The Death of Money (26 page)

The lost wealth and personal hardship resulting from the Rubin clique’s policies are
incalculable, yet their economic influence continues unabated. Today Rubin still minds
the global store from his seat as co-chairman of the nonprofit Council on Foreign
Relations. David Lipton, the Rubin protégé par excellence, with the lowest public
profile of the group, is now powerfully placed in the IMF executive suite, at a critical
juncture in the international financial system’s evolution.

The Rubin web of influence is not a conspiracy. True conspiracies rarely involve more
than a few individuals because they continually run the risk of betrayal, disclosure,
or blunders. A large group like the Rubin clique actually welcomes conspiracy claims
because they are easy to rebut, allowing the insiders to get back to work in the quiet,
quasi-anonymous way they prefer. The Rubin web is more a fuzzy network of
like-minded individuals with a shared belief in the superiority of elite thought and
with faith in their coterie’s capacity to act in the world’s best interests. They
exercise global control not in the blunt, violent manner of Hitler, Stalin, or Mao
but in the penumbra of institutions like the IMF, behind a veneer of bland names and
benign mission statements. In fact, the IMF’s ability to topple a regime by withholding
finance in a crisis is no less real than the power of Stalin’s KGB or Mao’s Red Guards.

The executive team at the IMF holds the view, more gimlet-eyed than any central bank’s,
that the international monetary system is severely impaired. Because of massive money
printing since 2008, a new collapse could emerge at any time, playing out not just
with failures of financial institutions or sovereigns but with a loss of confidence
in the U.S. dollar itself. Institutional memory reaches back to the dollar crash of
October 1978, reversed only with Fed chairman Paul Volcker’s strong-dollar policies
beginning in August 1979 and IMF issuance of its world money, the special drawing
right or SDR, in stages from 1979 to 1981. The dollar gained strength in the decades
that followed, but the IMF learned how fragile confidence in the dollar could be when
U.S. policy was negligently managed.

Min Zhu sees these risks as well, even though he was a college student during the
last dollar collapse. He knows that if the dollar collapses again, China has by far
the most to lose, given its role as the world’s largest external holder of U.S.-dollar-denominated
debt.
Zhu believes the world is in a true depression, the worst since the 1930s. He is characteristically
blunt about the reasons for it; he says the problems in developed economies are not
cyclical—they are structural.

Economists publicly disagree about whether the current economic malaise is cyclical
or structural. A cyclical downturn is viewed as temporary, a phase that can be remedied
with stimulus spending of the classic Keynesian kind. A structural downturn, by contrast,
is embedded and lasts indefinitely unless adjustments in key factors—such as labor
costs, labor mobility, taxes, regulatory burdens, and other public policies—are made.
In the United States, the Federal Reserve and Congress have acted as if the U.S. output
gap, the difference between potential and actual growth, is temporary and cyclical.
This reasoning suits most policy makers and politicians because it avoids the need
to make hard decisions about public policy.

Zhu cuts through this myopia. “
Central bankers like to say the problem is mostly cyclical and partly structural,”
he recently said. “I say to them it’s mostly structural and partly cyclical. But actually,
it’s structural.” The implication is that a structural problem requires structural,
not monetary, solutions.

The IMF is currently confronted with a full plate of contradictions.
IMF economists such as José Viñals have warned repeatedly about excessive risk taking
by banks, but the IMF has no regulatory authority over banks in its member countries.
Anemic global growth gives rise to calls for stimulus-style policies, but stimulus
will not work in the face of structural impediments to growth. Any stimulus effort
requires more government spending, but spending involves more debt at a time when
sovereign debt crises are acute. Christine Lagarde calls for short-term stimulus combined
with long-term fiscal consolidation. But markets do not trust politicians’ long-term
commitments. There is scant appetite for benefit cuts, even by countries on the brink
of collapse like Greece. Proposed solutions are all either politically infeasible
or economically dubious.

Min Zhu’s new paradigm points the way out of this bind. His clustering and gatekeeper
analysis suggests that policies should be global, not national, and his spillover
analysis suggests that more direct global bank regulation is needed to contain crises.
The specter of the sovereign debt crisis suggests the urgency for new liquidity sources,
bigger than those that central banks can provide, the next time a liquidity crisis
strikes. The logic leads quickly from one world, to one bank, to one currency for
the planet. The combination of Christine Lagarde’s charismatic leadership, Min Zhu’s
new paradigm, and David Lipton’s opaque power have positioned the IMF for its greatest
role yet.

■
One Bank

The Federal Reserve’s status as a central bank has long been obvious, but in its origins,
from 1909 to 1913, following the Panic of 1907, supporters went to great lengths to
disguise the fact that the proposed institution was a central bank. The most conspicuous
part of this exercise is the
name itself, the Federal Reserve. It is not called the Bank of the United States of
America, as the Bank of England and the Bank of Japan proclaim themselves. Nor does
the name contain the key phrase “central bank” in the style of the European Central
Bank.

The obfuscation was much by design. The American people had rejected central banks
twice before. The original central bank, the Bank of the United States chartered by
Congress in 1791, was closed in 1811 after its twenty-year charter expired. A Second
Bank of the United States, also a central bank, existed from 1817 to 1836, but its
charter was also allowed to expire in the midst of acrimonious debate between supporters
and opponents. From 1836 to 1913, a period of great prosperity and invention, the
United States had no central bank. Well aware of this history and the American people’s
deep suspicion of central banks, the Federal Reserve’s architects, principally Senator
Nelson Aldrich of Rhode Island, were careful to disguise their intentions by adopting
an anodyne name.

Likewise, the IMF is best understood as a de facto central bank of the world, despite
the fact that the phrase “central bank” does not appear in its name. The test of central
bank status is not the name but the purpose. A central bank has three primary roles:
it employs leverage, it makes loans, and it creates money. Its ability to perform
these functions allows it to act as a lender of last resort in a crisis. Since 2008,
the IMF has been doing all three in a rapidly expanding way.

A key difference between a central bank and ordinary banks is that a central bank
performs these three functions for other banks, rather than for public customers such
as individuals and corporations. Buried in the IMF’s Articles of Agreement, its 123-page
governing document, is a provision that states, “
Each member shall deal with the Fund only through its . . . central bank . . . or
other similar fiscal agency, and the Fund shall deal only with or through the same
agencies.” According to its charter, then, the IMF is to function as the world’s central
bank, a fact carefully disguised by nomenclature and by the pose of IMF officials
as mere international bureaucrats dispensing dispassionate technical assistance to
nations in need.

The IMF’s central-bank-style lending role is the easiest to discern of its functions.
It has been the IMF’s mission from its beginnings in the late 1940s and is one still
trumpeted today. This function grew at a time when
most major currencies had fixed exchange rates to the dollar and when countries had
closed capital accounts. When trade deficits or capital flight arose, causing balance-of-payments
problems, countries could not resort to a devaluation quick fix unless they could
show the IMF that the problems were structural and persistent. In those cases, the
IMF might approve devaluation. More typically, the IMF acted as a swing lender, providing
liquidity to the deficit country for a time, typically three to five years, in order
for that country to make policy changes necessary to improve its export competitiveness.
The IMF functioned for national economies the way a credit card works for an individual
who temporarily needs to borrow for expenses but plans to repay from a future paycheck.

Structural changes required by the IMF in exchange for the loan might include labor
market reforms, fiscal discipline to reduce inflation, or lower unit labor costs,
all aimed at making the country more competitive in world markets. Once the adjustments
took hold, the deficits would then turn to surpluses, and the IMF loans would be repaid.
However, that theory seldom worked smoothly in practice, and as trade deficits, budget
deficits, and inflation persisted in certain member nations, devaluations were permitted.
While devaluation can improve competitiveness, it can also impose large losses on
investors in local markets, who relied on attractive exchange rates to the dollar
to make their initial investments. On the other hand, if it so chooses, the IMF can
make loans to help countries avoid devaluation and thereby protect investors such
as JPMorgan Chase, Goldman Sachs, and their favored clients.

Today the IMF website touts loans to countries such as Yemen, Kosovo, and Jamaica
as examples of its positive role in economic development. But such loans are window
dressing, and the amounts are trivial compared to the IMF’s primary lending operation,
which is to prop up the euro. As of May 2013, 45 percent of all IMF loans and commitments
were extended to just four countries—Ireland, Portugal, Greece, and Cyprus—as part
of the euro bailout. Another 46 percent of loans and commitments were extended to
just two other countries: Mexico, whose stability is essential to the United States,
and Poland, whose stability is essential to both NATO and the EU. Less than 10 percent
of all IMF lending was to the neediest economies in Asia, Africa, or South America.
Casual visitors to the IMF’s website should not be deceived by
images of smiling dark-skinned women wearing native dress. The IMF functions as a
rich nations’ club, lending to support those nations’ economic interests.

If the IMF’s central-bank-lending function is transparent, its deposit-taking function
is more opaque. The IMF does not function like a retail commercial bank with teller
windows, where individuals can walk up and make a deposit to a checking or savings
account. Instead, it runs a highly sophisticated asset-liability management program,
in which lending facilities are financed through a combination of “quotas” and “borrowing
arrangements.” The quotas are similar to bank capital, and the borrowing arrangements
are similar to the bonds and deposits that a normal bank uses to fund its lending.
The IMF’s financial activities are mostly conducted off balance sheet as contingent
lending and borrowing facilities. In this way, the IMF resembles a modern commercial
bank such as JPMorgan Chase whose off-balance-sheet contingent liabilities dwarf those
shown on the balance sheet.

To see the IMF’s true financial position, one must look beyond the balance sheet to
the footnotes and other sources. IMF financial reports are stated in its own currency,
the SDR, which is easily converted into dollars. The IMF computes and publishes
the SDR-to-dollar exchange rate daily. In May 2013 the IMF had almost $600 billion
of unused borrowing capacity, which, when combined with existing resources, gave the
IMF $750 billion in lending capacity. If this borrowing and lending capacity were
fully utilized, the IMF’s leverage ratio would only be about 3 to 1, if quotas were
considered to be equity. This is extremely conservative compared to most major banks,
whose leverage ratios are closer to 20 to 1 and are higher still when hidden off-balance-sheet
items are considered.

The interesting aspect of IMF leverage is not that it is high today but that it exists
at all. The IMF operated for decades with almost no leverage; advances were made from
members’ quotas. The idea was that members would contribute their quotas to a pool,
and individual members could draw from the pool for temporary relief as needed. As
long as total borrowings did not exceed the total quota pool, the system was stable
and did not need leverage. This is no longer the case. As corporations and individuals
deleveraged after the Panic of 2008, sovereign governments,
central banks, and the IMF have employed leverage to keep the global monetary system
afloat. In effect, public debt has replaced private debt.

The overall debt burden has not been reduced—it has increased, as the global debt
problem has been moved upstairs. The IMF is the penthouse, where the problem can be
passed no higher. So far the IMF has been able to facilitate the official leveraging
process as an offset to private deleveraging. Public leverage has mostly occurred
at the level of national central banks such as the Federal Reserve and the Bank of
Japan. But as those central banks reach practical and political limits on their leverage,
the IMF will emerge as the
last
lender of last resort. In the next global liquidity crisis, the IMF will have the
only clean balance sheet in the world because national central bank balance sheets
are overleveraged with long-duration assets.

The biggest single boost to the IMF’s borrowing and leverage capacity came on April
2, 2009, very near the depths of the stock market crashes that began in 2008, a time
of pervasive fear in financial markets. The occasion was the G20 Leaders’ Summit in
London, hosted by the U.K. prime minister Gordon Brown and attended by U.S. president
Obama, French president Sarkozy, German chancellor Merkel, China’s Hu Jintao, and
other world leaders. The summit pledged to expand the IMF’s lending capacity to $750
billion. For every dollar the IMF lends, it must first obtain a dollar from its members;
so expanded lending capacity implied expanded borrowing and greater leverage. It took
the IMF over a year to obtain most of the needed commitments, although for a panoply
of political reasons, the full amount has not yet been subscribed.