Who wins in the International Casino? Jubilee 2000 Coalition

by Ann Pettifor, Director, Jubilee 2000 Coalition UK

"Every great crisis reveals the excessive speculations of many houses which no one before suspected." Walter Bagehot, 1873

In October 1998 the mis-named Long Term Capital Management Fund (LTCM) threatened collapse - and by doing so revealed excessive speculations that no one before had suspected. The hedge fund, believed to have had assets of $4bn, used these as security to borrow a further $120bn. Gullible bankers, using the deposits of innocent customers, lavished huge loans on LTCM. Not content, the fund managers, led by one John Meriwether, traded up a further $1.25 trillion in derivatives. $1.25 trillion is roughly equivalent to the annual income of China - or a billion people.

Derivatives are essentially a form of betting with other peoples' money, and were used amongst other things, to speculate against the pegged Hong Kong dollar. But LTCM bet the wrong way with the money it had borrowed, and as a result, threatened the big banks, including the central bank of Italy, with default on its loans. However unlike big companies and sovereign governments, LTCM's reckless fund-managers, and its equally irresponsible lenders, were not expected to face the wrath of market forces. Alan Greenspan, chair of the US Federal Reserve Bank stepped in to prevent collapse by arranging a bail-out for LTCM's owners - amid howls of protest at blatant "cronyism".

LTCM was bailed out, argued Greenspan, because its demise threatened systemic collapse of the international financial system. If so, the Chairman of the Fed must have much on his mind. There are an estimated 4,000 largely unregulated hedge funds in existence, trafficking in trillions of dollars of derivatives, and copying LTCM's strategies. "Hedge funds, like cockroaches and wolves, are rarely alone" notes Frank Partnoy.

To survive, and to thrive, cockroaches and wolves need an appropriate environment.

The appropriate environment for hedge fund speculators had been carefully cultivated over a number of years by G7 leaders, in their role as shareholders of the IMF and World Bank. Through these institutions the G7 advocated the de-regulation of capital markets - i.e. the removal of constraints on the movement of capital over national frontiers.

In its Annual Report of 1997, the IMF provides an illuminating account of a debate within the IMF Board on capital account liberalisation. "In their discussions" notes the Report, "directors agreed that an open and liberal system of capital movements fostered economic growth and prosperity by contributing to an efficient allocation of world saving and investment."

Some directors (the IMF Report does not name them) fretted about the likely costs to the Fund of liberalisation. From the time of the discussions outlined above, until October, 1998, the IMF was forced to bail out short-term mainly private, lenders by pouring $18bn into Thailand, $43bn into Indonesia, $57bn into South Korea and $23bn into Russia - just over $140bn. This emergency financing almost bankrupted the Fund. US Congressmen protested at these bail-outs by withholding a critical $18bn to be used to leverage further loans from other governments. By late October 1998, Congress had finally caved in. In December 1998 the IMF agree a $41bn package for Brazil. In total, capital liberalisation will have cost the IMF (and therefore its OECD government taxpayers) $200bn, in just over a year. In 1997 the IMF Board had "agreed to return to the issue (of demands on the IMF) at a later stage". There is no indication in the 1998 Annual Report of any further debate. IMF directors from OECD countries were too busy fighting the fires they had ignited with capital account liberalisation. President Clinton appealed to US congressmen to agree the allocation of $18bn. "There is no excuse for refusing to supply the fire department with water while the fire is burning", he argued. But as the Wall Street Journal argued, "the IMF has been treating fires with gasoline, rather than water."

Financial market "reforms" for capital liberalisation allowed Thai and South Korean banks and companies to borrow short-term foreign loans on the international markets. These "reforms" were a major cause of the following crisis. Hundred of billions of dollars of loans flooded in to fund projects like hotels, golf courses and new office developments. These loans had to be repaid in foreign currency, but revenues for repayment were raised in local currencies. As these currencies devalued, the cost of repayment in foreign currencies rocketed.

As Jeffrey Sachs has noted, the "subsequent panicked flight of such capital is at the root of the emerging-market debacle." The IMF strove hard to make the world safe for these reckless short-term lenders. Its highly paid, highly qualified staff created conditions in which central banks would devote their reserves to defence of the currency, and the IMF would dedicate its funds to the defence of central banks so that "lending to emerging markets would be like shooting fish in a barrel."

Finally, IMF austerity programmes continued to wreak havoc – particularly in countries whose "tiger economies" had until recently been burning bright. Unemployment skyrocketed and the dream of an end to poverty faded away. In the words of the Wall Street Journal, IMF "policies keep producing real-world nightmares of poverty and instability".

But European and US leaders have remained complacent, viewing these real-world nightmares from the lofty heights of growing, affluent economies. As stock markets rocketed to new heights, the IMF, undeterred by reports of corruption and cronyism in Moscow, agreed a loan of $22.6bn to the Russian Federation. While the loans were being made, unconcerned bankers were arranging the sale of Russian bonds in New York, and naming them "the moral hazard" bonds.

Western complacency persisted through the summer into the autumn of '98. Wim Duisenberg, president of the European Central Bank said in October,"We will see about a crisis if that event arrives." This complacency can be explained by the fundamental fault-line that runs through all Western economic policy-making. Namely that inflation is the main, if not the only threat to prosperity - and that as long as inflation is under control - and everyone believes that it now is under control - then we can all sleep well at night.

In January, 1998, Robert Reich, formerly Secretary of Labor in the Clinton Administration warned of the very opposite - the threat of deflation. He predicted correctly that a "large, uncoordinated global contraction is under way." He demonstrated how, even before the Asian currency crisis, world prices for basic commodities were falling. How demand was contracting in Asia. How Brazil's President Cardoso, on the advice of the IMF, and in order to lift the confidence of foreign investors and lenders, had increased interest rates - flattening consumer demand in Brazil, Latin America's largest market of 160 million consumers. This sent de-stabilising waves through surrounding economies and markets, waves which now threaten the US economy.

None of these global or domestic warning signs were heeded by central bankers or the IMF. On the contrary, a defiant Michel Camdessus argued in October 1998: "if we were to go back to July 1997 for Thailand or November 1997 for Korea...we would do the same thing again." Indeed the IMF is now proposing to put out the flames in Brazil with the same fire-fighting programmes it imposed on South East Asia. Finally on 30th October a reaction from the G7 did come. Having failed to come to a consensus at the meetings of the World Bank and IMF in October, further discussions of G7 finance ministers came up with a 3 point plan to:

One source of the crisis has been massive global speculation - by hedge funds like LTCM, betting billions of dollars on predictions of the movement of particular interest and currency exchange rates.

The G7 leaders decided on 30 October that governments needed to be able to borrow more money in order to stay in this gambling game with very high stakes. Furthermore that the G7 should "examine the question" of whether or not players on the other side of the table -- private companies like LTCM -- should have to be more open about how much of their gambling stake is borrowed money.

Who profits from this game? Despite the IMF's belief that in searching for profits, speculators invest money in poor countries and stimulate development, many others argue that in fact very little is actually invested in new farms and factories. Most is simply gambled away. As the crisis of the strong Hong Kong economy has shown, this speculation destabilises economies, causing massive dislocation and poverty, and forcing the closure of productive factories. Speculation seems only to benefit the big banks and gambling syndicates like LTCM. In part, this is because the casino is unfair -- the deck is stacked in favour of the gamblers. When western banks and hedge funds like LTCM have lost too much, the international financial institutions, represented by the IMF, and central banks like the US Federal Reserve, have bailed them out.

Our TV screens and newspapers often show the poor in Africa and the victims of hurricanes in Latin America. These countries suffer economic degradation largely because they have been pressurised to borrow heavily in foreign currencies. The resulting drain from their reserve banks of foreign debt repayments leads to devaluation of the currency and further economic degradation. International creditors are of course reluctant to write off these debts. Unlike creditors in domestic economic arrangements, international creditors have the power to dominate their debtors. Their response to the crisis of high levels of indebtedness is to offer more aid, and new loans, to pay off old loans. The slow-moving, slow-disbursing HIPC (Heavily Indebted Poor Countries) Initiative, is a creditor-driven initiative for debt relief, that offers very little relief. The cost the initiative is estimated at about $8 billion. The IMF is resisting deeper relief, saying it does not have the money . With almost the same breath IMF officials agreed to find $90 billion for the above-mentioned G7 response to the international casino's demands. This $90 billion will be used to exert pressure on emerging markets, and pour the IMF's own brand of gasoline on the economic fires of Latin America. And let there be no doubt, these new loans from the IMF, while bailing out speculators, will create an even deeper debt trap for emerging market economies.

The G7 could have taken another course. They could have decided to regulate capital flows instead of inflaming them. And they could have used that $90 billion to resolve the present debt crisis. $90 billion would wipe out the debt of the 25 poorest countries in the world. Alternatively, $90 billion is enough to allow the rich countries to double their aid for the next three years. $90 billion would help poor countries, stabilise the world economy and stimulate demand globally to the benefit of us all.

Surely this would be a more "efficient allocation of world saving" than using the money to increase risk, fan the fires of speculation and bail out creditors?

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