By Gary Littlejohn
Part 1: The IMF in Terminal Decline?
This set of three little essays is intended to outline the context in which the recent widely publicised BRICS initiatives have been taking place. In particular, the inauguration of new international banks is seen as a response to the dominance of Western finance capital and the failure of the so-called ‘Washington Consensus’ neoliberal orthodoxy that has produced negative economic effects worldwide, but nowhere more so than in developing countries.
Africa, which has about 16 per cent of the world’s population but only about two per cent of GDP and trade, has been particularly badly affected by the Structural Adjustment Programmes (SAPs) demanded by the IMF and World Bank as the price of ‘ensuring macroeconomic stability’ in indebted developing countries. The European Commission (EC) has ensured compliance with the SAPs by making such programmes a condition of aid and trade with the European Union. This has been secured through formal agreements with African governments, starting with various phases of the Lome Convention, and continuing through the Cotonou Agreement and various Economic Partnership Agreements.
The discussion of recent events in Europe in Part 2 is intended to show that such policies and programmes are by no means accidental, or merely focussed on developing countries/emerging economies. In fact, following the financial crisis of 2007-2008, similar issues have cropped up in Europe, thereby clearly indicating that the associated problems are systemic. Yet they are not being adequately addressed.
Changing context of International Finance Institutions (IFIs)
One need look no further than Joseph Stiglitz’s Globalization and its Discontents for a critique of the institutional functioning of the IMF. Criticisms of its policies and actions in Africa over the past 40 years are widespread. Now it is faced with two major problems: it is alleged to have broken its own rules and guidelines in the cases of Greece and Ukraine, and a new set of institutional rivals have been established. Evidently the latter development is more important, but the former, if true, is indicative of the IMF’s apparent attempt to maintain the status quo at a time when the centre of gravity of the world economy is shifting to the Far East.
The new rivals such as the BRICS New Development Bank (NDB) and the Asian Infrastructural Investment Bank (AIIB) have been founded largely because efforts by heavyweight IMF member states to obtain reform the IMF from within have proved fruitless, and even when proposals for reform have been agreed, they have been blocked by the US Senate. These new institutional developments seem to form part of a wider, more long-term strategy by Russia and China to restructure the basis for international trade by reducing the importance of the petrodollar as the de facto world reserve currency.
It has not been widely noticed that both Russia and China have been asking for payment in gold for much of their international trading, and in the case of Russia at least, where it has accepted US dollars or another currency, it has rapidly moved to use this currency to buy gold. This is not ‘paper gold’, that is, certificates declaring that one has a right withdraw gold from a vault located elsewhere, but actual bullion gold. China too requires payment in bullion gold, even from the USA, at least at times. China has also established a new gold vault for international trading purposes on the artificial island constructed for the new Hong Kong airport some years ago. China was unhappy when an attempt was made a few years ago to deliver tungsten covered in ‘gold’ paint instead of genuine gold bars, so they doubtless scrutinise such deliveries very carefully now. In addition, both China and Russia have recently declared that they are going to mine more gold on their own territories. This means that the proportion of total global gold reserves held in these two countries will soon rise to even higher levels. Russia already holds a preponderant proportion of total global gold reserves. It has recently openly discussed the possibility of inaugurating a gold-backed currency.
Such a move in itself would be a blow to the present dominant system of fractional banking and fiat money creation that is currently centred on London and New York. Evidently the Russian economy is not yet strong enough to make this move, but its resilience in the face of difficulties and its strong resource base on which other economies depend (including natural gas) suggest that this might one day prove to be feasible. Meanwhile, there has been no major international banking reform since the financial crisis of 2007-2008 and none is apparently envisaged, with Western politicians capitulating to financial capital on major policy issues, and even on the location of large bank headquarters. No bank is really too big to fail, and serious reform would have been possible after the taxpayer-funded bailouts of 2008.
A further noteworthy development has been that the current mild, shallow recession in Russia (induced by the decline in the oil price and by Western economic sanctions over its alleged role in Crimea and eastern Ukraine) has been dealt with in a slightly unexpected way. Not only did the floating exchange rate for the Ruble help to cushion the Russian economy against these setbacks, but interest rates were kept high after the Ruble stabilised at the end of last year. These continued high interest rates above the rate of inflation can best be interpreted as an anti-inflationary measure. In the short run, this has hit the poor in Russia, who still constitute 22 per cent of the population, but in the longer term, low inflation will benefit the poor, if it is accompanied by strong, diversified, technically innovative economic growth. We seem to be witnessing the development of a ‘sound currency’ policy aimed at choking off inflation for the long term. That could be a prelude to establishing the Ruble as one of the basket of currencies in a future replacement of the US petrodollar. Saudi Arabia’s recent overtures to Russia might be seen in this light, since the Saudis may anticipate the decline of the current petrodollar system.
On top of these measures, both Russia and China have been signing a series of bilateral deals with various countries that enable each party to trade in their own currencies, thereby avoiding use of the US dollar. This quite extensive set of agreements could be seen as being at least a kind of insurance against a dollar collapse, which would be understandable given the current systemic instability in global financial markets. The fact that the use of financial derivatives has been growing again, when markets should have been ‘deleveraging’ on a continuous basis since the financial crisis of 2007-2008, would be good enough reason for such prudence. However, the very extent of such currency swap trade deals promoted by Russia and China suggests that these actions are indicators of a policy of preparation for a basket of currencies to replace the US dollar on a more permanent basis. That would hardly be surprising in view of the reluctance of the USA to agree to reform of the IMF and World Bank.
It is often forgotten nowadays that the Bretton Woods agreement of 1944 established a dual reserve currency system, with the Pound Sterling and the US dollar having fixed rates of exchange against gold. Soon afterwards, the UK devalued Sterling in 1947, partly to retain a competitive edge in global trade while rebuilding its economy. It was also deeply in debt, at a level higher than that incurred in 2008. While the UK could sustain its reserve currency role owing in part to its extensive international trading network with colonies and former colonies, and in part to its relative industrial strength at the end of World War 2, it had by the 1960s lost a lot of its competitiveness owing to the German ‘economic miracle’ and to strong Japanese industrial growth that was funded by the USA. Even France, whose economy had been 25 per cent smaller than that of the UK in 1945, had by 1960 grown to be 25 per cent larger than the UK economy, with more modern infrastructure and massive urbanisation of about 30 per cent of its population. France succeeded in overtaking the UK like this while the UK living standards doubled in the same period. This less well known ‘miracle’ had been achieved by (capitalist) indicative planning, something that is being advocated in Russia at the moment.
Furthermore, Japanese growth was not funded by a ‘proportionate’ rate of capital investment. Instead, the introduction of ‘just in time’ manufacturing meant that less capital was required to achieve a given rate of output. Similarly, the use by firms in northern Italy of ‘flexible specialisation’ meant that they too could compete on international markets with less capital than that required by more conventional UK and US ‘Fordist’ manufacturing methods. By 1967, the UK balance of payments had become so dire that it had to devalue again and close down the Sterling Area (the trading area in which Sterling was the reserve currency).
Yet this economic growth in Europe and Japan was also adversely affecting the USA, despite the fact that it had come out of World War 2 as the world’s biggest and strongest economy. This was particularly true of competition from Japan. When President Nixon ‘closed the gold window’ in 1971, only 4 years after the UK devaluation of Sterling, what this meant was that the US dollar no longer had a fixed exchange rate with the gold, and floated against other currencies. The response of the USA was to reach a deal with Saudi Arabia that the USA would supply sophisticated weapons for Saudi Arabia’s armed forces and otherwise guarantee its security, in return for a guarantee that Saudi Arabia would only sell oil for US dollars. (The UK also managed to secure a long-term arms deal with Saudi Arabia.)
This arrangement created a huge demand for US dollars, and raised the dollar’s international purchasing power. It also created enormous funds of dollars in oil-producing (mainly Middle East) countries that needed to be recycled into ‘investment’ elsewhere. The petrodollar had been created, and the funds were loaned to many developing countries, often whether they needed them or not (John Perkins, Confessions of an Economic Hit Man).
The resultant indebtedness gave the World Bank and the IMF huge political power to enforce the policies that they favoured. Insofar as petrodollar loans were not used for productive investment, the debt would inevitably grow, and the indebted countries were obliged to follow economic policies favoured by the West, primarily the USA. By the 1980s, the European Commission was fully behind this approach (the Washington Consensus) and enforced it further through agreements such as the Lome Convention with African, Caribbean and Pacific (ACP) countries.
The USA also ensured that the terms of trade for food favoured energy intensive production that sustained the demand for oil and for motorised farming equipment. Comparatively low American food prices often drove out producers in developing countries, especially with the addition of the ‘Green Revolution’ that drove many small-scale farmers off the land and into urban unemployment, for example in India. An analogous process can now be seen with AGRA: the ‘Alliance for a Green Revolution in Africa’, although this new approach includes promoting genetically modified crops. The implications of all this in terms of Structural Adjustment Programs (SAPs) does not need to be explained to those studying Africa.
A new situation
It is this system that is now under threat from the new alternatives to the Bretton Woods Institutions. The World Trade Organisation (WTO) is probably not in a strong enough position to safeguard the status quo. Although this dominance by the Bretton Woods institutions has been bolstered by the intellectual property rights (IPR) and other trade provisions supported by the WTO, and ‘free trade’ has always been a policy pursued by dominant economies since the 19th century, the fact is that China has been able to achieve export-led growth of its economy in spite of the policies of such institutions. It has even prospered while joining them. Moreover, like Russia, it has joined the very important but little-known Bank of International Settlements. The significance of this will become clearer later.
How has the challenge been mounted?
Over the past 15 years, there have been intermittent claims on the Web that the price of gold is being manipulated. Be that as it may, there does not seem to have been much response in the gold price to the fact that Russia and China have been acquiring gold bullion. In addition a few European countries, including Germany and Belgium have asked for their gold back from the USA or the UK. The USA has delayed returning the gold to Germany. There are also reports that very soon after the coup in Ukraine in February 2014, all the gold bullion in the Ukrainian central bank, said to be worth USD 20 billion, was loaded on to a plane and has since not been accounted for.
Assuming for the sake of argument that the price of gold is indeed being kept artificially low, how does this play out for a country like Russia that is purchasing gold? According to one analysis, this needs to be considered in conjunction with the fact that a high price of oil resulting from the petrodollar arrangement described above keeps the demand for US dollars high. Given that natural gas prices tend to be determined by the price of oil, then Russia can sell both natural gas and oil at a relatively high price for dollars and then purchase gold fairly cheaply. The recent fall in the price of oil could be seen as threatening this market opportunity. In fact, as often happens with other commodities, the immediate response of Russia was to sell more gas at the lower price and to keep on purchasing gold, as well as changing its state budget and allowing the floating Ruble to absorb some of the shock by falling against other currencies, with an inflationary impact on domestic prices.
The longer run effect from 2000 up to 2014 has been that high oil prices have been used by Russia to diversify the economy away from commodity exports, to support the state budget including improved welfare payments, and to buy gold. Over this period the Russian economy has doubled in size and in 2015 is the fifth largest economy in the world. The purchase of gold by Russia (and China) has meant that most other currencies are not backed by something that is almost universally acceptable if confidence in the global financial system collapses. However the Russian and Chinese holdings of gold and the currency swap arrangements made by both Russia and China in the past few years mean that the entire set of countries involved, including BRICS partners and others in Asia and Latin America, no longer depend on dollars for trade to the extent that they once did.
The status quo that is now being undermined
On the other hand, historically, the fact that demand for oil creates a demand for US dollars has meant that the USA has been able to run up unprecedented debts, without suffering the kind of balance of payments crisis that affects other indebted countries (see graphic below). This debt has then been used to play risky financial games for short-run gains in financial markets. That is, the debt has been used as a tradable asset, and such assets have been used for speculative trading gains in financial markets. So-called ‘derivatives’ are a major form of such assets. The fact that so-called ‘investment’ bankers have been sure, even after the financial crisis of 2008, that US taxpayers can be forced to pick up the bill if complex unstable financial derivatives come unstuck has meant that the risky games have resumed, and no fundamental reform of Western financial markets has taken place.
Worse still, not only do taxpayers function as a backstop for such risky speculation, but the failure to keep ‘investment’ banking separate from retail banking has meant that a lot of such speculation is funded using the deposits made by ordinary individuals. Even worse, when one deposits money in a bank, it is not registered as a debt of that bank, but as an asset! So legally, the money no longer belongs to the individual depositor, but to the bank. The banks promise to return the money if requested, but in fact they can repudiate what in common sense terms would be their debt to the depositor. They can simply close their doors and either cease to function as a business or get the taxpayers to bail them out.
For the original illustration see VisualCapitalist.com
Ordinary people are thus losing out in two different ways: as depositors whose money is lost in speculative ventures (as opposed to productive investment) and as taxpayers. Now, with the new innovation known as a ‘bail in’ those depositors that still have money in the bank can have those deposits confiscated by the bank and used to help pay off its debts, as a condition of the bank receiving a bailout that is ultimately funded by taxes. This device was used during the Cyprus banking crisis and is now de facto EU policy for other EU countries. It will probably be used in the USA and elsewhere in future.
So the failure to separate retail banking from ‘investment’ banking, as used to be the case in the USA until 1998, puts individual depositors at risk of losses from the ‘investment’ arms of large banks. Apart from some weak measures in the UK, no real attempt has been made since 2008 to insulate retail banks from this risk. The most likely source of such losses comes from these already mentioned financial instruments known as derivatives. Astonishingly, derivatives actually use existing debt as collateral for taking on other debts, creating a risky ‘pyramid scheme’ type of structure that has the underlying strength of a house of cards. It is systemically unstable. It is precisely this type of risk that BRICS countries would rather not run.
Within developed economies, as we have seen very clearly since 2008, such risks are offloaded on to the general population, in a process rightly described as the privatisation of profit and the socialisation of loss. This creation of ‘debt bondage’ is analogous to the impact of petrodollars in developing countries, and thereby seriously undermines democracy in a manner that favours finance capital. Economic policy is increasingly taken out of the hands of the nation state. Yet the nation state remains the only realistic contender for a properly functioning democracy. As such, this functioning of Western financial systems constitutes a direct attack on democracy, with an increasing level of encroachment on the scope of democratic institutions. As we can see in Europe, at times this amounts to the replacement of a democratically elected government at the diktat of supranational financial institutions. The parallel with Structural Adjustment Programs in developing countries is evident, although in both developing and developed countries, the external imposition of economic policy though SAPs and/or EU Economic Partnership Agreements (EPAs) need not take so public a form as replacing a prime minister or an entire government.
In this context, one can see that Russia and China have found a means of avoiding reliance on such Western financial institutions and policies, by adopting a different approach at a time when they are not indebted to such institutions. Thus, the purchase of gold by China and Russia, using income from a positive balance of payments, has been part of a new strategy to reduce the reliance on US dollars for international trade. The currency swaps enable other countries with less gold but with tradable goods to ‘join the club’ by reducing their reliance on the US dollar. This has been going on for a few years, but the establishment of the BRICS New Development Bank (NDB) and the Asia Infrastructural Investment Bank (AIIB) has opened up new possibilities, by making it possible for emerging economies to plan both trade and investment without having to comply with the conditionalities of the Bretton Woods Institutions in deciding on their investment and growth priorities.
The Bank of International Settlements (BIS)
The BIS, based in Basle, Switzerland, is usually referred to as the “central bankers’ central bank”. This gives the misleading impression that it is a publicly-owned institution, like the central banks of most nation states. In fact, it is privately owned by influential international banks, and a quick look at its board gives the impression that the City of London has an important if not predominant position. Another major bank that gives the impression that it is state-owned is the Federal Reserve Bank, the central bank of the USA. The actual situation is that the “Fed” as it is known consists of a network of privately owned banks such as the Federal Reserve of New York (or whatever). The Fed issues US dollars in contravention of the Constitution of the United States of America, and has done so since 1913. No US President has attempted to reverse this situation since then, apart from John F. Kennedy.
Now, the board of the BIS meets fairly regularly and issues statements on banking policy, some of which are quite sensible, especially recent statements on the Euro. Most nation states are registered as members, but since it is privately owned this membership looks more like a means of ensuring compliance than an arena in which nation states can seriously contribute to policy making. In other words, private meetings of a privately owned institution that coordinates central bank policy internationally does not look like a beacon of democracy, especially when the central bank of the de facto world reserve currency (the Fed) is also privately owned. Only a few nation states are not members, including Iran and Syria. Is it pure coincidence that these countries are routinely vilified in the Western media?
Military action as a backstop
Given that the petrodollar system and other means described above function to ensure the indebtedness of large sections of the world economy, this means that central banks, including the European Central Bank which administers the affairs of the Euro currency, have huge influence over international economic policy. If indebtedness does not seem to be working to reproduce this situation, then strangely enough countries seem to find themselves targets of military action.
For example, when Saddam Hussein, who had been fully supported by the USA in his war against Iran, decided to sell oil for Euros, Iraq was targeted for invasion, whereas its own earlier invasion of Kuwait had not merited such a response. It had merely been pushed back out of Kuwait, and Coalition troops were then withdrawn from Iraqi territory. No regime change took place. The claimed reason for the later invasion was that Iraq had weapons of mass destruction (WMD) but as Frank Chikane has written (Things That Could Not be Said) South Africa had sent a mission of experts to Iraq and prior to the invasion had reported back to the UN, the USA and the UK that Iraq had no such WMD. Nevertheless, regime change took place, which was a war crime under international law.
When Libya decided to establish a series of African financial institutions designed to replace the World Bank and the IMF in Africa, even though it had recently ended its ‘pariah’ status over its alleged role in the Lockerbie plane crash, it was suddenly targeted for regime change on the grounds that it was threatening insurgents in Benghazi. No notice was taken of Libyan claims that such insurgents were members of Al Qaeda. The international response came before any Libyan government troops or artillery were moved towards Benghazi, yet the threat to put down the insurgency was not treated as an empty threat. No other country was even verbally threatened by Libya. Following the regime change that was mounted under the air cover of various NATO countries, there has to my knowledge been no public accounting for what happened to the roughly USD 50 billion of Libyan bank assets that were frozen during the conflict.
It has taken Iran years to get to the point where its meagre supplies of enriched uranium (enough for at most a few nuclear weapons) are probably no longer going to be treated as a program to acquire such weapons. Meanwhile Saudi Arabia’s response hinting that it may well acquire nuclear weapons from Pakistan passed with almost no media comment. Yet the intelligence agencies of both the USA and Israel have repeatedly publicly stated their opinion that Iran is not attempting to acquire nuclear weapons.
In none of these cases am I suggesting that the BIS, the World Bank or the IMF directly ordered military action. Western politicians seem to have a sharp instinctive sense of when the current international financial order is implicitly being threatened, even if the ‘delinquent’ countries do not always seem to be fully aware of the implications of the new policies that they have decided to pursue. In this context, the doctrine of ‘responsibility to protect’ (R2P) is a convenient ‘justification’ although it has no standing in international law and the consequences for vulnerable populations are invariably worse.
In sharp contrast, although both China and Russia are member states of the BIS, they are economically independent enough not to be subject to the pressures exerted through indebtedness. In addition, they are militarily strong enough to be no pushovers for NATO or any ‘coalition of the willing’. Furthermore, they seem to be too astute to fall for provocations that would draw them into a major war. Consequently, they have so far been able set their new joint agenda without being undermined by the means deployed against other countries since World War 2. Yet war remains an attractive proposition for countries dominated by finance capital. As Major General Smedley Butler (War is a Racket) has pointed out, war is profitable.
Public debt has apparently been a means of control of nation states for at least two hundred years, with wars allegedly financed on both sides by the same banks as a means of generating profits in the short run, and maintaining indebtedness in the longer run. This historical pattern (and its associated present array of supporting institutions) is now being challenged by a loose alliance of countries that seem determined to create alternative institutions. These new institutions are attractive to many countries at a time of widespread failure of the neoliberal orthodoxy and the failure of neocon militarism to resolve the resulting crisis.
Part 2 will look at how this process is playing out in the context of Europe, with the European Commission (EC) and the European Central bank (ECB) apparently attempting to maintain the status quo when the economic situation poses an increasing challenge to current EU institutions. The EU is facing problems in Southern Europe, especially Greece, and has been party to other problems in Ukraine. It is intended that Part 3 will attempt to analyse the implications of all this for Africa.
Gary Littlejohn was Briefings and Debates editor of the Review of African Political Economy from 2010 to 2015. He is the author of Secret Stockpiles: A review of disarmament efforts in Mozambique, Working Paper 21, Small Arms Survey, Geneva, October 2015.