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Commentary

The official history of the financial crisis hides another story

Honore de Balzac’s great novel “Lost Illusions” ends with an exposition of the difference between “official history,” which is “all lies,” and “secret history” – that is, the real story. It used to be possible to obscure history’s scandalous truths for a long time – even forever. But that’s not the case anymore.

Nowhere is this more apparent than in accounts of the global financial crisis. The official history portrayed the U.S. Federal Reserve, the European Central Bank, and other major central banks as embracing coordinated action to rescue the global financial system from disaster. But recently published transcripts of meetings of the Federal Open Market Committee, the Fed’s main decision-making body, that were held in 2008 reveal that the Fed has effectively emerged from the crisis as the world’s central bank, while it continues to serve primarily the interests of the United States.

The most significant meetings took place on Sept. 16 and Oct. 28 – in the aftermath of the collapse of the U.S. investment bank Lehman Brothers – and focused on the creation of bilateral currency-swap agreements aimed at ensuring adequate liquidity. The Federal Reserve would extend dollar credits to a foreign bank in exchange for its currency, which the foreign bank agreed to buy back after a specified period at the same exchange rate, plus interest.

This gave central banks – especially those that were located in Europe, which faced a dollar shortage as U.S. investors fled – the dollars they needed to lend to struggling domestic financial institutions.

Indeed, the European Central Bank was among the first banks to reach an agreement with the Fed, followed by other major advanced-country central banks, including the Swiss National Bank, the Bank of Japan, and the Bank of Canada.

At the October meeting, four “diplomatically and economically” important emerging economies – Mexico, Brazil, Singapore, and South Korea – got in on the action, with the Fed agreeing to establish $30 billion swap lines with each of their central banks.

Though the Fed acted as a kind of global central bank, its decisions were shaped, first and foremost, by U.S. interests. For starters, the Fed rejected applications from some countries – whose names are redacted in the published transcript – to join the currency-swap scheme.

More important, limits were placed on the swaps. The essence of a central bank’s lender-of-last-resort function has traditionally been the provision of unlimited funds. Because there is no limit on the amount of dollars that the Federal Reserve can create, no market participant can take a speculative position against it.

By contrast, the International Monetary Fund has finite resources provided by member countries.

The Fed’s growing international role since 2008 reflects a fundamental shift in global monetary governance. The International Monetary Fund emerged at a time when countries were routinely victimized by New York bankers’ casual assumptions, such as J.P. Morgan’s assessment in the 1920s that Germans were “fundamentally a second-rate people.” The IMF was a critical feature of the post-World War II international order, as intended to serve as a universal insurance mechanism--not one that could be harnessed to advance contemporary diplomatic interests.

Today, as the Fed documents clearly demonstrate, the IMF has become marginalized – not least because of its ineffective policy process. Indeed, at the outset of the financial crisis, the IMF, assuming that demand for its resources would remain low permanently, had already begun to downsize.

In 2010, the IMF made a play for resurrection, presenting itself as central to solving the euro crisis – beginning with its role in financing the Greek bailout. But here, too, a secret history has been revealed – one that highlights just how skewed global monetary governance has become.

The fact is that only the United States and the massively over-represented countries of the European Union supported the Greek bailout. Indeed, the major emerging economies all strongly opposed such an outcome, with the Brazilian representative calling it “a bailout of Greece’s private debt holders, mainly European financial institutions.” Even the Swiss representative condemned the measure.

As fears of a sudden collapse of the eurozone have given way to a prolonged debate about how the costs will be met through bail-ins and write-offs, the IMF’s position will become increasingly convoluted. Though the IMF is supposed to have seniority over other creditors, there will be demands to write down a share of the loans that it has issued. Poorer emerging-market countries would resist such a move, arguing that their citizens should not have to foot the bill for fiscal profligacy in much wealthier countries.

Even the original advocates of IMF involvement are turning against the Fund. EU officials are outraged by the IMF’s apparent effort to gain support in Europe’s debtor countries by urging write-offs of all debt that it did not issue. And the U.S. Congress has refused to endorse the expansion of IMF resources – part of an international agreement brokered at the 2010 G-20 summit.

While the outrage that followed the appointment of another European as managing director of the IMF in 2011 is likely to ensure that the Fund’s next head will not hail from Europe, the IMF’s fast-diminishing role means that it will not matter much. As the secret history of 2008 shows us, what really matters is who has access to the U.S. Federal Reserve.

Harold James is a professor of history at Princeton University and a senior fellow at the Center for International Governance Innovation. THE DAILY STAR publishes this commentary in collaboration with Project Syndicate © (www.project-syndicate.org).

 
A version of this article appeared in the print edition of The Daily Star on March 15, 2014, on page 7.
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Summary

The official history portrayed the U.S. Federal Reserve, the European Central Bank, and other major central banks as embracing coordinated action to rescue the global financial system from disaster. But recently published transcripts of meetings of the Federal Open Market Committee, the Fed's main decision-making body, that were held in 2008 reveal that the Fed has effectively emerged from the crisis as the world's central bank, while it continues to serve primarily the interests of the United States.

The Federal Reserve would extend dollar credits to a foreign bank in exchange for its currency, which the foreign bank agreed to buy back after a specified period at the same exchange rate, plus interest.

Indeed, the European Central Bank was among the first banks to reach an agreement with the Fed, followed by other major advanced-country central banks, including the Swiss National Bank, the Bank of Japan, and the Bank of Canada.

Though the Fed acted as a kind of global central bank, its decisions were shaped, first and foremost, by U.S. interests.

Today, as the Fed documents clearly demonstrate, the IMF has become marginalized – not least because of its ineffective policy process.


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