The Forward Observer is a series written by Kevin Virgil, CEO/Co-Founder of Frontera. Every two weeks he writes about trends that are re-shaping our world, and events taking place at the cutting edge of foreign affairs, business and finance.
I spend a fair amount of time in Washington, DC — America’s capital, or as one of my mentors enjoys calling it, “America’s Mordor”. More than any other city on earth, it is now overrun with well-paid ‘consultants’ who have managed to monetize their professional connections and experiences — lobbyists, “facilitators”, and other assorted rent-seekers. Every local think-tank has a ‘defense expert’, a ‘Middle East expert’, etc. But over the past two decades, no ‘experts’ have been more in demand in this town than professional China-watchers.
This should come as no surprise, given China’s meteoric rise during that time. However ‘China experts’ are thriving inside the Beltway today because over the past two decades the country’s meteoric rise has inspired both fascination and fear among the DC establishment. Amidst the endless political chatter about domestic economic decline, we are beginning to see something that we have never seen in Washington in our lifetimes — the early, yet unmistakable, signs of an inferiority complex.
Fear always sells in Washington. Whether you’re a defense industry lobbyist, a news network producer or a Congressional staffer, there is always demand for clear and convincing evidence that China is on the rise, or that it is gaining global influence at America’s expense in the zero-sum game of geopolitics. For example, much attention was devoted to China’s surpassing of Japan as the world’s second-largest economy in 2010, or when it outgrew the US economy at the end of last year (this might be my favorite headline, from a particularly shrill blog).
However, those seeking a clear indicator of China’s rising clout need look no further than the resounding diplomatic victory that they achieved in recent weeks, when a global charm offensive convinced America’s closest allies to join Beijing’s new development bank, the Asian Infrastructure Investment Bank (AIIB). What is most amazing is how those allies joined in spite of direct and aggressive lobbying from the highest levels of the US government, and the degree to which the White House was humiliated in the process.
I’ve been reading about the AIIB for awhile, and thought it was time to take a closer look at why it was formed, what it aims to do, and how it will work (or compete with) the Bretton Woods-era institutions in DC, namely the World Bank and International Monetary Fund (IMF).
I can’t claim to be an expert on China, but I do know a thing or two about American history – and particularly its economic history. It’s for this reason why I thought it was time to review the US government’s purported objections to the AIIB, and compare them to recent events within the (largely US-backed/controlled) World Bank and IMF. Ultimately this exercise led me to conclude such warnings are, as my British friends say, “an utter load of bollocks.” Washington certainly does have reason to object to wide acceptance of the AIIB, as I will shortly explain — but not for the reasons which they have stated.
What Is the AIIB?
The AIIB is intended to be an international development bank that invests specifically in large-scale infrastructure projects in Asia. Though the bank has been founded and led by China and will be headquartered in Beijing, it includes 57 founding member-nations — 37 from the Asian continent, and 20 from elsewhere. Nearly every ‘G-20’ member nation applied to join and was accepted, with the exceptions of the US, Canada, Japan and Taiwan. Later this year the AIIB intends to formally begin operations with a capital base of US$ 50 billion, and intentions to double that amount within twelve months.
The AIIB is structuring itself in a manner largely similar to the World Bank, with one key exception — the Chinese government has given assurances that it will not allow any one member to carry a veto right. This point, which proved crucial in persuading several Western countries to join, is arguably the biggest structural flaw at the US-based institutions, since the US government carries an effective veto right at the IMF (even though it only holds 20% of its voting shares) and has historically required that the World Bank’s president always be an American. Europeans have traditionally filled leadership positions at the IMF.
Why Is It Needed?
Recently I was in a meeting on the 24th floor of an office tower in Phnom Penh. I was looking out at the city streets – shared equally these days between tuk-tuks, mule-drawn carts, and Korean luxury automobiles – when another expat marveled at how, just ten years prior, most of the city’s streets had not yet been paved with concrete. Moments like that are when one begins to grasp the enormity of change that is now occurring in southeast Asia, and across the entire continent.
For the pace of change to continue, Asia needs enormous infrastructure investment. Back in 2009 the Asian Development Bank (ADB) estimated that US$ 8 trillion will be required before the end of this decade (for context, roughly ten times what the US government has expended on its military campaigns in Afghanistan and Iraq). Here is a look at the capital base available to the existing development banks:
ADB: US$ 160B
World Bank: US$ 223B
IMF: US$ 327B (total quotas)
Assuming the ADB’s forecast is accurate, then they and the other major development banks will be able to fund less than 10% of the needed amount. This of course ignores the facts that (a) most development banks have lately shifted away from infrastructure support and are now focusing on more politically correct agendas such as gender equality and climate change, and (b) the IMF and World Bank have a global remit and do not focus exclusively. This fact remains highly visible in today’s newspapers amidst recent IMF commitments (and likely defaults) with Greece and Ukraine – as featured in my most recent article, and who are currently two of the the IMF’s four largest borrowers along with Portugal and Ireland. The dev-banks, it seems, have their hands full in Europe these days — creating even more urgency for new solutions in Asia.
Why Does the US Object?
Ever since China began its global charm offensive to recruit founding members of the AIIB, the Obama administration has been applying equal pressure to discourage other countries from joining. Alas, it was all for naught; last month nearly every G-7 country elected to apply for membership, including France, Israel, and [gasp] the United Kingdom. The Financial Times – never one to avoid a bit of schadenfreude where the US government is concerned – reported at the time with barely disguised glee:
“The Chinese government can scarcely believe its own luck. Heaping Asian insult upon Capitol Hill injury, last week Benjamin Netanyahu committed Israel to join Beijing’s new Asian Infrastructure Investment Bank…What began as a seemingly quixotic defection to the AIIB by the UK — the first US partner to turn a deaf ear to American protestations about the bank — has turned into an unalloyed strategic triumph for Beijing.”
For the past several months the US has urged its friends and allies to boycott China’s invitations to the AIIB. US Treasury Secretary Jack Lew has been its loudest critic, claiming that a Chinese-led bank could ‘fail to meet environmental standards and other safeguards’. Even after “America’s AIIB Disaster” (that’s how ‘The Diplomat’ phrased it, not me) Lew refused to back down and insisted on lecturing the Chinese on good governance and monetary policy. Which is a bit rich coming from the man who is overseeing a wholesale debasement of his own currency that is unmatched in American history…but I digress.
Does the US have a point?
This is the point where my exercise in research became quite entertaining. Let’s review each of the Obama administration’s objections to the AIIB, in turn:
The AIIB could subvert the work of the existing development banks, to include the ADB, World Bank and IMF.
As we have already pointed out, the demand for capital investment in Asia alone is enormous. The existing institutions’ ability to address the funding gap is roughly akin to filling a pint glass with an eyedropper. One would think that a general attitude of “the more, the merrier” is appropriate here; that is not the case in Washington, where some trepidation about the need to begin sharing leadership responsibilities with China is a better explanation.
The AIIB may not practice good governance, and not require its borrowers to support human rights, fair working practices, etc.
This is certainly a laudable practice to which all development banks should aspire, and the AIIB is no exception. China certainly does not have a sterling reputation when it comes to whom it chooses to do business with. They are the lender and investor of choice amongst bush-league African dictators, who know the Chinese willingness to provide vast sums of money in return for resources, and without all of the pesky questions about human rights that Western institutions insist on asking.
That being said, before Jack Lew puts the IMF and World Bank on a pedestal he may want to recall their historical support for those aforementioned dictators, to include the ghastly Mobutu Sese Seko of Zaire in the 1970s. Mobutu may have been a corrupt thug, but he was Washington’s friend in an unfriendly region at the time, and he received well over US$ 1 billion in World Bank loans and IMF credits during his long tenure.
I could offer more examples of tin-pot dictators doing favorable deals with US-controlled development banks (Suharto in Indonesia, or Marcos in the Philippines) but why not focus on a region that REALLY hates the IMF. No I’m not talking about Greece (though they certainly do have their reasons to do so these days). I’m referring to Latin America – a place never lacking in free-spending chavistas and financially inept governments.
That region, which experienced a golden era of nearly 8% annual growth from 1960-1980, experienced its own economic crash in the ‘80s — conveniently enough, when the IMF and World Bank “bailed out” Mexico, Argentina and other debtor nations. Several countries had loaded up on cheap debt amidst a flood of liquidity (sound familiar?!). Unfortunately most of those loans were priced in US dollars, which suddenly became very expensive in 1980 when Fed Chairman Volcker spiked interest rates as high as 20% to fight the ‘stagflation’ wrought by the 1970s oil price shocks.
On the brink of disaster, Latin American leaders were only too happy to meet with the IMF and World Bank officials that Washington dispatched to the region. Multi-billion dollar bailouts ensued, which of course came with strings attached— mass privatizations, financial deregulation, and public-sector cuts that developing economies had no idea how to manage, and could scarcely afford to sustain. US banks and IMF stakeholders made a killing off the high-interest loans, while the region slipped into a ‘lost decade’ of its own stagnation. I don’t often agree with Joseph Stiglitz, the former World Bank Chief Economist, but I have to nod my head when he points out that IMF policies in 1980s Latin America were ‘medicine that killed the patient.‘
Secretary Jack Lew recently commented that he has been “encouraged by my conversations in Beijing in which China’s leaders made clear that they aspire to meet high standards and welcome partnership.” If the benchmark for those aspirations is the historical conduct of the IMF and World Bank, who have acted as nakedly partisan agents of US policy for several decades, then China should rest assured that the bar has been set comfortably low.
China might use the AIIB as an agent to gain influence.
Now we’re getting somewhere! As already pointed out, we know that the US has used the World Bank and IMF to its own economic advantage since their inception.But, with China already having achieved the title of world’s largest economy, why is the US so reticent to allow Beijing to take a more active role in global leadership?
The answer, of course, is containment — a strategy that worked quite well against Russia in the Cold War (though a point to which the Vietnamese, Cambodians, Afghanis, Angolans, and victims of other proxy wars might take umbrage). As George Friedman of Stratfor frequently points out, the US often relies on imbalance and friction to maintain its dominance in contested regions. Hence the positioning of 30,000 troops in South Korea since the 1950s, or the ongoing ‘Dragoon Rides’ of US armored units throughout Eastern Europe — not nearly enough commitment to matter in a conventional war, but just enough to force your enemy to expend resources (or discourage them from doing so) in dealing with the imbalance. The end result is that the status quo is maintained.
The US is now engaged in a wholesale campaign of economic containment with respect to China. Why else would President Obama have traveled to Myanmar in 2010 – and made a second trip last year – when the country has been a pariah state since the 1960s? Or why has it pressuring its trading partners to exclude China from the Trans-Pacific Partnership — a regional economic bloc that excludes what is now the world’s largest economy? Let’s be honest and re-brand the TPP as the ABCC (the “Anyone But China Club”).
The containment strategy generally worked in the Cold War, when the US eventually forced the Soviet Union to spend itself into oblivion. What is markedly different today, as we have just seen with the AIIB’s resounding success, is a slow but gradual erosion of American influence as its friends realize that their interests are best served by maintaining good relations with both of today’s leading economies.
The high response rate to the AIIB’s membership drive is another indicator that the rest of the world is actively seeking alternatives to US leadership in the global financial system. This should come as no surprise — Washington has abused its status as owner of the world’s reserve currency for decades. When President Nixon unilaterally dropped the gold standard in 1971, thereby exporting dollar inflation around the world, his Treasury Secretary John Connally infamously told the world “It’s our currency, but it’s your problem.” At the time Connally knew that America’s trading partners had no alternative. The difference between then and now, of course, is that the US economy’s share of global GDP has dropped by over 20% as the rest of the world catches up, and its stability is much less certain as its liabilities, as a percentage of GDP, are now higher than at any point since World War II.
From the introduction of FATCA – the most onerous and arrogant tax enforcement system ever devised – to the weaponization of the dollar as a tool against its adversaries, the US government is practically encouraging other nations to develop those alternatives. Recent attempts by the UK government to deny Russia access to the (supposedly non-partisan) global SWIFT network will only accelerate this trend.
For the moment, DC policymakers are content to maintain the status quo of unabated money printing and “take it or leave it” burdens like FATCA. It’s important to remember, though, that the rest of the world does not channel their frustration like Americans do — the Chinese will not scream incoherently and vent their rage via Twitter hate-rants. They will do what they are already doing exceedingly well, which is to play the long game. Beijing will continue to smile and work within the confines of the American-led financial system, while introducing gradual but unmistakable initiatives that continue to chip away at dollar market share.
Whether it’s direct convertibility for cross-border FX intorenminbi, enormous trade deals that bypass the dollar system, or the launching of a development bank thatdoes not require US leadership, the end of US financial leadership is in its early days — but the trend is unmistakable. In the absence of dramatic policy changes from Washington, embarrassments like the AIIB debacle are only just beginning.
I am fascinated by this trend toward alternatives to thedollar-based financial system. It is exceedingly difficult to find reliable information on the topic, but steps are clearly being taken in Moscow, Beijing and around the world.
Tune in next time when we look at the increasing trend for cross-border FX conversion that does not require the use of US correspondent banks, and the early stages of an alternative financial system that is being built specifically to avoid the need to use the dollar.