Page 2 of 2 China discovers value in the IMF
By Peter Lee
During US Treasury Secretary Geithner's recent visit to China, Yu Yongding took
him to task, as Bloomberg tells us:
The US should take China's
interests into consideration "so that your own interest can be protected," Yu
said. "You should not try to inflate away your debt burden." China could still
diversify some of its Treasury holdings into euros or commodities, Yu added.
"Yes, some people say the euro is very weak," Yu said. "Okay, weak is good,
we'll buy very cheap."
The best outcome for China would still be to negotiate with the US and reach
agreement on its Treasury holdings, Yu said. "The borrower should keep their
promises," he added. "The US should be a responsible country."
China is, one would imagine, guardedly hopeful that the Barack
Obama administration will be able to fix the US economy, cut the deficit down
to reasonable size, and get international trade (and Chinese exports) humming
again.
But it also doesn't want to be under the US gun and be forced to buy Treasury
bills to finance a yawning deficit simply because Beijing has no place else to
put its money. So China is looking for options, and not just the euro threat
that Yu wielded.
A roundtable of Chinese economists convened on the occasion of Treasury
Secretary Geithner's visit this month expressed the majority view that holding
US bonds was risky, and advised the careful, long-term diversification of
dollar holdings into "tangible and strategic commodities," equities and bonds,
and through overseas mergers and acquisitions.
In addition, China is pursuing several avenues for decreasing dollar exposure
that involve utilizing and repurposing the primary supranational financial
institution - the IMF. Somewhat opportunistically, China proposed that the IMF
sell off 400 tons of gold in order to finance its operations. One of the main
likely purchasers of that much gold would, of course, be China, which recently
surpassed Switzerland as the world's fifth-largest holder of gold reserves.
Nudging IMF away from dollar
In a development of considerably more long-term significance, China is also
trying to nudge the IMF into creating large-volume and liquid internationally
tradable financial instruments that are not dollar-based.
China's stated interest in funding the IMF's emergency fund through a $40
billion bond purchase is bound up in the suddenly not-so-arcane issue of
Special Drawing Rights. In March, the president of the People's Bank of China,
Zhou Xiaochuan, proposed that the world should look at transitioning from the
US dollar to the SDR as a reserve currency.
The SDR is a little-used fiat currency that the IMF is authorized to issue. It
is based on a basket of currencies: at present, the US dollar accounts for 44%,
the euro 34%, the British pound 11% and the Japanese yen 11%.
Since the SDR is a universally accepted international financial instrument
whose value does not rely on solely on the dollar, the Chinese are interested
in it as a chance to hedge, albeit partially, against a potentially tanking
dollar.
Zhou invoked John Maynard Keynes, who proposed a supranational currency at the
time of the Bretton Woods conference in 1944 as the most logical, multi-polar
solution to international settlement of accounts. However, Mr Zhou probably
derives his enthusiasm for the SDR from philanthropist George Soros and
economist Joseph Stiglitz, enthusiastic cheerleaders for the SDR, rather than
from a close reading of Mr Keynes.
Both Soros and Stiglitz consider the US dollar an inappropriate currency for
the international settlement of accounts because of the vast deficits the US
has been running.
Foreign governments with a surplus of dollars find that the only safe haven of
any size is the US Treasury market, so that the world economy is, in effect,
doing business in order to subsidize US deficit spending. Shifting toward a new
international currency, such as the IMF's SDR, would tie currency creation to
actual terms of trade instead of to the US deficit; the US government would be
forced to live within its means; developing countries would invest their SDRs
in development projects instead of Treasuries; and nirvana would ensue shortly.
China's floating of the SDR issue provoked a spasm of terror on America's
far-right wing, which raised the specter of a new world currency supplanting
the dollar inside the United States. Among mainstream economists, the general
response has been that replacement of the dollar by the SDR in international
settlements is "not gonna happen".
Despite professions of bafflement and scorn from Western economists, the
prospect of SDR bonds has elicited strong interest from all the BRIC countries,
especially Russia - an indication that people who actually run economies rather
than simply talk about them find the SDRs a potentially valuable and
significant development.
Indeed, the evolving relationship between the IMF, the SDR, and China offers
some interesting wrinkles. The potential creation of SDRs is connected to the
"New Arrangements to Borrow" (NAB) - the initiative announced at the Group of
20 summit to increase the IMF's ability to lend by $500 billion.
The NAB is designed to be pain- and cost-free: a pre-emptive show of financial
force modeled on the guarantees the US government is providing to American
financial institutions, in this case demonstrating that the IMF was backed by
an additional $500 billion in commitments.
The purpose is to convince the financial markets that banks and markets in
target countries are backed by ample resources from the IMF and are viable, so
that credit will ease and lending resume - without the IMF (or its backers)
having to actually disburse the cash.
The philosophy was recently put on display in Poland, which received a $20
billion commitment - not $20 billion - from the IMF as an expression of
confidence in its reasonably healthy economy and financial sector.
The proposed $100 billion contribution to the NAB proposed by President Obama
at the Group of 20 meeting isn't cash either - it's a credit line, to be drawn
if and when the IMF needs it. Japan has already provided a similar $100 billion
facility.
Cash - not credit
Interestingly, the BRIC countries aren't interested in offering a credit line,
despite the seemingly attractive possibility that it might never be called on.
They want to expend hard cash to lend money to the IMF today - by buying bonds
- and get some of those diversified SDRs in return.
Surprisingly, the dominant force in the IMF - the Obama administration - does
not appear hostile to the SDR.
Obama's economic brain, Office of Management and Budget director Peter Orszag,
is a follower of Stiglitz. There are signs that the Obama administration
accepts the idea that being able to fund US deficits through creation of
international fiat currency creates a moral hazard, and that China's desire to
move away from the dollar is understandable and, from a macroeconomic point of
view, perhaps even desirable.
Whether the NAB facility and the coveted SDRS ever materialize will be decided
by running the gauntlet of the US Congress. Unfortunately, the Obama
administration seems to be recapitulating, rather disastrously, its missteps on
the closing of Guantanamo.
The remaining $400 billion in support is contingent on the US coming up with
its $100 million - just as, in the case of the Guantanamo closure, Europe was
going to take Uyghur detainees if the US took a few.
The White House has not been able to frame or sell the IMF credit line very
effectively. Domestic consensus building has largely been limited to the
release of a letter from the Bretton Woods Association - albeit with an
impressive bipartisan list of signatories including Henry Kissinger,
Condoleezza Rice, Paul Volker, Brent Scowcroft, Colin Powell, and Robert Rubin
- urging arrangement of the credit. [1]
Instead of simply defining the $100 billion as a credit, Orszag awkwardly
characterized it for budget purposes as a low-risk swap of assets whose risk,
if it took place, had a 5% risk of default, that is a budgetary cost of $5
billion. [2]
In order to speed approval of the credit line, the IMF credit line was tacked
on to the Supplemental Appropriation for the Iraq and Afghan wars. The Senate
passed the appropriation but House Republicans have seized on the issue - as
they did the case of Guantanamo prisoners - as a way to defeat Obama both
domestically and in the eyes of the international community.
It looks like the NAB issue will be misleadingly painted as a $100 billion
giveaway to bail out Old Europe and a profanation of the sacred cause of
funneling $98 billion to deserving troops and contractors without distracting
amendments.
The White House's efforts to whip the bill through the House of Representatives
are complicated by liberal anti-war and anti-IMF activists' attempt to add
about 40 Democratic "no votes" to the Republicans' and defeat the Supplemental.
The Obama administration will have to decide if it is worth expending its
political capital to fight for the rather remote and abstract imperative of a
contingency fund for the IMF. If it doesn't, the entire refinancing of the IMF
may go down the tubes.
For the purposes of China, the NAB will offer an interesting possibility if it
goes ahead. If the credit was drawn down, the US would be holding IMF
securities denominated in SDRs - which it could sell to China. Likewise for the
Japanese $100 billion and, presumably, the other credit lines. And those
proposed bonds will be denominated in SDRs also.
Half a billion dollars in SDR-denominated securities is not going to topple the
US dollar from its throne as the world's reserve currency. But it would provide
a significant haven for a chunk of China's US dollar reserves - now north of
$1.5 trillion - if and when Beijing decides that it wants to decrease its
exposure to the dollar.
And it would give China a compelling reason to support the survival of the IMF
- and the continued creation of SDRs.
Notes
1. To view the document, click
here.
2. See http://cboblog.cbo.gov/?p=270
Peter Lee writes on East and South Asian affairs and their intersection
with US foreign policy.
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