If creating new money is so easy, why didn’t the IMF just go ahead and move to create the full $2.5 trillion package?
By Anil Madan
On March 30, 2020, within weeks after the first lockdowns and isolation protocols went into effect, the United Nations Conference on Trade and Development (UNCTAD) called for a $2.5 trillion coronavirus crisis package for developing countries. It stated that:
- $1 trillion should be made available through the expanded use of special drawing rights (SDR)
- $1 trillion of debts owed by developing countries should be cancelled this year
- $500 billion is needed to fund a Marshall Plan for health recovery and dispersed as grants.
Less than a month later, on April 23, 2020, UNCTAD issued a news release under the catchy headline: “Covid-19 is a matter of life and debt, global deal needed.” That report again called for $1 trillion in debt relief and a new international body to oversee such a debt relief program. UNCTAD’s rationale was reasonable although its call for another layer of bureaucracy is lamentable. UNCTAD projected that commodity-rich exporting countries would see a $2-3 trillion drop in investment from overseas over the next two years.
More importantly, it estimated that in 2020 and 2021 alone, developing countries’ repayments on their public external debt alone will soar to between US$2.6 trillion and $3.4 trillion. UNCTAD’s report also noted that in the two months since the virus began spreading beyond China, developing countries have taken an enormous hit in terms of capital outflows, growing bond spreads, currency depreciations and lost export earnings, including from falling commodity prices and declining tourist revenues.
Almost one and one-half years since UNCTAD’s call, it has become starkly clear that developing countries simply do not have the resources to meet their debt obligations and that dealing with the impact of Covid-19 is likely to demand even more resources than UNCTAD projected. However, it is one thing to call for a $2.5 trillion package, but quite another to generate that much money. Or maybe not. After all, in the US the Federal Reserve Bank has shown us that it can simply “create money” out of nothing. The Federal Reserve’s website notes that during the 2007-2008 financial crisis, its balance sheet expanded from $870 billion in August 2007 to $4.5 trillion in early 2015. Thereafter, the Fed attempted what it calls “normalization” but was only able to achieve a modest reduction to $3.8 trillion by 2017. Since Covid-19 became a reality, the massive stimulus packages enacted by the U.S. Congress under Presidents Trump and Biden, the Fed’s balance sheet has grown to almost $8.25 trillion. The Fed accomplishes this “magic” by buying US government Treasury securities with money it doesn’t have—it simply issues an electronic credit to the Treasury in exchange for the “securities” or notes and bonds. And the Treasury in turn has newly found money to spend.
But how to do this on the international stage? Under the IMF’s Articles of Agreement, the Managing Director has the authority to propose an SDR allocation to help meet a long-term global need to supplement existing reserves.(The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves.) If the proposal is approved by the Executive Board and Board of Governors of the IMF, support from member countries representing at least 85% of the total voting power is required to bring it about. SDR allocations are distributed across the IMF membership in proportion to IMF quota shares.
Kristalina Georgieva, Managing Director of the IMF issued a statement touting the benefit to all member countries of the proposed $650 billion allocationin their efforts to recover from the Covid-19 crisis. She also promised that IMF staff “will develop new measures to enhance transparency and accountability in the use of SDRs while preserving the reserve asset characteristic of the SDR. In parallel, staff would also explore options for members with strong financial positions to reallocate SDRs to support vulnerable and low-income countries.” It is not clear what exactly IMF staff can do to preserve the reserve asset characteristic of the SDR. However, note the not-so-subtle call for the richer nations of the world to reallocate their shares of SDRs to poorer countries.
Georgieva also stated: “If approved, a new allocation of SDRs would add a substantial, direct liquidity boost to countries, without adding to debt burdens. It would also free up badly needed resources for member countries to help fight the pandemic, including to support vaccination programs and other urgent measures.” Well, this goes without saying. Obviously, giving free money to a country without adding a corresponding obligation to repay it, adds to liquidity. However, channeling more money to countries by itself does nothing to increase the supply of vaccines to fight Covid-19.
If creating new money is so easy, why didn’t the IMF just go ahead and move to create the full $2.5 trillion package? There are two answers to this question as well as some practical considerations.
First, astute readers will have noticed that SDRs are distributed across IMF membership countries in proportion to IMF quota shares. This means that just under $120 billion would be allocated to the US. But US law requires approval from Congress of any SDR allocation that exceeds the equity stake of the US in the IMF. That is approximately $115-120 billion. Therefore, if the IMF were to make an allocation of $1 trillion in SDRs, the need for Congressional approval would be triggered.
US law mandates that Congress approves a general SDR allocation in a set five-year period in which the US gets more than its equity stake in the IMF. The need for approval would be tripped in a $1 trillion new SDR allocation because the US SDR share would exceed the equity stake of the US in the IMF. It is not clear that Congress would approve a $1 trillion tranche of new SDRs.
The Biden Administration supports the issuance of the tranche of $650 billion worth of SDRs. Treasury Secretary Janet Yellen has endorsed the plan. But there is much criticism leveled at Secretary Yellen and the Biden administration in general. The most strident criticism is that the $650 billion tranche of SDRs represents near the highest amount, rounded, that the Biden administration can endorse without congressional approval and that the Biden administration is attempting to circumvent Congress by breaking the issuance of new SDRs into tranches. The remaining $350 billion of the UNCTAD proposal for $1 trillion can be okayed later because a year later, any IMF issuance would fall into a new five-year period.
Other criticisms involve the specific benefits that some nations will receive. For example, critics lament that more than 250 people have been killed by Myanmar’s security forces since the military coup. Yet, Myanmar would stand to receive about three-quarters of a billion dollars’ worth of SDRs.
Senator John Kennedy of Louisiana questions the wisdom of the SDR issuance because the largesse is going to benefit Iran, Russia and other countries. Iran, for example, would get about $4.5 billion worth of SDRs. Although member states are obligated to exchange SDRs for their currency, US sanctions on Iran make it unlikely that a direct exchange of Iran’s SDRs to US dollars is going to happen. But that is no real impediment. Many countries including China, Russia, India, and several European countries are eager to do business with Iran. Conversion of Iran’s IMF stake to Euros and ultimately to US dollars is perhaps just a matter of paying a commission to another nation acting as middleman.
Notwithstanding the IMF’s lofty statements, the reality is that the world’s poorest countries will get less than 10% of the proposed allocation. Ultimately, the poorer countries will have to depend on how much of their stakes the US, China, Britain, and the EU countries are willing to give away as donations.
European countries have economic and debt problems of their own so they may be reluctant donors of their allocated shares of SDRs. However, the IMF has also stressed that the SDRs are necessary to help developing countries cope with climate change initiatives. Since the EU has committed itself to addressing climate change seriously, it is likely that at least some of the EU countries will channel funds to developing nations for climate-change-specific projects. China maydistribute a large portion of itsnewfound stake. After all, it is easy enough for the Chinese to convert their stake to dollars and loan the proceeds to poorer countries who agree to buy Chinese products. This is consistent with China’s ongoing strategic approach to financing its Belt and Road initiative. Here, China will have found free money easily converted to U.S. dollars to benefit its initiatives around the world.
While it is true that ultimately, the issuance of SDRs by the IMF is nothing more than a funny money game akin to issuing new Bitcoin, the truth of the matter is that to the extent that the US and China can direct their own stakes in the new tranche to countries that will buy products and services that spur American or Chinese GDP respectively, there is a benefit to all concerned.
The nations of the world desperately need the assistance. Creation of funny money has a serious side to it.
* Published in print edition on 6 August 2021
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