraordinary to see Summers making this case. During the Asian financial crisis, Summers had been deputy secretary of the US Treasury. He had played a leading role in coordinating Washington’s response to the crisis through the IMF. He had even met with Suharto in Jakarta to personally convince him to agree to its terms. But now, the world economy needed a kind of financial assistance, Summers implied, that moved past the legacy of the interventionist IMF, whose powers he himself had once helped to unleash. This year’s annual meetings, which failed to consider ambitious measures to rescue the world economy, he claimed, would be remembered as nothing more than a “missed opportunity”.

As the Fed’s decisions threaten a new wave of global economic instability, these meetings may also be remembered for something else entirely: as an illustration of the paradoxical nature of US power in the third decade of the 21st century – mighty enough to break the world, but not to put it back together again.