The Exchange Stabilization Fund and the IMF in the 1980s and 1990s

In order to support and give meaning to a nation’s international economic and financial policy, its monetary authorities require a mechanism to undertake foreign exchange operations. For the US Government that instrument is the [ESF] ... . Globalization of the world economy and financial markets has changed the nature and scope of strains on the balance of payments adjustment . indebtedness problems have arisen with serious implications for world financial markets.

David C. Mulford, Undersecretary of the Treasury for International Affairs (Hearings before the Subcommittee on International Trade, Investment and Monetary Policy, 1984)

International financial markets have changed from where they were under the Bretton Woods structure, the emergence of private global finance has to a very substantial extent made much of the purposes of the Bretton Woods structure of dubious merit in the current environment.

Federal Reserve Chairman Alan Greenspan (FOMC meeting, 1995)

President Richard Nixon’s decision in 1971 to take the dollar off of gold eliminated the gold drain and speculative attack threats. It also ended the Bretton Woods system of fixed exchange rates. This meant that neither the United States nor its European counterparts needed to defend their exchange rates in the same manner they did under the par value system. Consequently, use of the system of swaps that had been so carefully crafted in the 1960s began to decline. However, this was not the case for the governments of developing economies, most of whom maintained pegged exchange rates for many years after the end of the Bretton Woods monetary order. At the same time, many developing countries also began borrowing from private international credit markets. The combination of increased international capital mobility, growing external sovereign debt held by private financial institutions, increasing foreign portfolio investment in emerging market economies, and the maintenance of pegged exchange rates contributed to two decades of financial instability in the developing world.

While the International Monetary Fund (IMF) took center stage in managing international financial crises in the 1980s and 1990s, the United States stepped in to complement the Fund’s efforts by providing credits to economies in crisis on more than 50 different occasions via the Treasury’s Exchange Stabilization Fund (ESF). Why did US economic policymakers feel acting as an international lender of last resort (ILLR) alongside the Fund was necessary rather than letting the IMF manage crises on its own? In this chapter, I explain how changes in the nature of the international financial system following the denouement of the Bretton Woods order revealed IMF shortcomings as a de facto ILLR. It was precisely these shortcomings that provide the backdrop for US involvement in foreign bailouts. In the 1970s and early 1980s, the rise of global bank lending was the key driver of change. The onset of sovereign debt crises in the 1980s led to an expansion of the Fund’s role as an international financial crisis manager. Yet the strategy it adopted—known as "concerted lending,” which I discuss in more detail below—made the institution’s crisis response agonizingly slow. On a number of occasions, the United States stepped in to provide "bridge” loans via the ESF to borrowers that were waiting on a plodding IMF to disburse much-needed financial support. Change again came in the 1990s with the rise of footloose global portfolio investment. Volatile short-term capital flows sent a number of emerging market economies into crisis and caused their currencies to crash. These new capital account crises required an ILLR to respond with both great speed and great force. If loan packages were not sufficiently large, the heterogeneous pool of global investors would not view the package as a credible backstop and the stampede out would continue. In this context, the ESF provided credits designed to supplement IMF loans by increasing the size of the overall financing package. Together, the joint credits were intended to calm market jitters with an overwhelming use of financial force. Taken together, this chapter highlights how the United States’ unilateral bailout actions were designed to complement IMF credits in a way that would move the crisis-management effort closer to Walter Bagehot’s ideal.

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