IMF & Global Debt Crises

By Hema Senanayake –

The way the economic system works is very peculiar but unique and hence predictable. A few months ago, the world never thought that China was about to experience an economic crisis or severe disturbance in the economy. But a weak ago, The International Monetary Fund (IMF) has warned that China’s debt has risen by 7% and is driving global debt back towards unsustainable levels. A few days ago, Bloomberg reported that China told some brokerage firms to reduce proprietary trading in the foreign-exchange market, another step by the authorities to defend the beleaguered currency. The Yuan was depreciated to 16 years low against U.S. dollar. Authorities might be worrying that prolonged weakness of yuan might generate capital outflows. Chinese government struggles to mitigate the crisis. 

None of the developed major economies are doing well. So are the next level major economies. According to the World Bank, middle income countries are home to 75% of the world’s population and 62% of the world’s poor.  Poverty is in abundance there. Developing countries like ours are chaotic. Before Sri Lanka, the IMF approved a loan to Argentina amounting to 44 billion USD. This amounts to 1,000% of its country quota. Usually, IMF grants up to 450% of any country’s quota. Yet the Argentinean economic crisis continues unabated. Now some economists suggest dollarizing Argentina to overcome the crisis as Ecuador did some twenty years ago. Dollarization of a country means the adaptation of U.S. dollar as its currency. 

All these chaotic situations show that the whole world needs a paradigm shift in economic thinking. Current thinking is in error. Our political leaders, economists and central bankers who are aligned with the ruling elite do not understand it. Critics of the government are no different.

The error in the existing world view of economics arises from very fundamental economic premise. All economists who accept market exchange of goods and services admit the general equilibrium approach in economic analysis. That means they accept that the demand and supply equilibrium is met at an average price (even though there are small fluctuations), clearing the market finding buyers for what is supplied to the market. 

This is a very fundamental principle in a market economy. The U.S. President Biden believes it. President Xi in China believes it. Prime Minister Modi believes it. Our president Ranil believes in this. And at institutional level this principle is believed by IMF, the World Bank and many such international financial institutions. This same principle is so believed by all economists in both isle of our parliament like Dr. Harsha de Silva of SJB and Prof Rajith Madduma Bandara of Pohottuwa. Even NPP believes in this. 

This thinking is global. Global debt crises have a direct link to this thinking. So far, I mean from the time Leon Walras introduced his general equilibrium model in 1874, none has questioned whether the law of supply and demand operates by creating a component of debt that can never be paid back, which debt causes the continuing accumulation of severe debt. This question has been raised recently by a concerned researcher. Before that global leaders and international financial institutions presumed that the law of demand and supply operates without creating a component of debt that can never be paid back. That means market economy as a system is fine. Contrary to this, the new research has found out that the economic system is not fine because it has a systemic inherent contradiction which requires us to fill a certain gap from a component of debt that can never be paid back when the demand and supply equilibrium is met. So, such debt should keep on accumulating. 

If the economic system is fine, meaning that there is no systemic contradiction, then the method of retribution as it operates now is sufficient to ensure debt sustainability. In this retributory method you will not be given any loan in future if you have defaulted on the prior loan obtained. Banks with a central regulatory credit reporting agency operate this punitive system in many countries or almost all IMF member countries.

If the economic system is not fine and has a systemic contradiction then it requires us to fill a certain gap by creating a component of debt that can never be paid back, then the method of retribution in lending will not ensure debt sustainability. The United States proved this inadequacy recently. For example, in 2008 financial crisis the U.S. government bailed out all major 16 banks. 

Recently, a Japanese scholar namely Professor Yamaguchi suggested that a public money administration system might be a better alternative to the present fractional reserve banking system in which most of the money in the system creates at the point of lending as “debt money.” Perhaps, hybrid method might be more sensible as it ensures more flexibility in lending. The bottom line is that these alternatives are not required to be discussed if IMF thinks that the economic system is fine without any systemic contradiction. So, we have a direct question to the IMF. Does the IMF believe that the economic system is fine without having a systemic contradiction which requires us to fill a certain gap by a component of debt that can never be paid back as we operate the economy at present? Future debt crises around the world might depend on the IMF’s answer to this question. 

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