After being vetted and groomed in midlevel positions in the 1990s, this bland bureaucratic team was carefully placed and promoted within the White House, Treasury, IMF, and elsewhere in the 2000s, to ensure Rubin’s web of influence and role as the de facto godfather of global finance. Geithner is the former Treasury secretary and former president of the Federal Reserve Bank of New York. Lew currently holds the Treasury secretary position. Froman was a powerful behind-the-scenes figure in the White House National Economic Council and National Security Council from 2009 through 2013 and then the U.S. trade representative. Larry Summers is a former Treasury secretary and chaired President Obama’s National Economic Council. During his White House years, Froman was the U.S. “sherpa” at G20 meetings, sometimes seen whispering in the president’s ear just as a key policy dispute was about to be ironed out with Chinese president Hu Jintao or another world leader. From 2009 through 2013, Gensler was chairman of the Commodity Futures Trading Commission, the agency that regulates Treasury bond and gold futures trading.
The members of the Rubin clique are extraordinary in the incompetence they displayed during their years in public and private service, and in the financial devastation they left in their wake. Rubin and his subordinate and successor, Larry Summers, promoted the two most financially destructive legislative changes in the past century: Glass-Steagall repeal in 1999, which allowed banks to operate like hedge funds; and derivatives regulation repeal in 2000, which opened the door to massive hidden leverage by banks. Geithner, while at the New York Fed from 2003 to 2008, was oblivious to the unsafe and unsound banking practices under his direct supervision, which led to the subprime mortgage collapse in 2007 and the Panic of 2008. Froman, Lipton, and Lew were all at Citigroup along with Rubin and contributed to catastrophic failures in risk management that led to the once-proud bank’s collapse and its takeover by the U.S. government in 2008, with over fifty thousand jobs lost at Citigroup alone. Gensler was instrumental in the 2002 passage of Sarbanes-Oxley legislation, which has done much to stifle capital formation and job creation in the years since. He was also on watch at the Commodity Futures Trading Commission in 2012 during the catastrophic collapse of MF Global, a bond and gold broker. Recently Gensler has shown better sense, calling for tougher derivatives regulation.
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 Ban
k 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.
The largest IMF commitments came from the European Union and
Japan, each committing $100 billion, and China, which committed another $50 billion. Other large commitments of $10 billion each came from the other BRIC nations, Russia, India, and Brazil, and from the developed nations of Canada, Switzerland, and Korea.
The most contentious commitment to the IMF’s new borrowing facility involved the United States. On April 16, 2009, just days after the G20 summit, President Obama sent letters to the congressional leadership requesting its support for a $100 billion commitment to the new IMF borrowings. The president, guided by Rubin protégé Mike Froman, had made a verbal pledge of the $100 billion at the summit, but he needed legislation to deliver on the actual funding. The letters to Congress stated that the new funding was a package deal intended to increase IMF votes for China and to force gold sales by the IMF. President Obama’s letters also called for “a special one-time allocation of Special Drawing Rights, reserve assets created by the IMF . . . that will increase global liquidity.” The president’s letters were refreshingly candid on the IMF’s ability to print world money.
China wanted additional votes at the IMF, and it wanted more gold dumped on the market to avoid a run-up in the price at a time when it was acquiring gold covertly. The United States wanted the IMF to print more world money. The IMF wanted hard currency from the United States and China to conduct bailouts. The deal, which had something for everyone, had been carefully structured by Mike Froman and other sherpas at the summit and signed on by Geithner, Obama, and the G20 leaders.
Looking a bit deeper, the Obama letter to Congress contained another twist. The new commitments to the IMF came not as quotas but as loans, consistent with the IMF’s growing role as a leveraged bank. The president sought to reassure Congress that the loan to the IMF was not an expenditure and therefore would have no impact on the U.S. budget deficit. The president’s letter said, “That is because when the United States transfers dollars to the IMF . . . the United States receives in exchange . . . a liquid, interest-bearing claim on the IMF, which is backed by the IMF’s strong financial position, including . . . gold.” This statement is entirely true. The IMF does have a strong financial position, and it has the third-largest gold hoard in the world after the United States and Germany. It was curious that just as Federal Reserve officials were publicly disparaging gold’s role in the monetary system, the president felt the need to mention gold to the Congress as a confidence booster. Despite disparagement of gold by academics and central bankers, gold has never fully lost its place as the bedrock of global finance.
The Death of Money Page 23
