IMF blesses China's yuan but the dollar is still dangerously dominant

'A dollar-centric financial world has created powerful and sinister distortions,' says SLJ Macro. The world will be safer as the Chinese yuan comes of age

By Ambrose Evans-Pritchard

Billions of pounds of QE unlikely to cause inflation - IMF. IMF chief Christine Lagarde has welcomed Japan's massive new money priting programme.

IMF chief Christine Lagarde gives China's yuan the thumbs up
The Chinese yuan is to join the elite currency basket of the International Monetary Fund, opening the way for a surge of investment flows that could send tremors through the global financial system.

The watershed moment marks an end to increasingly unhealthy era of US dollar dominance that has failed to keep pace with dramatic changes in the world economy, and it weakens Western control over the machinery of global markets and the economic rulebook.

The yuan will be become the fifth currency to make up the IMF’s basket of "Special Drawing Rights" (SDR) later next year, alongside the dollar, the euro, sterling and the Japanese yen.

The Fund deemed the yuan to be “freely usable”, even though China still has tight capital controls and badly bungled the Shanghai stock market crash earlier this year.

The IMF's decision was clearly a political move aimed at drawing China into the college of global governance.
David Marsh, from the official monetary forum OMFIF, said it is the first time that a developing country has been anointed in this way and marks a "momentous shift in the global power balance".

"Acquiescence by the US in this landmark move is recognition that China’s march to the top table of the world economy is unstoppable," he said.

Christine Lagarde, the IMF’s managing director, said China’s reform drive would bring about a “more robust international monetary and financial system”.

Stephen Jen, from SLJ Macro Partners, said premier Li Keqiang and reformers in China’s central bank are using the IMF push – with its allure of global prestige – to defeat vested interests within the Communist Party and push through free-market policies that would otherwise be impossible. “This is more than a vanity project,” he said.

He called the move a “cunning tactic” to outmanoeuvre opponents by inducing them to accept a commitment that looks symbolic and innocuous, but in reality implies a series of far-reaching steps that open up the Chinese financial system. It is economic revolution by stealth.

The world will be a much safer place if they can pull it off. Mr Jen said the global currency system has become dangerously unbalanced, a financial edifice based on dollar hegemony with a record $9 trillion of cross-border lending in dollars - most of it entirely outside US jurisdiction.

The world has never been so dollarised.

“This increasingly dollar-centric financial world has created several powerful and sinister distortions,” he said. It was a cause of the "global savings glut" before the Lehman crisis, and it then swamped emerging markets with excess liquidity created by the US Federal Reserve – a process now going into reverse.

This global “dollar standard” is incompatible with a multipolar trading system where many of these same emerging markets are much more dependent on China’s economy than they are on US demand. Finance and trade are out of alignment.

Yet China faces huge risks trying to open its system and free the yuan. Nobody knows whether capital will flood out of the country, or into it, and either could cause trouble.

Yang Zhao, from Nomura, said there is $17.3 trillion sitting in Chinese deposit accounts, and a big chunk is held by rich Chinese who will be allowed to switch half their assets into foreign stocks, bonds and real estate under the new "QDII2" liberalisation scheme.

Markets remain skittish over the risk of capital flight after a devaluation scare in August, which set off an exodus of hot money and forced the authorities to defend the yuan. The police launched an assault on “underground banks” accused of smuggling money abroad.

Diana Choyleva, from Lombard Street Research, said there could be a “torrent of outflows” as soon as China lifts restrictions, setting off a yuan devaluation that would send a deflationary shock through the world economy. “This will be the moment of maximum danger,” she said.

Analysts say the pent-up money waiting to leave is roughly $2.2 trillion but it could be higher, and could snowball in a crisis.

The authorities know this and are keeping tight control over the exchange rate after burning their fingers over the summer. The yuan has been steady for four months on a trade-weighted basis.

Yet this currency stabilisation is untenable. Mr Jen said China faces the “Impossible Trinity”: it cannot have an independent monetary policy, an exchange target and an open capital account at the same time. One must give.

The central bank thinks the easiest of the three is to open up the capital account, but they do not yet know how to do so safely.

Set against the outflows is another great stash of capital likely to pour into the yuan as a result of liberalisation and the IMF effect. Foreign funds may want a bigger share of China’s bond market, already $6.5 trillion and growing fast.

There will come a time China’s A-share market is fully included at a 20pc weighting on the MSCI emerging market index, which would theoretically entail $340bn of equity purchases. On top of this, Nomura expects China’s current account surplus to approach $800bn next year, drawing a constant stream of money into the country.

The yuan weighting in the SDR will be 10.92pc, implying that central banks could switch $500bn to $1 trillion into Chinese bonds over coming years to keep their portfolio balanced, chiefly at the cost of the euro, yen and sterling. Whether they will actually do so is far from clear.

Mark Williams, from Capital Economics, said China’s hopes for reserve currency status have gone backwards since the heavy-handed intervention in the stock market. “Managers of foreign exchange reserves will think twice before entrusting their assets to policymakers who have shown themselves willing to steamroller the rights on investors when it suits them,” he said.

In the end, China’s plan for a superpower currency that can match the dollar entirely depends on the whether the Communist Party establishes the rule of law, competent supervision, consistency and global trust.

Beijing has won the coveted blessing of the IMF and Washington. Now it has to deliver.

Liberalism’s Imaginary Enemies

In Paris, it’s easier to battle a climate crisis than confront jihadists on the streets.

By Bret Stephens

Little children have imaginary friends. Modern liberalism has imaginary enemies.

Hunger in America is an imaginary enemy. Liberal advocacy groups routinely claim that one in seven Americans is hungry—in a country where the poorest counties have the highest rates of obesity. The statistic is a preposterous extrapolation from a dubious Agriculture Department measure of “food insecurity.” But the line gives those advocacy groups a reason to exist while feeding the liberal narrative of America as a savage society of haves and have nots.

The campus-rape epidemic—in which one in five female college students is said to be the victim of sexual assault—is an imaginary enemy. Never mind the debunked rape scandals at Duke and the University of Virginia, or the soon-to-be-debunked case at the heart of “The Hunting Ground,” a documentary about an alleged sexual assault at Harvard Law School. The real question is: If modern campuses were really zones of mass predation—Congo on the quad—why would intelligent young women even think of attending a coeducational school?

They do because there is no epidemic. But the campus-rape narrative sustains liberal fictions of a never-ending war on women.

Institutionalized racism is an imaginary enemy. Somehow we’re supposed to believe that the same college administrators who have made a religion of diversity are really the second coming of Strom Thurmond. Somehow we’re supposed to believe that twice electing a black president is evidence of our racial incorrigibility. We’re supposed to believe this anyway because the future of liberal racialism—from affirmative action to diversity quotas to slavery reparations—requires periodic sightings of the ghosts of a racist past.

I mention these examples by way of preface to the climate-change summit that began this week in Paris. But first notice a pattern.

Dramatic crises—for which evidence tends to be anecdotal, subjective, invisible, tendentious and sometimes fabricated—are trumpeted on the basis of incompetently designed studies, poorly understood statistics, or semantic legerdemain. Food insecurity is not remotely the same as hunger. An abusive cop does not equal a bigoted police department. An unwanted kiss or touch is not the same as sexual assault, at least if the word assault is to mean anything.

Yet bogus studies and statistics survive because the cottage industries of compassion need them to be believed, and because mindless repetition has a way of making things nearly true, and because dramatic crises require drastic and all-encompassing solutions. Besides, the thinking goes, falsehood and exaggeration can serve a purpose if it induces virtuous behavior. The more afraid we are of the shadow of racism, the more conscious we might become of our own unsuspected biases.

And so to Paris.

I’m not the first to notice the incongruity of this huge gathering of world leaders meeting to combat a notional enemy in the same place where a real enemy just inflicted so much mortal damage.

Then again, it’s also appropriate, since reality-substitution is how modern liberalism conducts political business. What is the central liberal project of the 21st century, if not to persuade people that climate change represents an infinitely greater threat to human civilization than the barbarians—sorry, violent extremists—of Mosul and Molenbeek? Why overreact to a few hundred deaths today when hundreds of thousands will be dead in a century or two if we fail to act now?

Here again the same dishonest pattern is at work. The semantic trick in the phrase “climate change”—allowing every climate anomaly to serve as further proof of the overall theory. The hysteria generated by an imperceptible temperature rise of 1.7 degrees Fahrenheit since 1880—as if the trend is bound to continue forever, or is not a product of natural variation, or cannot be mitigated except by drastic policy interventions.

The hyping of flimsy studies—melting Himalayan glaciers; vanishing polar ice—to press the political point. The job security and air of self-importance this provides the tens of thousands of people—EPA bureaucrats, wind-turbine manufacturers, litigious climate scientists, NGO gnomes—whose livelihoods depend on a climate crisis. The belief that even if the crisis isn’t quite what it’s cracked up to be, it does us all good to be more mindful about the environment.

And, of course, the chance to switch the subject. If your enemy is global jihad, then to defeat it you need military wherewithal, martial talents and political will. If your enemy is the structure of an energy-intensive global economy, then you need a compelling justification to change it. Climate dystopia can work wonders, provided the jihadists don’t interrupt too often.

Here’s a climate prediction for the year 2115: Liberals will still be organizing campaigns against yet another mooted social or environmental crisis. Temperatures will be about the same.

We deride chances of Marine Le Pen and Donald Trump at our peril

Gideon Rachman

The rise of political extremists says something disturbing about liberal democracy in the west

I have a nightmare vision for the year 2017: President Trump, President Le Pen, President Putin.
Like most nightmares, this one probably won’t come true. But the very fact that Donald Trump and Marine Le Pen are running strongly for the American and French presidencies says something disturbing about the health of liberal democracy in the west. In confusing and scary times, voters seem tempted to turn to “strong” nationalistic leaders — western versions of Russia’s Vladimir Putin.
In Washington recently, I found most mainstream political analysts dismissing the idea that Mr Trump could win the Republican nomination, let alone the presidency. This struck me as complacent. If Mr Trump were a normal candidate he would be regarded as favourite for the nomination. He is ahead in the crucial early states of Iowa, New Hampshire and South Carolina.
Outrageous remarks about Mexicans, Muslims, the disabled and women have not dented his popularity.

Many Democrats chortle that if the Republicans are mad enough to nominate Mr Trump, he would certainly be trounced by Hillary Clinton in the presidential election. But even that cannot be assumed. The most recent national poll on a Trump v Clinton contest had Mr Trump winning by five points.
Some of Mr Trump’s statements are so openly racist that they make Ms Le Pen look like a moderate.
The leader of the French far right has been carefully softening her image in preparation for a run at the presidency in 2017. Even before the terrorist attacks in Paris, almost all surveys showed her reaching the final round of the election. This month her National Front may make a significant breakthrough by winning regional elections, making it look more like a potential party of government.
The rise of the political extremes is not confined to the US and France. Ultra-nationalist parties are in power in Hungary and Poland, both members of the EU. Nationalist parties are on the rise in Scotland and Catalonia, threatening the survival of the UK and Spain as nation states.

A sense of crisis is growing in Germany with the expected arrival of more than 1m refugees this year, leading to a backlash against Chancellor Angela Merkel’s government. With recessions and debt crises in southern Europe, “fringe” parties have moved into government in Greece and Portugal.

So what is going on in western politics? The overarching development is a loss of faith in traditional political elites and a search for radical alternatives. Behind that, it seems to me, there are four broad trends: an increase in economic insecurity, a backlash against immigration, a fear of terrorism and the decline of traditional media.
The US has now experienced several decades of declining or stagnant real wages for the majority of Americans. In many European countries, including France, double-digit rates of unemployment have become the norm. The financial crisis of 2008 has resulted in an enduring loss of trust in the competence of elites and the fairness and stability of western economic systems.

Economic insecurity has been supplemented by a sense of social instability, linked to rising immigration. The influx of Hispanics into the US and of Muslims into western Europe has allowed the Trumps and Le Pens to argue that feckless elites have allowed fundamental social changes to take place without consulting ordinary people. Mr Trump has called for the deportation of 11m illegal immigrants from the US and Ms Le Pen once compared Muslims praying in the streets of France to the Nazi occupation.

Nicolas Sarkozy, the former French president, who is likely to run against Ms Le Pen in 2017, has joined in the assault on “multiculturalism”. This kind of rhetoric about Muslim immigration and elite betrayal is also now commonplace in Germany.
In the wake of the Paris attacks, fear of terrorism is merging with hostility to immigration. The shockwave from the French capital was felt across the Atlantic — where Mr Trump, along with most of the Republican field, has been quick to claim that admitting refugees would increase the risk of a terrorist attack.

For populists, nationalists and extremists across the western world, a common theme is that the mainstream media are suppressing debate and are controlled by an untrustworthy elite.
Republican candidates have learnt that chastising reporters is an easy way to win applause. In France and Germany the argument that the politically correct “lying media” have suppressed debate about immigration is increasingly popular. Meanwhile, the rise of social media has allowed alternative narratives to flourish. Those Americans who want to believe that President Barack Obama is a Muslim find like-minded souls online or in the echo chamber of talk radio.
Conspiratorial talk is flourishing on social media in Europe.
The late senator Daniel Moynihan said: “Everyone is entitled to his own opinion, but not to his own facts.” In the age of social media, that is no longer true. For the likes of Mr Trump, Ms Le Pen and Mr Putin, anything can be labelled “true”. In this climate, against a backdrop of economic, social and physical insecurity, extremism flourishes.

Managing a World of Great Powers

Javier Solana

 Globe centered on Asia 
MADRID – Today, great-power competition is a fact: The United States now competes with an increasingly active Russia and a rising China. The Middle East, the South China Sea, and Ukraine are just three theaters where this new reality is playing out.
Upon rereading former US Deputy Secretary of State Strobe Talbott’s book The Great Experiment, I was left with the impression that the seeds of some of the dynamics at play today were sown some time ago. The book describes a conversation that took place in December 2000 between President Bill Clinton and President-elect George W. Bush. Clinton says that, judging by Bush’s electoral campaign, the security issues that seemed to concern him most were Saddam Hussein and the construction of a large-scale antimissile defense system. “That’s absolutely right,” Bush responds.
These issues were put on hold when tragedy unexpectedly struck, in the form of the September 11, 2001, terrorist attacks in the US, which brought a period of international cooperation during which solidarity against terrorism reigned. It was a time when we were all Americans, and when Bush described Putin as “very straightforward and trustworthy.”
The winds began to change that December, when the US announced that it was withdrawing from the Antiballistic Missile Treaty, in order to build an antimissile defense system to protect itself from a potentially nuclearized Iran. This did not go unnoticed in Russia.
The US at the time did not seem to understand that a multipolar world order was emerging – one that would make it very difficult to pursue, without serious consequences, the policies that Bush and Clinton had discussed in 2000. In a 2007 speech at the Munich Security Conference, Russian President Vladimir Putin made this plain, vehemently rejecting the intervention in Iraq and especially US plans to expand antimissile defense systems to Europe, calling this an act of aggression toward Russia and a breach of common European security.
In the summer of 2008, three events placed the new multipolar order in stark relief. China dazzled the world as host of the Olympic Games, reinforcing its status as a significant international player.
Russia’s military actions in Georgia – in the midst of the Games – showed the world that the concept of spheres of influence was still alive and well in the Kremlin. And the collapse the following month of the US investment bank Lehman Brothers, which unleashed a global financial crisis from which the world economy has yet to recover fully, underscored the advanced economies’ vulnerabilities, while largely sparing China.
With a new sense of confidence in its great-power status, China seemed to qualify the concept of a “peaceful rise” that its leaders have invoked since the era of Deng Xiaoping, adopting a more muscular foreign-policy approach within its neighborhood. Drawing on alleged historical rights, China began to expand its territorial claims, along with its military presence, in the South and East China Seas. In 2013, tensions peaked when China unilaterally declared an Air Defense Identification Zone (ADIZ) covering territories in the East China Sea that it claims, but Japan controls.
Many of the countries affected by China’s actions in the South and East China Seas have security treaties with the US, which has been the major maritime power in the Pacific region since World War II. China’s ADIZ declaration was therefore viewed by the US as a provocation. By expanding its sovereignty claims, China was actually expanding its claims to influence.
It has taken the international institutions some time to catch up to the changing world order.
The 2010 G-20 summit in Seoul produced an agreement to increase the emerging countries’ quotas in the International Monetary Fund by 2014. But the US Congress refused to ratify the changes, so nothing came of the agreement.
China then took matters into its own hands, spearheading the creation of the Asian Infrastructure Investment Bank. Fragmentation of the international institutions seemed imminent – that is, until European countries decided to join the AIIB. Though the US resisted at first, and has still refused to join, that decision was lent some nuance in a later conversation between Chinese President Xi Jinping and US President Barack Obama.
Meanwhile, Russia was exposing its own renewed foreign-policy ambitions in Ukraine. By violating the Helsinki Final Act in the spring of 2014, Putin placed Russian foreign policy in direct opposition to that of the US and Europe. This position was reaffirmed in September, when Putin decided to intervene in the Syrian conflict, securing for Russia a role in any attempt to bring peace to the country.
Today, the world is very different from what some might have imagined at the end of the last century, a decade after the Berlin Wall came down. Historically speaking, 15 years can seem long or short, depending on the intensity of change. During the last 15 years of mounting great-power competition and renewed instability in the Middle East – including the Arab Spring, the rise of the brutal Islamic State, Sunni-Shia proxy wars, and unspeakable human suffering – change has been very intense, to say the least.
But confrontation is not the whole story. Promising steps have been made in two critical areas: nuclear non-proliferation, especially through the nuclear deal with Iran, and the fight against climate change, exemplified in the encouraging preparations for the current climate summit in Paris.
If there is one lesson to be learned from all of this, it is that well-executed, tenacious diplomacy still holds extraordinary power to resolve conflicts. It remains the best instrument to produce those cooperative outcomes that confrontation effectively impedes.