IMF Power Play: Capital Controls or Failed States?

Coincidences abound these days. GS calls for derivatives clearinghouses, as does the IMF. GS, and in the not too distant future, presumably other TBTF institutions face civil suits enforced by national states from many parties. The IMF declares the debt load of these states the biggest risk to the financial system.

The global financial system and the world economy are slowly regaining their health, thanks in large part to unprecedented interventions by governments, but the sharp rise in government debt during the economic crisis from already elevated levels helped create what the IMF says is the newest threat to the financial system: growing sovereign risk. IMF (April 2010)

2. Yesterday, October 10, the G-7 met and agreed the following plan of action:

• "Take decisive action and use all available tools to support systemically important financial institutions and prevent their failure

3. Today the International Monetary and Financial Committee strongly endorsed the above commitments IMF (Oct. 2008)

On Christmas Day, 800 A.D., Pope Leo III crowned Charlemagne Emperor of the Romans. While scholars' views vary as to the Pope's intent, and Charlemagne's prior knowledge thereof, that the Vatican had thereafter a large effect on national politics in Christendom is without doubt. Concerns about the Vatican's continued influence almost 1000 years later, inter alia, led the framers of the US Declaration of Independence and Constitution to declare their sovereignty from, not only the mother country, but also such supra-national institutions.

Of course, that was then and this is now. The US Government, now hobbled by the debt load, incurred, in part, to support TBTF financial institutions- a policy urged by the IMF 2 years ago- is now being urged, by the same IMF, to reduce sovereign debt risks, which are the "newest threat to the financial system."

As the saying goes, with friends like these...

For decades, admittedly with varying intensity, the IMF has, in general, urged open capital markets- a policy at odds with the IMF's original mandate. Two years ago, the inevitable result of such national sovereignty abdicating policies in the absence of vigorous supra-national regulation brought the world's financial system to the brink of disaster.

With the benefit of hindsight, from one perspective, the IMF could be seen to have loudly urged national governments to "take as much (debt) rope as you'd like," and whispered, "to hang yourselves with."

How times have changed.

The dilemma which, in large part, led to the creation of the IMF- how to have the cake of international capital mobility and eat the cake of national sovereignty (yes, it's a stretch, but go with it), was, according to Louis Pauly, in his Who Elected the Bankers? confronted directly by Bretton Woods negotiators: They could see no way around the fact that states, if they valued economic stability as much as they valued their political independence, would have to maintain the capacity to deploy capital controls.

In the event, capital controls fell out of favor and thus capital sovereignty in the largest states was greatly diminished but the costs associated with supporting the banks profiting the most from the open environment have been shouldered by these same states. This seems, borrowing a term for yesterday's post, asymmetric.

Why should the state pay for what it cannot control?

Why, if the IMF supported the use of all available tools to restore financial stability but 18 months ago, does its most recent report highlight the risks of growing sovereign debt, but not the risks of private sector financial institutions whose failure to pilot the open capital market seas successfully played such a large role in the "risky" debt growth?

Louis Pauly asked, "Who Elected the Bankers?" If the IMF is taking its cue from Pope Leo III and playing for power with TBTF institutions, we have an answer. The IMF didn't Elect the Bankers, It Crowned Them.

Coincidences abound these days. GS calls for derivatives clearinghouses, as does the IMF. GS, and in the not too distant future, presumably other TBTF institutions face civil suits enforced by national states from many parties. The IMF declares the debt load of these states the biggest risk to the financial system.

The question of who is in control begs an answer. If the states aim to retain sovereignty, they will be forced to use the tool of capital controls. Indeed, in the current battle with GS, the US may find, if capital controls aren't imposed, that GS leaves a shell company to bear the brunt of any penalties. More broadly, if the national states don't impose control, they may soon find themselves, like Greece, California or New York, overly indebted entities with no power to solve their own problems, and thus waiting for hand-outs from the new supra-national institutions they created.

Let the games commence!