The International Monetary Fund (IMF) was created toward the end of the Second World War as part of an attempt to build a new, more stable international economic system and avoid the costly mistakes of the previous decades. Over the past 60 years, it has continued to change and adapt. But since its inception, it has been shaped by history and molded by the economic and political ideas of the time.
When delegations from 44 countries met at Bretton Woods, New Hampshire, in July 1944, to establish institutions to govern international economic relations in the aftermath of the Second World War, avoiding a repeat of the failings of the Paris Peace Conference that had ended the First World War was very much on their minds. Creation of an International Bank for Reconstruction and Development would help restore economic activity, while creation of an IMF would help restore currency convertibility and multilateral trade. For both John Maynard Keynes, the economist who headed the British delegation, and Harry Dexter White, the chief drafter of the IMF charter for the U.S. delegation, the motivating principle for creating the IMF was to engender postwar economic growth by establishing an institution that would prevent a relapse into autarky and protectionism, not just to avoid a recurrence of the Great Depression.
This article looks at some of the key 20th-century events that had the greatest influence on the IMF and draws some general conclusions about the force of history on the international monetary system that now prevails.
1. The Paris Peace Conference
The Paris conference of 1918 did consider a blueprint for restoring prosperity and world peace, in the form of U.S. President Woodrow Wilson’s 14 Points. But six months later, when delegates agreed on the terms of what became known as the Treaty of Versailles, key parts of the blueprint had been cast aside. Within a decade, prosperity was lost. In another decade, peace was gone as well. The most famous failure was Wilson’s inability to convince the U.S. Senate to confirm the country’s membership in the League of Nations. Arguably, the most disastrous, however, was the failure to lay the groundwork for economic cooperation among the world’s great trading nations.
2. The Great Depression
The Great Depression that began in 1929 amplified the negative consequences of Versailles, as an implosion of international trade interacted with domestic policy errors to deflate both output and prices around the world. It severely tested the confidence of analysts and voters in the efficacy of free markets and strengthened belief in an activist role for the public sector in economic life. It thus became easier and more natural to start discussions on a post-World War II framework from the assumption that an intergovernmental agency with substantive powers would be beneficial and even essential for the international financial system.
3. World War II
The Second World War provided both the impetus and the context for reforming the international system. When the United States entered the war in response to the bombing of Pearl Harbor in December 1941, Treasury Secretary Henry Morgenthau, Jr., put White in charge of international economic and financial policy and asked him to come up with a plan for remaking the system once the war was over. As it happened, White had already sketched out a rough plan for an international stabilization fund, and he was able to produce a first draft within a couple of months. On the other side of the Atlantic, Keynes was developing a plan for an international clearing union to be run jointly by Britain and the United States as “founder states.” Though less overtly multilateral than White’s scheme, and based on the British overdraft system rather than on White’s rather complicated proposal for currency swaps, Keynes’s scheme was similar in its essence to White’s. Over the next two years of discussion and negotiation, the two plans would meld into a draft for the IMF charter.
One major consequence of the war was that it left the United States in virtual control of the world economy The financial structure of the IMF would thus be based on the U.S. dollar rather than on an international currency of its own making. Its lending power would be limited, and the IMF would lack most of the powers of a central bank. Its headquarters would be neither in London nor even in New York, but in Washington, where the U.S. Treasury could exert a strong gravitational pull. For the next three decades, the IMF would be essentially a dollar-centric institution, with the United States providing most of its loanable resources and effectively controlling most of its lending decisions.
4. The Cold War
Harry Dexter White had worked hard in 1944 to persuade the Soviet Union to join the IMF, in the belief that economic cooperation between the Soviet Union and the United States would be the key to postwar peace and prosperity. The Soviet delegation to Bretton Woods did sign the Articles ad referendum, but Joseph Stalin eventually refused to ratify the agreement, apparently because he feared (not without justification) that IMF policies would be controlled largely by the West. When that tension segued into the Cold War, White’s vision of universal membership was dashed. Poland withdrew from membership in 1950. Four years later, Czechoslovakia was forced to withdraw. Shortly after taking power in 1959, Fidel Castro pulled Cuba out. For more than three decades after Mao Zedong took control of China, the U.S. government blocked efforts by the People’s Republic to be seated as Chinas representative on the IMF Executive Board. Most other countries in the Soviet or Chinese spheres of influence simply did not join. Not until the 1980s would the trend be reversed, with the seating of China and renewed membership for Poland.
The obvious effect of the Cold War on the IMF was this limitation on membership. In the terminology of the period, the IMF included the first world and much of the third, but the second was absent from the table. The IMF became largely a capitalist club that helped stabilize market-oriented economies.
5. African independence
Only 3 of the IMF’s 40 original members were in Africa: Egypt, Ethiopia, and South Africa. Of those, one was more closely connected to the Middle East, and one was minority controlled and more culturally linked to Europe. Most of the continent was still under colonial rule. That situation began to evolve in 1957, when the newly independent countries of Ghana and Sudan became IMF members. Applications then flooded in, and by 1969, 44 of the IMF’s 115 members were in Africa. By 1990, all of Africa’s 53 countries were in the IMF They comprised nearly one-third of the member countries, though their average small size and mostly low incomes meant that they controlled less than 9 percent of the voting power and held only 3 of the 22 seats on the Executive Board.
The emergence of Africa as a continent of independent nations had a major effect on the size and diversity of the IMF, and it required a substantial intensification of the IMF’s involvement with and oversight of its borrowers. Most of these countries, especially in sub-Saharan Africa, had very low per capita incomes and were among the least economically developed countries in the world—a picture that still holds true. Their economic problems tend to be structural even more than macroeconomic; rooted in the need for improvements in education, health care, infrastructure, and governance rather than finance; and more deeply ingrained and persistent than in other regions. Solving these problems requires lending on concessional terms and a wide range of technical expertise. Consequently, the IMF’s role has expanded beyond its original boundaries, and close collaboration with the World Bank and other development agencies has become imperative.
6. Rise of multiple economic centers
As the world economy—and world trade—began to recover after the Second World War, U.S. economic hegemony gradually eroded. The first to rise from the ashes was Western Europe.. Through a combination of national drive, international support—from the U.S. Marshall Plan, the World Bank, and, eventually, the IMF—and homegrown multilateralism in the form of the Common Market and the European Payments Union, much of Europe was growing rapidly and was increasingly open to multilateral trade and currency exchange by the late 1950s. The Federal Republic of Germany joined the IMF in 1952 and quickly became one of the world’s leading economies. Next came Asia. Japan also joined the IMF in 1952 and, by the 1960s, was on its way to joining the United States and Germany on the top rung of the economic ladder. Then the 1970s saw the rise of economic power in Saudi Arabia and other oil-exporting countries in the Middle East. In 30 years, the U.S. share of world exports fell from 22 percent to 12 percent, while its share of official international reserves dropped even more dramatically, from 54 percent in 1948 to 12 percent in 1978.
As the balance of economic and financial power became more widely dispersed, more and more currencies became fully convertible for current account and even capital transactions. Trading partners grew at different rates and with different mixes of financial policies. Pressures on fixed exchange rates and on the limited supply of gold and U.S. dollars became increasingly frequent and more severe. The IMF responded in 1969 by amending its Articles and creating Special Drawing Rights (SDRs) to supplement existing reserve assets, but that action was too limited to deal with the underlying problem of differential pressures. As a result, even before the first oil shock in 1973, the original Bretton Woods system of fixed but adjustable exchange rates was no longer viable.
7. The Vietnam War
The intensification of U.S. involvement in the Vietnam War in the 1960s and early 1970s would not by itself have had substantial effects on the IMF, other than the direct effect on Vietnam’s membership. When the government of South Vietnam was about to fall in April 1975, its officials tried desperately to borrow as much as they could from the IMF The IMF refused to go along, and, within a few months, it recognized the Socialist Republic of Viet Nam as the successor government. The larger effect, however, was on the U.S. economy and its external payments position. In combination with a sizable increase in domestic spending on President Lyndon Johnson’s Great Society programs, the rise in external military spending gradually worsened the overvaluation of the U.S. dollar under the Bretton Woods system of fixed exchange rates. In a series of spasms, the system dissolved between 1968 and 1973. With the dollar no longer convertible into gold, the precious metal could no longer serve a central or even a useful function in the international monetary system. The Vietnam War was by no means the sole culprit in this decline, but its catalytic role was certainly substantial.
8. Globalization of financial markets
Private sector financial flows were of limited scope and importance when the IMF was founded. Trade flows were financed largely by trade credits, and most economists considered cross-border portfolio flows to be as much a potential destabilizing nuisance as a potential source of investment capital.
The range and importance of capital flows began to increase in the 1950s as European countries gradually reestablished convertibility. The first big increase, however, came in the 1970s, with the emergence of the Eurodollar and other offshore financial markets. It was driven further by the accumulation of “petrodollars” by oil-exporting countries in the 1970s and the recycling of those assets to oil-importing sovereign borrowers through large international banks. By the 1990s, cross-border flows had become an essential source of finance for both industrial and emerging market economies around the world, and the structure of international financial markets had become so complex that their size could no longer be measured, much less controlled.
One effect of financial globalization was that IMF financing became quantitatively marginalized for many potential borrowers. In the early days of the IMF, countries facing a financing gap in their balance of payments could often close it solely by borrowing from the IMF By the 1980s, their object was more often to “catalyze” other capital inflows by borrowing relatively small amounts from the IMF to support an agreed package of policy reforms and thereby hoping to convince other creditors that the country was a good prospect. What mattered was not so much the quantity of money as the quality of the reforms. Globalization thus fundamentally altered the relationship between the IMF and its borrowing members and between the IMF and other official and private creditors.
Another effect was to weaken the “credit union” character of the IMF as a membership institution because, by the 1980s, the more advanced economies were able to finance their external payments with private flows and did not need to borrow from the IMF Much of the membership of the IMF became divided into persistent creditor and debtor groups.
A third effect of financial globalization was that countries with emerging financial markets became reliant on private capital inflows that turned out to be volatile and unreliable when economic conditions weakened, either globally or regionally. When those inflows suddenly went into reverse in the second half of the 1990s, several middle-income countries—Mexico in 1995; Thailand, Indonesia, and Korea in 1997; Russia in 1998; Brazil in 1999—turned to the IMF for financial assistance on a scale that was much larger than what the IMF had provided in earlier cases.
9. International debt crisis
In August 1982, a gradual two-year worsening of conditions in international debt markets suddenly accelerated and precipitated a major economic and financial crisis. A scattering of countries, including Hungary, Morocco, Poland, and Yugoslavia, had already seen their bank creditors turn their backs in 1981 and the first half of 1982. When the banks suddenly pulled out of Mexico, the crisis took on systemic proportions. Within a few months, Argentina, Brazil, and Chile were also in trouble, and the crisis was continuing to spread. Not until 1990, when world interest rates were settling down and the bank debts of the most heavily indebted developing countries were being replaced by Brady bonds, would it be possible to declare the crisis over. The debt crisis transformed the IMF, catapulting it into the role of international crisis manager. When a series of financial crises broke out in the 1990s, as mentioned above, the IMF was able to draw on this earlier experience, though it also had to try to find new solutions to what turned out to be ever-more complex country circumstances and more rapid and widespread contagion as crises spread around the world.
10. Collapse of communism
The fall of the Berlin Wall in 1989 and the dissolution of the Soviet Union in 1991 enabled the IMF at last to become a nearly universal institution. In three years, membership increased from 152 countries to 172, the most rapid increase since the influx of African members in the 1960s. (The IMF now has 184 members.) Many of the new members needed to borrow from the IMF, and almost all of them needed technical assistance and regular consultations. Consequently, the size of the IMF staff increased by nearly 30 percent in six years. The Executive Board expanded from 22 seats to 24 to accommodate Directors from Russia and Switzerland, and some existing Directors saw their constituencies expand by several countries.
The world economy and the IMF have changed greatly in the six decades since Bretton Woods. Much of the volume of IMF lending has become crisis-driven, and the IMF’s involvement in crisis prevention and resolution has intensified correspondingly. Because more than half of the membership is now in a persistent creditor or debtor position with little prospect of switching sides, many states tend to view themselves as members of such a group more than as part of the global community. The membership has also become much larger, more diverse, and nearly universal, and the IMF’s responsibilities in global economic governance have increased correspondingly. The breadth of its involvement in policymaking in member countries, especially borrowing countries, has vastly expanded.
The evolution of the IMF has been driven—and necessitated—by these shifts in world economic and political conditions. If the events chronicled here had not affected the IMF along these lines, the institution would have become marginalized and even irrelevant. The challenge for the IMF has always been to hold onto its vital center (the original narrow mandate to promote orderly payments adjustment and global financial stability) while adapting its activities to new circumstances and new ideas. The 60th anniversary of Bretton Woods in 2004 provided the impetus for the IMF to respond to this challenge by launching a strategic review (see page 7) aimed at positioning the institution to respond flexibly to the further changes that the world economy will go through in the decades to come.
Keynes and White created the IMF because they believed that the world needed an official institution to promote multilateral cooperation in place of autarkic economic policies and to compensate for the inherent limitations of private markets. As much as the world and the institution have changed, those goals remain at the core of the rationale for the role of the IMF.
James Boughton is an Assistant Director in the IMF’s Policy Development and Review Department and the official historian of the IMF.