The global financial crisis highlighted the problems of monetary colonialism, where some countries buy real goods and services from other countries, especially emerging nations, and in exchange sell them securities or IOUs with low rates of interest. Now, developed nations are pursuing policies to devalue their currencies, through a combination of low interest rates and increasing the supply of money. These actions erode the value of sovereign bonds in which other nations, like China, Japan, Germany and others, have invested their savings. Between 2008 and 2012, the depreciation of the US dollar resulted in a loss for foreign creditors of over $600 billion. This undermines global trust.
Nations increasingly seek to manipulate the value of currencies to allow them to capture a greater share of global trade, boosting growth. But a calculated policy of engineered currency devaluations to gain trading advantages invites destructive retaliation in the form of tit-for-tat currency wars. These beggar-thy-neighbour policies exacerbate international tensions, manifesting itself in trade protectionism and disputes.
Many nations have used regulations and political pressure to force banks and investors to adopt patriotic balance sheets. This entails institutions purchasing their national government bonds and prioritising lending to domestic borrowers. Increases in cross border capital flows have slowed in the period from 2008 to 1.9 percent per annum from 7.9 percent per annum in the 1990-2007 period.
Low interest rates and weak currencies have also led capital to flow into emerging nations with higher rates and stronger growth prospects. Since 2009, in excess of $3 trillion have flowed into emerging markets. These frequently short-term, volatile money movements have the potential to destabilise these economies, derailing their development. This forced some nations to deploy financial repression of their own—controls on capital flows into the country.
The devaluation of the US dollar had driven up the price of commodities, such as food and energy which are denominated in the American currency. In poorer countries where spending on food and energy, including everyday essentials like cooking oil, is a high proportion of income, this has caused hardship. These developments threaten to reverse progress in reducing poverty. Higher commodity prices in combination with large flows of capital have created inflationary pressures in many countries, which have forced authorities to increase interest rates, which have slowed economic growth.
Under the guise of regulations needed to strengthen the financial system, the US has implemented measures whose extra-territorial application may give American banks a business advantage. Such measures do not foster international co-operation in regulating finance.
The tension between developed and emerging countries over the control of international institutions, such as the International Monetary Fund (IMF) and the World Bank, highlights increasing mistrust.
America supported Europe’s candidate for the IMF Presidency (Christine Lagarde). Europe helped elect the American candidate (Jim Yong Kim) as the head of the World Bank. The US and Europe used its disproportionate voting power to achieve their desired outcome.
In his resignation letter of July 2012, Peter Doyle, a senior IMF economist, excoriated the institution. He wrote of a “European bias” arguing that Lagarde’s appointment was compromised: “Even the current incumbent is tainted, as neither her gender, integrity, or élan can make up for the fundamental illegitimacy of the selection process.”
Speaking at an IMF press conference, Brazil’s finance minister highlighted the inequality of the quotas that dictate voting power: “The calculated quota share of Luxembourg is larger than the one of Argentina or South Africa… The quota share of Belgium is larger than that of Indonesia and roughly three times that of Nigeria. And the quota of Spain, amazing as it may seem, is larger than the sum total of the quotas of all 44 sub-Saharan African countries.”
The voting imbalance is a legacy of a time when the IMF was designed to aid ailing third world or developing countries. But the IMF’s purpose has now changed. The developed world increasingly looks to the savings of the emerging nations to help solve current debt problems, such as those in Europe.
In April 2012, the IMF increased its resources by $430 billion to help deal with potential financial crises. IMF officials made obligatory statements that the funds are “available for the whole IMF membership, not earmarked for any particular region”. But everyone was aware that the funds are likely to be needed to solve the persistent Eurozone debt crisis.
Of the $430 billion in additional commitments, emerging nations chipped in around $115 billion. The US refused to contribute its required share of $70 billion, based on its jealously protected voting quotas.
China, Russia and Brazil have sought more evidence of “Eurozone governance” before finalising their commitment. The fact that a communist country, a formerly communist country and a country which has been a recent problem child should require proof of Western Europe’s economic management credentials is ironic. There is increasing concern in emerging markets, where incomes per head are well below Western levels, about having to take on the risk of large losses to preserve the unsustainable monetary and regulatory arrangements of developed nations.
Emerging market countries also resent the fact that the IMF conditions for bailouts of Greece, Ireland and Portugal have been noticeably less rigorous than those imposed on Asian countries in the aftermath of the 1997-98 monetary crisis. In an opinion piece published on June 7, 2012, in the Financial Times, Jin Liqun, chairman of the supervisory board at the China Investment Corporation, the nation’s sovereign wealth fund, writing with Keyu Jin, assistant professor at the London School of Economics, pointedly noted: “Viewed from China, the management of the Eurozone debt crisis offers a stark contrast to the handling of the 1997-98 East Asian crisis. In that episode, Thailand, South Korea and Indonesia were all forced to implement tough austerity programmes imposed by the International Monetary Fund…Unlike many of today’s Europeans, the people of East Asia did not have the luxury of large relief funds from outside their countries. The people had to tolerate hardship, and they did not believe in the magic of street demonstrations. In a poignant case, the Korean people contributed gold and household foreign exchanges to the government to help ease fiscal pressure….”
Reacting to criticism of China’s response to the European debt crisis, they provided an ominous riposte: “From the outset of the crisis China has responded positively and firmly to Europe’s appeal for support. But it should be received as an important and responsible stakeholder, not as an outside creditor relegated to lower levels of seniority in moments of urgency. It should be treated equally with the European Central Bank in the event of any debt restructuring.”
Denying powerful and increasingly wealthy emerging nations their legitimate role in international affairs undermines the unity required to deal with major global economic challenges. Reflecting these tensions, the BRICS (Brazil, Russia, India, China and South Africa) have proposed a vague proposal for a new development finance institution, financed by emerging nations, as an alternative to the IMF and World Bank.
The tensions between developed and emerging countries is likely to be tested by expected policy moves in the US, Europe and Japan. As the US begins to seriously reduce its purchase of government bonds and increase interest rates to more normal levels, the likely increase in interest rates will trigger capital withdrawals from some vulnerable emerging economies (such as the ‘fragile five’: Brazil, Indonesia, India, Thailand and South Africa). At the same time, expected looser monetary policies in Europe and Japan could ameliorate the effects of US policy changes but might also exacerbate other problems. A devaluing Yen and capital outflows from Japan were significant factors in the emerging market crises of the late 1990s.
In December 2013, Governor of the Bank of England Mark Carney warned of a shift in risk from West to East: “The greatest risk is the parallel banking sector in the big developing countries.” Carney was less fulsome in identifying the role played by developed nations and their policies in this change.
Satyajit Das is the author of Extreme Money and Traders, Guns & Money