from Follow the Money

How many divisions does the IMF have?

October 6, 2005

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So asks Andy Mukherjee of Bloomberg.  He wonders if IMF efforts to get China to allow its exchange rate to appreciate significantly would have exactly as much impact over Chinese policy as IMF efforts to get the US to reduce its budget deficit.

Zero.  

The IMF lacks obvious leverage over either country.

But to me, that is one of the reasons why the IMF should be involved. 

No one questions the United States potential leverage.  But some certainly would question the United States' wisdom in taking on its biggest creditor - and would worry that the US would be the plaintiff, the judge and the jury in the case of the US v. China's exchange rate peg.

If the IMF does not work to convince China that its current peg is an impediment to global adjustment - and that global adjustment requires renminbi appreciation, not just token efforts to develop a more "flexible" exchange rate regime, the US is likely to take matters into its own hands.  

As Mark Thoma notes, "quiet diplomacy" (not criticizing Chinese policy in public) has not produced large results - in part, I suspect, because Chinese exchange rate policy is hostage to domestic interests in China just as US fiscal policy is hostage to domestic interests.   Since 2003, China's reserve accumulation has doubled and now is running at close to $300 billion a year, and the UScurrent account deficit looks set to rise by about $300 billion.  If you worry about global imbalances, the absence of adjustment on either side of the Pacific has to raise a few warning bells.

I suspect the real problem is not that the IMF lacks leverage, but rather that the IMF - if it took a more aggressive stance - might find that its effective leverage is actually very large.  If China ignored an IMF declaration that China's exchange rate peg was an impediment to global adjustment, it would be politically impossible for the US also not to take action.  That means that IMF criticism of China could be more consequential than IMF criticism of the US.    The IMF can safely assume that its calls for the US to change will be widely ignored, but cannot make the same assumption about China.

But that asymmetry comes from the way the IMF's criticism would interact with US politics, not from an intrinsic asymmetry in Chinese or American leverage.   If unheeded IMF criticism of US fiscal policy led China (or India, or Russia, or Saudi Arabia or any one of another countries) to conclude that it should stop financing the US and stop adding to their portfolio of Treasuries (let alone sell off their existing stock), the IMF's criticism would suddenly carry a fair bit of weight.  The US has been able to ignore the IMF's warnings in part because the United States' creditors have opted to ignore the IMF's (implicit) warnings about the risks of financing the US.

One final point.  Mukherjee is right that nothing would suit the US better than a slow, sustained, predictable appreciation of the RMB - one that provided an ongoing incentive for hot money to flood into China, and thus assured rapid growth in China's reserves and ongoing Treasury purchases.   You hardly need to be a fancy hedge fund to recognize that kind of money machine.   The central banks capital losses are easy capital gains for anyone who can get funds into China.   Mukherjee:

Adams must know as much as anyone else that if the IMF were to take its biggest shareholder's demand seriously and force China to accept a big revaluation in the yuan, People's Bank of China may reduce its purchases of Treasuries. A sudden jump in interest rates won't be in the interest of the U.S. economy. What the Bush administration would really want to see is a slowly and steadily appreciating yuan. Slow and steady appreciation in the Chinese currency, which has risen 2.3 percent against the U.S. dollar to 8.09 since the July 21 revaluation, is advantageous from the U.S. Treasury's standpoint: The yuan will remain a one-way bet and speculators would keep sending more dollars into China, hoping to gain from further appreciation in the Chinese currency.

What continues to surprise me is that China seems to think a policy of giving steady capital gains to speculators is in China's interest!

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