Daniel W. Drezner

The hegemon is not going away

The hegemon is not going away

Yesterday the Federal Reserve announced a currency swap arrangement beyond the G-10 economies — $30 billion each was extended to Brazil, South Korea, Singapore and Mexico.  Krishna Guha explains the logic behind this step in the Financial Times

In effect, the US central bank is taking care of the dollar liquidity needs of these four emerging economies, leaving the IMF to take care of the rest. International officials believe that the European Central Bank may also take some responsibility for providing further support for vulnerable economies in Europe, including potential members of the eurozone, along with the IMF. The Fed is providing its support to Mexico, Brazil, South Korea and Singapore via currency swaps on essentially the same terms as those offered to the 10 industrialised economies with which it already has reciprocal currency arrangements, including the eurozone, UK and Japan. These are much more generous than the terms on which the US government and multilateral institutions lent money to developing countries during emerging market crises, for instance in the 1990s. In today’s operations the Fed simply lends dollars to the local central bank, and the local central bank lends the dollars on to local banks. The Fed takes the counterparty credit risk of the central bank on the other side of the swap, with collateral in the form of an equivalent amount in local currency. There are no policy conditions…. It worried that the IMF might not have enough resources to support all the emerging economies that might need dollars. The Fund’s total lending capacity is about $250bn. The Fed swaps supplement this with an extra $120bn for Brazil, Mexico, South Korea and Singapore alone. The Fed hopes the Fund’s resources will be enough to deal with the remaining needs of the emerging economies.

Meanwhile, the IMF also announced the creation of a new credit facility:    The geopolitical implications of these moves are pretty surprising to Brad Setser

[I]t has been fashionable to argue that the crisis would increase China’s financial influence — as China sits on a ton of foreign exchange and potentially offered an alternative source of foreign currency liquidity. Indeed, China seems keen on doing a deal with Russia that would help Russian state-owned energy firms raise foreign exchange to help cover their maturing external debts — and the in the process, help reduce the drain on the government of Russia’s foreign exchange reserves. But so far the crisis hasn’t had that effect — in part because the US and Europe have moved quickly (by the standards of governments) to help a broad range of countries meet their foreign currency needs. That was driven first and foremost by the needs of the emerging economies — and the ripple effect their deepening trouble would have on the US and Europe. But I wonder if the possibility that institutions like the IMF could be bypassed if they didn’t respond more quickly and creatively than in the past didn’t help to spur the recent set of policy changes. Those in the IMF’s Executive Board who normally would object to unconditional lending didn’t block the new short-term lending facility — perhaps at least in part because of recognition that the IMF potentially isn’t the only game in town (or in the world). China’s rise, in effect, contributed to the a change in the political climate that helped to lift some of the political constraints that in the past limited the IMF’s scope. I certainly didn’t anticipate this. Three months ago I was among those thinking that the rise of the emerging world’s reserves would reduce the IMF’s future relevance.

I agree with Brad that the presence of alternative sources of financing could explain why the Fund and the G-7 have moved so quickly.  There’s something else going on, however — China is moving very, very slowly.  They’ve already had opportunities to provide alternative sources of financing and declined.  Indeed, for all the bluster about countries like Iceland and Pakistan working around the IMF, in the end they’ve needed both Fund capital and the Fund imprimatur in order to get access to liquidity.  One could argue that these are countries more inclined to ally with the West, but that doesn’t really hold true for Pakistan — and it certainly doesn’t hold true for Belarus.  So what’s going on?  I don’t know yet — but my hunch is that there are two things driving this curious inaction:

  1. These countries are focusing on domestic problems first.  So is the G-7, of course, but the nature of the Russian and Chinese polities make those governments extra concerned about any signs of unrest. 
  2. For all their aspirations to great power status, both countries lack the policy expertise necessary to take on greater leadership roles.  This leads to profound risk aversion, which leads to inaction.  On the flip side, the U.S. is accustomed to talking to the countries in crisis, which both provides it with more information and allows Washington to act more quickly. 

This is just spitballing — I could very well be wrong.  But there’s no doubt that, six weeks into this crisis, America’s hegemonic status has, if anything, become more entrenched.