How China Is Offering an Alternative to the IMF

Yves here. This post makes an important follow-on to Michael Hudson’s discussion of how China and America are pursuing markedly differing economic strategies.

While the IMF is extremely unpopular in Asia due to its heavy-handed management of the late 1990s currency crises, it’s not clear that China can yet step in. The reason that dollar swap lines are valuable is that most trade transactions are denominated in dollars. Any bank that aspires to be an international bank has to be able to clear dollars, which means having banking operations in the US. Foreign banks typically have the ambition to do more than just provide foreign exchange services, which leads them to try to offer lots of other dollar based financing and transaction services. As we saw in the crisis, that can lead to a world of hurt when they wind up holding dollar denominated dreck like CDOs that collapses in value on their balance sheets. But to get bailed out, they had to go to the regulator of their parent, who then had to beg their central bank for dollars, which not being the Fed, it couldn’t create. Hence the need for currency swap lines with central banks to get dollars to them.

In the wake of the Asian crisis, the Asian Tigers have made a point of keeping their foreign exchange rates low so as to have large foreign exchange reserves so as to be able to ride out future upheavals on their own. In addition, for the Chinese currency swap lines to be of much benefit, the beset country would have to need renminbi. Thailand and Indonesia in particularly were caught out in 1997; Thailand’s bhat was pegged to the dollar and when it was forced to revalue, it suffered from the flight of hot money. Thailand and soon its neighbors had trouble servicing foreign debt.

Author C.P. Chandrasekhar discusses the Japanese plan, relying on ASEAN, to set up a $100 billion facility. I recall at the time noticing that it didn’t go anywhere due to US opposition. However, that crisis was due to dollarized economies, by virtue of having fixed dollar pegs, going pear shaped. Japan might have been able to have some sway if Japan was running trade deficits with any of the Tigers (possible since Japan had become a high-cost manufacturer and was outsourcing to Vietnam and Malaysia). But this was ultimately a dollar-based problem, and I have trouble seeing how non-dollar-creating countries could band together to solve it.

That is a long-winded way of saying until the renmimbi becomes the reserve currency, which is a long long way away (China would need to run sustained trade deficits, which is tantamount to exporting jobs), I have trouble envisioning the circumstances in which renminbi swap lines would do more than help at the margin in an economic crisis. But it is a forward-thinking move.

By C.P. Chandrasekhar, Former Professor, Centre for Economic Studies & Planning, Jawaharlal Nehru University. Originally published at the Institute for New Economic Thinking website

The People’s Bank of China’s network of local currency swap arrangements provide Asian countries with a much-needed safety net, while also strengthening China’s diplomatic position.

China seems poised to take leadership of regional efforts to forge a safety net that protects countries in East Asia from the fragility that cross-border financial flows engender. My new INET Working Paperanalyses why: Leadership stems from China’s important role in production value chains spread across the region and the support provided to those networks by the massive investments facilitated by China in projects launched as part of the Belt and Road Initiative (BRI). The Council on Foreign Relations estimates that by early 2020 China had spent an estimated $200 billion on BRI projects. But aside from the capital flows associated with the BRI, the People’s Bank of China (PBoC) has put in place a network of bilateral, local currency central bank swap arrangements that provide countries a much-needed safety net. These swaps are less highlighted instruments that have contributed to China’s growing global influence in developing countries worldwide. Between January 2009 and January 2020, the PBoC entered into such arrangements with 41 countries, including many in Asia.

These bilateral swap arrangements (BSAs), denominated in RMB and the currency of the relevant partner central bank, allow the latter to access RMB liquidity for short periods at relatively low rates of interest, in return for its own currency as implicit collateral. Under a swap arrangement, while the borrowing central bank has access to the foreign currency liquidity line, it can lend it to institutions and agents in its own jurisdiction that face shortages of the relevant foreign currency, in this case the RMB. For partner countries, the greater the availability of RMB swap lines, the larger their leeway in using available dollar earnings and reserves to settle transactions with other countries. They can also, as Argentina and Pakistan did, use, or showcase their ability to use, the RMB accessed through the swap line, to acquire dollars and shore up their dollar reserves to meet commitments to third parties.

In principle, the bilateral swap network provides countries a means of addressing foreign currency shortages and tide over balance of payments difficulties resulting from boom-bust capital flow cycles, without having to turn to the US and the IMF for assistance. Access to such a regional, IMF-independent safety net has been a need felt in the region ever since the 1997 Southeast Asian financial crisis, in the aftermath of which leading Southeast Asian nations availed of bail-out packages, which, though funded substantially by governments in the region, were crafted by the IMF. The policy conditions that accompanied the bail-outs severely damaged Southeast Asian economies, leading to the conviction that the IMF “didn’t know Asia” and that “its remedies were likely to do great damage to the Asian economy”. This experience triggered a search for regional, IMF- and US- independent arrangements that could be accessed in times of financial difficulty, without having to implement policies detrimental to the economic interests of countries in the region.

The first major initiative seeking to create such a facility was a proposal mooted by Japan to establish an Asian Monetary Fund (AMF), with capital of $100 billion, of which Japan was to contribute half. Recognizing that such a Fund would weaken US and IMF influence in the region, representatives of both opposed the proposal. Their opposition was strengthened by the fear among countries in the region, especially China, that this would lead to excessive Japanese economic and political influence. Overall, three factors worked to undermine the proposal. The first was the subordinate position Japan held in its special bilateral relationship with the US. The second was the fear of Japanese dominance among other countries in the region, influenced not just by its economic strength, but by the history of Japanese colonialism in the region—a fear which the US is seen as having exploited, especially vis-a-vis China. Third, the dependence of many ASEAN countries on US markets and US-mediated capital flows, which resulted in these countries softening their stance once the US and the IMF expressed their opposition to the AMF.

Having failed to push through its AMF proposal, Japan focused on providing post-crisis bilateral support to countries in the region through the New Miyazawa Initiative. Announced in October 1998 by Finance Minister Miyazawa Kiichi, the Miyazawa Initiative was a $30 billion package to support economic recovery in East Asian countries affected by the crisis, by providing financial assistance on a bilateral basis, as well as funding a facility at the Asian Development Bank ($3 billion) to guarantee bonds issued in international financial markets. The success of the initiative was reflected in the substantial use of the assistance on offer. To an extent, support through the Miyazawa Initiative was an alternative to conditionality-tied borrowing from the IMF. While funds through the initiative were only supplementary in countries that had entered into an agreement with the IMF, in countries like Malaysia, Vietnam, and Myanmar that had not accepted or were not provided IMF support, they served as an alternative.

The Miyazawa Initiative also experimented with currency swap arrangements. It extended the forms of support available beyond loans and credit guarantees, to include currency swap arrangements between central banks, which were taken up by the central banks of South Korea and Malaysia. However, the Initiative proved to be a short-term response to the crisis, rather than the launch of a network of bilateral mechanisms under Japanese aegis that could provide an enduring financial safety net for countries in the region.

In the following period, countries experimented with setting up a cooperative financing arrangement as a means to address financial and balance of payments fragility, possibly influenced by fears of a likely power imbalance in the region favoring Japan. The effort culminated in the Chiang Mai Initiative (CMI), involving the ASEAN+3 (ASEAN countries plus China, Japan, and South Korea), which was essentially a networkof bilateral foreign exchange swap arrangements. The CMI would have served its purpose if it satisfied the requirements set for regional crisis prevention and resolution framework. These were that it should be: (i) adequate to the task in terms of the volume of resources available; (ii) independent of US influence and IMF-style conditionality; and (iii) a framework that sidesteps regional tensions that could undermine the effort. In practice, the CMI and its multilateralized version CMI-M failed to meet these requirements.

Pressures from the US and the Bretton Woods institutions of the kind experienced at the time of the debate over a potential AMF, and geopolitical tensions in the region led to a decision to outsource the task of monitoring and surveillance of countries availing of the swaps under the CMI to the IMF. Beyond a specified borrowing limit, a borrower was required to have entered into an agreement with the IMF and be subject to the latter’s conditionality and surveillance to be eligible. Initially, any swap in excess of 10 percent of the agreed amount in an arrangement required IMF surveillance. That was raised to 20 percent in 2005 and 30 percent in 2012. What this meant is that the amount of foreign exchange that could be accessed without being subject to IMF conditionality was insignificant, especially since vulnerability in the region rose substantially after 1997, and especially after 2004 when there occurred a surge in financial capital movements from metropolitan centers to emerging markets, fuelled by the accommodative monetary stance and low-interest rate policy adopted by developed country central banks, especially the US Fed.

In practice, nothing came of these regional cooperation efforts expressly aimed at addressing the vulnerabilities that stem from the enhanced and volatile flows of capital across borders. Three factors explain that failure. The first was the subordination of the regional agreement to the IMF, as a means of perpetuating the existing regional balance of power and of ensuring repayment, which subverted the regional effort. The second, was the turn to the US Federal Reserve, when offered an opportunity, to access dollar liquidity through swap arrangements which this institution can proliferate without limit, given its control over dollar issuance. The third is increasing acceptance of bilateral arrangements with one of the regional powers—Japan or China—to access dollar or regional currency liquidity.

It is in this background that China has intensified efforts to use bilateral swap arrangements and capital flows as a means of establishing leadership with a regionally ‘internationalized’ currency. Faced with its own economic woes and handicapped by its relationship with the US, Japan has fallen behind in the race for regional leadership. But China too is confronted by regional fears of the consequences of its dominance and by a backlash from other powers, which are rallying together as is the case with the US, Australia, Japan, and India that have come together in the ‘Quad,’ for example. China’s belligerence does not help. But its financial generosity may yet win it enough supporters for a network of bilateral swaps and flows that create under its leadership a bilaterally-driven, IMF-independent safety net, that realizes a long-felt need in the region.

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  1. vlade

    The main question here is whether China would, at anytime soon, be willing to accept all that goes with the reserve currency. Which, to some extent, means handling the currency not to China’s direct industrial benefit.
    I’m not sure it’s something China would be willing to accept that anytime soon.

    1. PlutoniumKun

      I suspect what we are seeing here is a disconnect between the foreign policy aims of Beijing and the economic strategy. It must be very tempting for China to look at the potential for the renminbi to be a reserve currency, or at least a major player in financial markets. But to achieve this would mean a fundamental change in economic strategy, and would almost certainly do domestic damage to much of their industry and undermine their ability to control money flows (which is vital if they are not to face a debt crisis).

      My guess is that while they are extending feelers to see if its achievable, ultimately they will realise that its just not worth the cost. But having said that, there have been some decisions coming out of Beijing in recent years that have put international politics ahead of the domestic economy (with the crackdown on HK, for example), so its not impossible that the Beijing version of neocons are now more powerful than the economic realists.

      All these shenanigans makes me wish more than anything that JM Keynes had succeeded in his aims at Bretton Woods.

      1. Sameer Gupta

        To be honest I see this as pretty consistent with China’s defensive posture in the region. The idea is to build regional networks and bodies that will make it very difficult for the US to assert supremacy over China’s neighbourhood specifically by providing other countries with various political and economic incentives to support a multipolar world.

        As we saw with the collapse of the non aligned movement in the 1970s, it was debt and no access to capital without the west which prevented these countries from successfully addressing technology transfer, trade imbalance and other such grievances despite there being at least some political consensus around these issues. The lack of power held by the global south at this time is reflected by the ease with which UNCTAD was marginalized in favour of the WTO despite strong opposition from the global south to the terms of the Uruguay round of GATT as well.

        Even with their military, we have seen that they remain focused on matching American might in their own backyard, their production isn’t oriented around offensive military capacity aimed at meeting American might in every theatre of war. It is aimed at defending what they see as their “lake”.

        Their B&R infrastructure program is similarly aimed at not only hedging against a potential American blockade of the South China Sea but also creates new bilateral trading relationships that will theoretically enable closer integration of the Eurasian economy. If that program has included components for digital economy, healthcare and resource development, it’s not surprising that China would also pursue a monetary strategy which enables countries to more easily do business with China and consequently be less willing to accede to American pressure.

        I’m happy to be challenged but in light of a broader regional orientation as evidenced by the Shanghai Cooperative Organization and the Asian Infrastructure Bank taking on a key role within Chinese foreign policy, I think this small step toward “dedollarization” is probably not signalling this Chinese ambition to financialize their own economy and put forth the rmb as the global reserve currency but rather is a defensive move intended to facilitate closer integration of regional economies with China and make it harder for the US to pursue its containment strategy.

  2. The Rev Kev

    Most countries would have to be pretty desperate to accept Chinese funds and all that implied. But at the same time, the IMF has deliberately made most countries pretty desperate.

  3. ChrisFromGeorgia

    I have a question, probably a naive one, though worth asking I think:

    Why do any of these countries need dollars? I understand that they may have dollar-denominated debt which means when their local currencies tank they have debt crises, like Greece did. So wouldn’t the solution be to stop borrowing in dollars?

    1. PlutoniumKun

      Others could reply in more detail and with more knowledge than I, but a core problem for small poorer countries is to get the foreign currency in to buy both essentials (such as oil) and the raw materials and plant needed to build up their domestic industries. This is a key reason why so many ‘tiger’ economies would deliberately unbalance their initial investments to favour exports over (for example) providing for domestic demand and domestic needs. Its a simple way to prevent a loss of foreign currency hamstringing their early development. But obviously before this is achieved, you simply need an ample supply of foreign currency for basics. Even North Korea needs foreign currency. In theory, borrowing it should be a way of either buying in the technology needed for industrialisation, or at least tiding the country over a downturn. But in reality this is not always the case.

      1. NotTimothyGeithner

        Who wants Gaddafi Era Libyan currency in the Summer? Pre-Euro Greek, Nordic countries, and so forth out of season? The US is so big it doesn’t matter because all debts can be paid in US dollars and the US government exclusively accepts taxes in US dollars, but if Gaddafi needs to buy items he can’t store or is looking to avoid a high demand period, he might be better served with a different currency to support Libyan currency. Gaddafi had 40 to 60 billion in the currency fund. Then there are disasters. Agriculture, tourism, and areas with seasonal challenges are going to have a problem. The Russian quest for a warm weather port wasn’t about naval bases but running ships through the winter to avoid the ruble not being taken by merchants who wanted currency they can spend in the winter.

        Montreal lost the Expos due to currency exchange rates. There is at least one scene in Disney’s The Mandalorian where negotiations include kinds of currency and their worth.

      2. NotTimothyGeithner

        I would add this whole scenario is why Hamilton pushed to pay off state debts by the new federal government instead of defaulting. Dealing with currency issues would be a nightmare especially after ticking off the UK so recently. Everyone would deal with the US despite no monarch if the money was sound, and with the US being a potential autarky, it would always be open for business. I’ve suspected this is Putin’s real goal for Russia. Move it back into semiautarky status and make rubles a stable all year currency, he just has rebuilding to do. He has plenty of bad ideas and has changed course from time to time on policies. Yes, it makes sense, but most political leaders are brain dead.

        1. deplorado

          What do you mean by stable “all year” currency (also related to your first comment)? Is there a seasonal dependency in the strength of the ruble, and how so?

    1. Sound of the Suburbs

      They did avoid a Great Depression by saving the banks.
      They studied the Great Depression to avoid this fate.

      Richard Koo used to be a central banker at the Federal Reserve Bank of New York, and he looked at both sides of the bank’s balance sheets during the Great Depression.
      Richard Koo shows the US money supply / banking system (8.30 – 13 mins):
      1) 1929 before the crash – June 1929
      2) The Great Depression before the New Deal – June 1933
      3) During the New Deal – June 1936

      The money supply ≈ public debt + private debt
      The “private debt” component was going down with banks going bust and deleveraging from a debt fuelled boom causing debt deflation (a shrinking money supply).
      It was the public borrowing and spending of the New Deal that helped the economy recover.
      The money supply ≈ public debt + private debt
      The New Deal restored the money supply by increasing the “public debt” component of the money supply.
      Once the New Deal was working, they reduced Government borrowing and plunged the nation back into recession again.
      The enormous public spending and borrowing of WW2, eventually sorted things out.

      Richard Koo could see where the Troika went wrong in Greece.
      The IMF predicted Greek GDP would have recovered by 2015 with austerity.
      By 2015 Greek GDP was down 27% and still falling.
      The money supply ≈ public debt + private debt
      The “private debt” component was going down with deleveraging from a debt fuelled boom. The Troika then wrecked the Greek economy by cutting the “public debt” component and pushed the economy into debt deflation (a shrinking money supply).
      Greece was pushed into a Great Depression type event by the Troika.

      Getting the experts in from the IMF doesn’t always help.

  4. LowellHighlander

    Does anyone else feel relieved, after reading this article, that President Obama’s [corporate] trade deal for the Pacific Rim fell through (the one he pushed mightily on his way out the door)?

    China might well have its “issues” concerning civil rights and all, but from what I can tell, it doesn’t slaughter peoples abroad left and right (well, on the left) as the Empire does. Moreover, I’m always nonplussed by all these political theorists who worship the idea of “checks and balances” within the Federal government, and between the Federal government and the states, but then fail to advocate for such a [meaningful] system at the international level, especially with regard to economic relations.

    My overall point here is that, as China’s influence in economics along the Pacific Rim grows, the spooks operating out of Langley, Foggy Bottom, and elsewhere – by “spooks”, I refer to those who plant, anonymously, nightmarish scenarios in the paper(s) of record if we don’t do whatever is necessary to “stop China” – must not be allowed one inch of leeway in their drive to start a war against China. For me, that means waving the Flag high and proud in defence of democracy, peace, and the Constitution (here, Congress’ prerogative to declare war).

  5. Susan the other

    We need a new global currency. “Currency” in the truest sense of the word. Something like a Sustainability Credit. Divided among the earth’s population in some sort of a carbon budget. There isn’t enough time left to fiddle around with the IMF’s idea of debt and credit – based on nothing, I’d add. And China seems to only want to out-compete us on our old stupid playing field. Those days are over. So what happened to the blurb about the US Fed being willing to “back” some small country in eastern Europe. That would be a start for money for the right purpose. That could all be arranged.

  6. deplorado

    I may have completely misunderstood this — but I seem to remember that the newly minted digital yuan will allow foreign entities to get credit in yuan directly from China’s central bank.

    If that is the case, wouldnt that start turning the wheel toward the yuan as a reserve currency, without China’s having to maintain trade deficits?

    And, even without a trade deficit (or a big one like the US’s), China is still importing a giant quantity of all kinds of resources, and if it starts paying in yuan and not dollars for all that, wouldnt that also create excess yuan reserves outside of china ( the equivalent of eurodollars), thereby permitting itself to become a substantial reserve currency player without becoming a high trade deficit economy?

    Last fall China opened its bond marked substantially more, which points to it maybe pursuing a mechanism for recycling yuan from the world over and therefore establishing itself as an open and massively tradable and liquid currency market.

    I really wish for a well-informed comment on this.

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