A Chinese Becomes Deputy Head of the IMF

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by Michael Liebig


The International Monetary Fund (IMF) is certainly one of the most influential international institutions. It does matter a lot when the head of the IMF addresses the debt crisis in the United States by demanding that “bold fiscal action” be taken “immediately” to avert “an adverse fiscal shock” with international ramifications. The IMF’s impact on monetary, financial and economic policy issues often has also far-reaching political-strategic ramifications.

Normally, international institutions like the IMF – with its 187 member states – are rather stiff structures, however, during the past months, the IMF has gone through unprecedented ruptures: On May 14, 2011, the IMF’s Managing Director, Dominique Strauss-Kahn, was arrested in New York on charges of sexual assault. On May 19, DSK had to resign as head of the IMF. On June 28, the IMF Executive Board selected the former French Finance Minister, Christine Lagarde, as DSK’s successor. On June 30, the indictment against DSK effectively collapsed, after New York prosecutors had to admit that the alleged victim of DKS‘ alleged sexual assault had lied in her account of events.

Over the coming months, we’ll probably learn more about the background of the “DSK affair”, however what is clear already now is the fact that the events of the past weeks have catalyzed an irreversible transformation of the IMF.

The World’s Biggest Creditor

Some observers think that, compared to DSK, Madame Lagarde will be more affable towards the United States, pointing to the fact that she had worked for the American law firm Baker & McKenzie and had lived in Chicago for several years. I doubt that Lagarde’s American connections will have significant implications for the future of the IMF. Lagarde is a realpolitik actor and realpolitik dictates that the relative weight of China (plus India, Brazil and other rising powers) is getting adequately incorporated into the IMF’s structures and policies.

So, not surprisingly, on July 5, Lagarde announced the appointment of Min Zhu as Deputy Managing Director of the IMF: “Min Zhu brings a wealth of experience in government, international policy making and financial markets… As Deputy Managing Director, he will play an important role….in meeting the challenges facing our global membership in the period ahead, and in strengthening the Fund’s understanding of Asia and emerging markets more generally.”

Min Zhu is the first Chinese in the highest leadership body of the IMF. Before going to the IMF, he was Deputy Governor of the People’s Bank of China – the Chinese central bank, where he was responsible for international affairs and policy research.

Min Zhu represents a country that has gone through a spectacular economic rise during the past three decades. Today, China is the world’s leading export nation and the world’s biggest creditor, having accumulated $3.200 billion in currency reserves. The United States‘ debt to China stands at $1.200 billion. So China has enormous power and leverage in international economic, financial and monetary affairs. And China will use that leverage – without much fanfare, but systematically and with determination. The Chinese want to to change the global financial-monetary system so that it will reflect the true correlation of forces in the global economic-financial system – and China’s leading role in it.

China Wants a New World Monetary System

The Chinese plans are no secret. Already in March 2009, when Min Zhu was still Deputy Governor of the Chinese central bank, his boss presented what he called a “vision” for a radical transformation of the world monetary system. Zhou Xiaochuan, Governor of the People’s Bank of China wrote that “the inherent vulnerability and the systemic risks of the [current] international monetary system” derives from the contradiction that a “credit-based national currency” – the US dollar – is simultaneously the global reserve currency. Instead, the global monetary system should be anchored on a supra-national reserve currency. John Maynard Keynes had recognized the problem, noted Zhou, proposing “the creation of an international currency unit ‘Bancor’, based on the values of 30 leading commodities. Unfortunately, his proposal was not accepted.”

Keynes “Bancor” proposal for a synthetic, supra-national reserve currency as the anchor for the world monetary system was rejected by the United States at the 1944 Bretton Woods conference, where the IMF was created. But since then, the concept has been taken up repeatedly in proposals for reforming the world monetary system. In Germany, the economist Wilhelm Hankel has been a vocal advocate of the “Bancor” concept. The concept was also incorporated in the 1979-92 “European Monetary System” with the synthetic “ECU” unit of account, based on a basket of European currencies and gold and it has also influenced the current the design of the current Euro single currency.

When Zhou Xiaochuan wants a future world reserve currency to be based on “leading commodities,” not just a currency basket, he obviously has also gold, silver and other precious metals in mind. On July 21, the Frankfurter Allgemeine Zeitung carried a most interesting article on “the gold rush” in China, noting that China has become the world’s biggest market for gold – bars, coins, jewelry and industrial use. The Chinese “Panda” gold coin is now competing with the South African “Krueger Rand” and the American “Eagle”. Compared to its giant currency reserves, China’s gold reserves are still minor: 1054 tons, almost the same as Switzerland’s. In comparison, the United States possess 8133 tons, Germany 3401 tons.

I would think that the modest role of gold in China’s reserves will change. History tells us that gold-possessing debtor countries are – sooner than later – forced to transfer their gold reserves to their creditors when doubts about the validity of debtors‘ currency arise. How did the USA accumulate its vast gold reserves? During World War I, the big gold holders Britain and France got enormously indebted to the United States. To avert military defeat, the Entente depended on industrial and other supplies from the USA. The Americans didn’t accept paper money, but demanded gold as payment.

Jumping to the present, it seems quite unrealistic that the USA can settle its giant accumulated debt vis-a-vis China without eventually transferring at least parts of its gold across the Pacific. Occasionally, there have been rumors that American gold has already been “collateralized” by China. These rumors cannot be verified, but they are not implausible. When India was almost insolvent in 1991 and needed foreign credits by the IMF among others, part of India’s gold reserves were “collateralized” by the creditors and physically transferred to London. (The shock and humiliation triggered India’s post-1991 economic reforms and subsequent economic rise)

And What About the Rating Agencies?

China’s foreign policy, and notably its financial foreign relations, are characterized by deliberate “understatement” and long-term planning. China is resolutely pursuing its interests, but avoids a “bully” attitude towards other actors on the international scene. As we have seen in the case of the Chinese central bank’s plan to transform the world monetary system, the Chinese don’t keep their intentions secret. Another area in which the Chinese have far-reaching plans are “rating agencies”. In the context of the sovereign debt crisis in Southern Europe, the actions of the three American rating agencies have become notorious: Every “crisis management” move by the European Union has been counteracted by Moody’s, Standard & Poor’s and Fitch. Angry EU leaders have demanded the creation of a European Rating agency. Well, the Chinese have already their own rating agency. Its existence is hardly known yet, but who knew the big Chinese commercial banks ten years ago? Today, Chinese banks control 50% of the banking market in Asia, the powerhouse of the world economy.

China’s rating agency is “Dagong Global Credit Rating Co., Ltd.”, which was founded in 1994 by a group of economists from Chinese Academy of Social Sciences. A closer look at Dagong provides an breath-taking insight into the Chinese view of global economic-financial affairs: “Dagong has downgraded the local and foreign currency long term sovereign credit rating of the United States of America from “AA” to “A+“, which reflects its deteriorating debt repayment capability and drastic decline of the government’s intention of debt repayment… Sovereign credit rating of the United States [was put] on the Negative Watch List.”

Quite a statement, considering the fact that the US sovereign credit rating by the three American rating agencies is “AAA” – the very best. Dagong puts its rating of the United States at the same level as that of Italy. Dagong explains its rating, noting that, in the first half of the fiscal year 2011, 44.8% of the US budget is debt financed, which “will endanger the government’s ability and willingness to repay the debts.“

The chairman of Dagong, Guan Jianzhong, wants a radical reform of the international rating system, because “the largest debtor country [USA] controls the international rating say and maintains the debtor’ benefit,” which “covers up its solvency risk and harms creditor’s interests,” notably China’s. Therefore, “we must firmly choose to establish a new international rating system.”

And, take note of the next sentence: “The world needs Chinese capital to ‚go global‘, and the reliable credit risk rating information is the prerequisite to push Chinese capital to efficiently flow to the world.”

Of course, the official statements by the Chinese government use a different language, but the message is the same. Take a recent statement by Prime Minister Wen Jiabao: „China is the biggest creditor of the USA. Therefore we watch President Obama’s economic policy very closely. Naturally, we are worried, as we have lent giant sums to the USA. The United States must act as to assure their credit worthiness.” And Wen has also has clearly signaled that China is a lot less worried about the fiscal problems in Southern Europe, which have been the focus of international media attention for the past 18 months.

Kissinger’s Observation

With the appointment of Min Zhu as IMF Deputy Managing Director, China’s strategic plans for reforming the world monetary system, including the rating issue, have made an important step forward. It’s one step, others will follow in the context of a long-term policy design. In the near-term China wants to see 1) an expanded of role of China within the IMF. The current allocation of 17% voting rights of the United States compared to China’s 4% is hardly justifiable any longer. China wants 2) an expanded role for the IMF, particularly in the “surveillance” of big debtor countries like the USA. It seems China wants to use the IMF in forcing the USA to seriously reduce its public debt, which is what the IMF has done vis-a-vis other highly indebted countries so often in the past. Let’s not forget: the current political fight between the Obama administration and the Republicans is over reducing the growth rate of new debt – not reducing total debt. And 3) China wants a bigger role for the Chinese yuan among the leading currencies (US dollar and euro).

In June, Henry Kissinger’s new book was released, it’s title is On China. Kissinger knows China well and the Chinese leadership seems to trust him. In an interview with Die Zeit, this realpolitiker made some observations which I think are quite accurate: “If we think of China as a ‚rising power‘ entering the world stage, that view doesn’t correspond to China’s self-perception. The Chinese think they have been a dominant power all along – with a short interruption of 150 years. They are merely coming back to their traditional position… Up to 1820 China’s economic performance surpassed that of Europe.”

Kissinger is right. The Chinese are exceptionally conscious of the 2500-year-old history and culture, which generates an unique mix of determination and patience in realizing their policy aims. Transposed in a European context, for Chinese it’s not outlandish to ask “What can we learn from Charlemagne?”, as Kissinger put it in the Zeit interview. Indeed, in a historical perspective, the current shifts in global economic and political-strategic affairs mean a return to “normality”. And that applies also to the second big Asian power, India. The next co-chairman of Germany’s biggest private bank, Deutsche Bank, will be Anshu Jain – an Indian.

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