IMF AND WORLD BANK

IMF AND WORLD BANK

Why do economies need money? This chapter defines money as a unit of account that is used as a medium of exchange in transactions.

Without money, individuals and businesses would have a harder time obtaining (purchasing) or exchanging (selling) what they need, want, or make. Money provides us with a universally accepted medium of exchange.

Did You Know?

Throughout history, some types of money have gained widespread circulation outside of the nations that issued them. Whenever a country or empire has regional or global control of trade, its currency becomes the dominant currency for trade and governs the monetary system of that time.

Here’s a quick look at some of some of the most powerful currencies in history:

• Persian daric.

The daric was a gold coin used in Persia between 522 BC and 330 BC.

• Roman currency.

Currencies such as the aureus (gold), the denarius (silver), the sestertius (bronze), the dupondius (bronze), and the as (copper) were used during the Roman Empire from around 250 BC to AD 250.

• Thaler.

From about 1486 to 1908, the thaler and its variations were used in Europe as the standard against which the various states’ currencies could be valued.

• Spanish American pesos.

Around 1500 to the early nineteenth century, this contemporary of the thaler was widely used in

Europe, the Americas, and the Far East; it became the first world currency by the late eighteenth century.

• British pound.

The pound’s origins date as early as around AD 800, but its influence grew in the 1600s as the unofficial gold standard; from 1816 to around 1939 the pound was the global reserve currency until the collapse of the gold standard.

• US dollar.

The Coinage Act of 1792 established the dollar as the basis for a monetary account, and it went into circulation two years later as a silver coin. Its strength as a global reserve currency expanded in the 1800s and continues today.

• Euro.

Officially in circulation on January 1, 1999, the euro continues to serve as currency in many European countries today.

Until the nineteenth century, the major global economies were regionally focused in Europe, the Americas, China, and India.

Ancient societies started using gold as a means of economic exchange. Gradually more countries adopted gold, usually in the form of coins or bullion, and this international monetary system became known as the gold standard.

In the pre–World War I global monetary system that used gold as the basis of international economic exchange.

In 1821, the United Kingdom, the predominant global economy through the reaches of its colonial empire, adopted the gold standard and committed to fixing the value of the British pound.

The United Kingdom officially set the price of its currency by agreeing to buy or sell an ounce of gold for the price of 4.247 pounds sterling. At that time, the United States agreed to buy or sell an ounce of gold for $20.67.

The Advantages of the Gold Standard

The gold standard dramatically reduced the risk in exchange rates because it established fixed exchange rates between currencies. Any fluctuations were relatively small.

Collapse of the Gold Standard

If it was so good, what happened? The gold standard eventually collapsed from the impact of World War I. During the war, nations on both sides had to finance their huge military expenses and did so by printing more paper currency. As the currency in circulation exceeded each country’s gold reserves, many countries were forced to abandon the gold standard.

In the 1920s, most countries, including the United Kingdom, the United States, Russia, and France, returned to the gold standard at the same price level, however, the revival of the gold standard was short-lived due to the Great Depression, which began in the late 1920s.

Post–World War II

The demise of the gold standard and the rise of the Bretton Woods system pegged to the US dollar was also a changing reflection of global history and politics.

Bretton Woods

In the early 1940s, the United States and the United Kingdom began discussions to formulate a new international monetary system. John Maynard Keynes, a highly influential British economic thinker, and Harry Dexter White, a US Treasury official, paved the way to create a new monetary system. And in July 1944 representatives from forty-four countries met in Bretton Woods, New Hampshire, to establish a new international monetary system. The Bretton Woods Agreement lasted until 1971 and established several key features.

In 1944, the Bretton Woods Agreement established a new international monetary system. The creation of the International Monetary Fund (IMF) and the World Bank were two of its most enduring legacies.

The two institutions may seem to have confusing or overlapping functions. However, while some similarities exist (see the following figure), they are two distinct organizations with different roles.

The Bank is primarily a development institution; the IMF is a cooperative institution that seeks to maintain an orderly system of payments and receipts between nations. Each has a different purpose, a distinct structure, receives its funding from different sources, assists different categories of members, and strives to achieve distinct goals.

And, the IMF came into existence in December 1945 with twenty-nine member countries. (The Soviets, who were at Bretton Woods, refused to join the IMF.)

In 1947, the institution’s first formal year of operations, the French became the first nation to borrow from the IMF. Over the next thirty years, more countries joined the IMF, including some African countries in the 1960s. The Soviet bloc nations remained the exception and were not part of the IMF until the fall of the Berlin Wall in 1989.

The IMF experienced another large increase in members in the 1990s with the addition of Russia; Russia was also placed on the IMF’s executive committee. Today, 187 countries are members of the IMF; twenty-four of those countries or groups of countries are represented on the executive board.

The purposes of the International Monetary Fund are as follows:

1.      To promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems.

2.      To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.

3.      To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.

4.      To assist in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade.

5.      To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.

6.      In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.

In addition to financial assistance, the IMF also provides member countries with technical assistance to create and implement effective policies, particularly economic, monetary, and banking policy and regulations.

Special Drawing Rights (SDRs)

A Special Drawing Right (SDR) is basically an international monetary reserve asset. The SDR serves as the unit of account of the IMF and some other international organizations, and countries borrow from the IMF in SDRs in times of economic need.

The IMF has been subject to a range of criticisms that are generally focused on the conditions of its loans, its lack of accountability, and its willingness to lend to countries with bad human rights records.

These criticisms include the following:

1.      Conditions for loans.

The IMF makes the loan given to countries conditional on the implementation of certain economic policies, which typically include the following:

·         Reducing government borrowing (higher taxes and lower spending)

·         Higher interest rates to stabilize the currency

·         Allowing failing firms to go bankrupt

·         Structural adjustment (privatization, deregulation, reducing corruption and bureaucracy)

2.      Devaluations. In the initial stages, the IMF has been criticized for allowing inflationary devaluations.

3.      Free-market criticisms of the IMF. Believers in free markets argue that it is better to let capital markets operate without attempts at intervention. They argue attempts to influence exchange rates only make things worse—it is better to allow currencies to reach their market level.

4.      Lack of transparency and involvement. The IMF has been criticized for “imposing policy with little or no consultation with affected countries.

5.      Supporting military dictatorships. The IMF has been criticized over the decades for supporting military dictatorships.

The World Bank and the World Bank Group

The World Bank came into existence in 1944 at the Bretton Woods conference. Its formal name is the International Bank for Reconstruction and Development (IBRD), which clearly states its primary purpose of financing economic development. The World Bank’s first loans were extended during the late 1940s to finance the reconstruction of the war-ravaged economies of Western Europe. When these nations recovered some measure of economic self-sufficiency, the World Bank turned its attention to assisting the world’s poorer nations.

The World Bank has one central purpose: to promote economic and social progress in developing countries by helping raise productivity so that their people may live a better and fuller life.

The Bank is currently involved in more than 1,800 projects in virtually every sector and developing country.

Today, The World Bank consists of two main bodies, the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA), established in 1960.

The World Bank is part of the broader World Bank Group, which consists of five interrelated institutions:

1.      the IBRD;

2.      the IDA;

3.      the International Finance Corporation (IFC), which was established in 1956;

4.      the Multilateral Investment Guarantee Agency (MIGA), which was established in 1988; and,

5.      the International Centre for Settlement of Investment Disputes (ICSID), which was established in 1966.

These additional members of the World Bank Group have specific purposes as well. The IDA typically provides interest-free loans to countries with sovereign guarantees. The IFC provides loans, equity, risk-management tools, and structured finance. Its goal is to facilitate sustainable development by improving investments in the private sector. The MIGA focuses on improving the foreign direct investment of developing countries. The ICSID provides a means for dispute resolution between governments and private investors with the end goal of enhancing the flow of capital.

The current primary focus of the World Bank centers on six strategic themes:

1.      The poorest countries. Poverty reduction and sustainable growth in the poorest countries, especially in Africa.

2.      Post conflict and fragile states. Solutions to the special challenges of post conflict countries and fragile states.

3.      Middle-income countries. Development solutions with customized services as well as financing for middle-income countries.

4.      Global public goods. Addressing regional and global issues that cross national borders, such as climate change, infectious diseases, and trade.

5.      The Arab world. Greater development and opportunity in the Arab world.

6.      Knowledge and learning. Leveraging the best global knowledge to support development.

The World Bank provides low-interest loans, interest-free credits, and grants to developing countries. There’s always a government (or “sovereign”) guarantee of repayment subject to general conditions

Role;

The following are four examples of the world’s difficult needs that the World Bank tries to address:

1.      Even in 2010, over 3 billion people lived on less than $2.50 a day.

2.      At the start of the twenty-first century, almost a billion people couldn’t read a book or sign their names.

3.      Less than 1 percent of what the world spends each year on weapons would have put every child into school by the year 2000, but it didn’t happen.

4.      Fragile states such as Afghanistan, Rwanda, and Sri Lanka face severe development challenges: weak institutional capacity, poor governance, political instability, and often ongoing violence or the legacy of past conflict.

Criticism;

According to the Encyclopedia of the New American Nation and the New York Times, the World Bank is criticized primarily for the following reasons:

1.      Administrative incompetence. The World Bank and its lending practices are increasingly scrutinized, with critics asserting that “the World Bank has shifted from being a ‘lender of last resort’ to an international welfare organization,” resulting in an institution that is “bloated, incompetent, and even corrupt.” Also incriminating is that “the bank’s lax lending standards have led to a rapidly deteriorating loan portfolio

2.      Rewarding or supporting inefficient or corrupt countries. The bank’s lending policies often reward macroeconomic inefficiency in the underdeveloped world, allowing inefficient nations to avoid the types of fundamental reforms that would in the long run end poverty in their countries.

3.      Focusing on large projects rather than local initiatives. Some critics claim that World Bank loans give preference to “large infrastructure projects like building dams and electric plants over projects that would benefit the poor, such as education and basic health care.”

4.      Dominance of G7 countries. The industrialized countries dominate the World Bank (and IMF) governance structures. Decisions are typically made and policies implemented by these leading countries—the G7—because they are the largest donors, some suggest without sufficient consultation with poor and developing countries.

The World Bank continues to play an integral role in helping countries reduce poverty and improve the well-being of their citizens. World Bank funding provides a resource to countries to utilize the services of global companies to accomplish their objectives.