by Clive Corcoran
Caption photo: Dominique Strauss-Kahn
Just how momentous an event is this, and have the capital markets fully discounted the ramifications? Will the post WWII “convention” that the IMF should be run by a European, but also someone that is entirely acceptable to the US, which holds almost 17% of the voting shares for the bank, be continued?
The replacement process for DSK could become both contentious and disruptive to capital markets in fairly short order. The more obvious and immediate disruptions could manifest themselves in relation to the ongoing saga of the bail outs of the peripheral EZ nations. To put it more precisely the real saga and the IMF and EU’s primary objective has been, in regard to its actions with Greece, Ireland and Portugal, to bail out the private banking sector within Europe where German, French and UK banks have particularly troublesome exposure to any sovereign debt re-structuring (or whatever is the current euphemism of the day) by these three countries — and who knows what may lie ahead for Spain, Italy etc.
Longer term the selection and replacement procedure will almost certainly bring to the fore far more systemically troubling issues such as the antiquated structure of the IMF and the fact that, for example, Brazil has just 1.38% of the voting power within the IMF which is less than that for relatively tiny economies such as Belgium and the Netherlands. Even worse, the world’s second largest economy, China, which has about 40% of the GDP of the US, has 3.8% of voting rights compared to the US with almost 17%.
Let’s examine each of these potential disruptions, quite different in their order of magnitude, in turn:
Holding the Eurozone together
What would be the possible implications for the EZ debt crisis if the candidate to replace DSK was to come from one of the newer G20 economies and who was less familiar with the nuances of European politics, and quite possibly less beholden to sorting out the mess that the EZ finds itself in?
Many within the European banking system and political establishments are particularly concerned that the new IMF head should have a deep knowledge of the EZ financial landscape, its major players and has a demonstrable interest in “looking after” the interests of some of Europe’s largest private banks – as well as some that are partly private and partly public e.g. RBS and Lloyds in the UK.
It has been claimed that Mr. Strauss-Kahn showed an extraordinary skill at holding together the fragile consensus within the EU between contrasting viewpoints from the Germans (even within the fractious German coalition) and other EZ member states. Most mainstream economists, bankers and policy makers within Europe and North America would strongly argue that there would be a substantial risk in appointing someone to head the IMF without the nuanced knowledge of European politics along with the flawed structure of the EMU and its various “stabilization” facilities including the EFSF
The New York Times is one of many publications to beopining that Christine Lagarde, the current French Finance minister is a leading contender for replacing DSK:
Mr. Strauss-Kahn’s resignation now sets off the jockeying for his replacement. The French finance minister, Christine Lagarde, is considered the leading candidate to succeed Mr. Strauss-Kahn, her friend and colleague. Her straight talk has helped burnish Ms. Lagarde’s reputation as one of Europe’s most influential ambassadors in the world of international finance.
The fact that Madame Lagarde has emerged as a front runner so quickly, and that she has that quality so valued in bankers – a safe pair of hands, is perhaps a source of comfort to traders and asset allocators on the day that the current head’s resignation has been announced. But there are also suggestions that her appointment may not be as effortless as it might seem. There clearly will be some awkward questions raised by numerous G20 nations that are economically punching above their weight in terms of their stature within the IMF, and these questions are likely to bring to the surface the glaring imbalances facing the IMF. In particular there is the highly anomalous condition where a small group of European nations enjoy unusually generous voting rights within the IMF than they would be entitled to in a system that was both merit based and a better reflection of 2011 rather than 1944. Just how well organized the pressure from newer and less empowered states remains to be seen, but there is one candidate that has already attracted attention as a possible rival to Mme Lagarde and who could potentially act as a “bridge” across the old order/new order divide. Again to quote from the NYT:
Her main competition, analysts say, is Kemal Dervis, a former finance minister of Turkey. Mr. Dervis is credited with rescuing the Turkish economy after it was hit by a devastating financial crisis in 2001, in part by securing a multibillion-dollar loan from the I.M.F. Before that, Mr. Dervis worked at the World Bank for 24 years.
The selection of Mr Dervis would be a bold move for the IMF but notably absent from the leading contenders is any one from the BRIC’s or other fast growing Asian economies. Rather if Mme. Lagarde emerges as the preferred candidate the selection process will begin to appear very much like business as usual or to put it more pejoratively as a “stitch up”. In other words, a coordinated effort by the old economies to hang on to the privileged positions granted to them more than 60 years ago. Even more ironic is the fact that many of these mature and “rich” economies are also the most indebted, topped by the US and UK which have public balance sheets that are financially embarrassing.
The world of 2011 is a very different place to that which emerged after the second world war in which the major powers created new global institutions to create the conditions for financial reconstruction and mechanisms to foster a more collaborative world order. But it was a world order that was almost exclusively cast in the mould envisaged by the five great powers at the time – the United States, Russia, France, the United Kingdom and China. These five states were provided with permanent seats on the UN Security Council – another global institution which emerged after the prolonged horror and destruction of WWII.
Interestingly the IMF took no such account of the pre-eminent roles that Russia and China would wield in the development of commerce and capital flows in the 60 plus years that have followed the establishment of the IMF.
Just two years ago the Indian foreign minister interviewed at the G20 conference in London ridiculed the notion that his country had no special status on the UN Security Council and that the old boy’s network which still prevailed at that body was an anachronism which deserved no place in the 21st century.
But no matter how compelling the arguments from the newer and more dynamic economies may be to enhance their role and power within the IMF, there seems, at least at the time of writing, to be no coordinated effort by these economies to seize the initiatives provided by Mr Strauss-Kahn’s dramatic departure.
The WSJ points this out in the following piece
It isn’t clear that emerging economies are ready to agree on a single candidate. Brazil’s finance minister Guido Mantega said the top IMF role shouldn’t be reserved for a European. South Africa’s finance minister Pravin Gordhan also forcefully argued the point. “Institutions such as the IMF must reform so that they can become credible, and to be credible they must represent the interests and fully reflect the voices of all countries, not just a few industrialized nations,” Mr. Gordhan said in a statement. A candidate from a developing country, he added, “will bring a new perspective” to the IMF.
It is, of course, a complete misnomer to be calling China an emerging market as it now exceeds Japan, Germany and other major G8 economies in terms of its economic output. In fact it is only surpassed by the US which has about 25% of world GDP. Indeed the ability to hide out under the BRIC moniker and to allow cliche driven economists and policy makers to avoid confronting the issue of how to engage China to its rightful position at the very top table of global banking is likely to be one of the major consequences of the DSK succession.
There has been much posturing and rhetoric from the more accurately characterized EM economies, such as Brazil, India and Russia, about how the IMF needs to recognize, within its voting infrastructure, the increasingly vital role of their new high growth economies, but at this most opportune time for the EM’s to be using their leverage to gain greater influence within the IMF, there has yet to be any coherent strategic move to advance a top level candidate who can represent their constituency.
The real vacuum seems to stem from the inability of China to want to take a leadership role in seizing the opportunity to become far more influential and engaged in the IMF’s affairs. This is all the more surprising in view of the often made comments of Chinese officials that the current monetary regime, predicated on the integral role of the US dollar, is more influenced by domestic issues affecting the US economy than any stewardship of the global reserve currency as a store of value.
Last week I was a guest speaker at a conference in Beijing and had the benefit of witnessing a a 60 minute presentation from a senior representative from the PBOC. The topic of the paper delivered by the lady from the PBOC, indeed the theme of the conference, revolved around the question of the pathway towards internationalization of the RMB.
It was clear from the phraseology and content of her presentation that China sees its entry into the front line of global banking and finance as a long way off. Several times during the presentation she placed emphasis on the need for a series of small steps, and the need for gradual evolutionary change rather than any decisive and potentially disruptive steps in the manner in which the PBOC handles its interface to the freely marketed currencies and capital instruments of the rest of the world.
The current offshore market for RMB – conducted by the Hong Kong Monetary Authority – runs, relatively speaking, at miniscule levels when one contrasts it to the $4 trillion which is cash settled each day in the freely marketed currencies of the world. One gets the sense that the internationalization and accessibility to RMB denominated assets is, to quote an apt phrase, on a slow boat from China.
In conclusion it would seem that the real fall-out from the sudden exit of DSK will be to highlight the fact that China remains essentially outside the world’s capital markets. For all of the talk about finding a replacement reserve currency/SDR’s for the US dollar, or of winding down US dollar denominated assets, when the opportunity arises for China to become a major protagonist in carving out the future direction of the IMF, it would seem that the isolationist and disengaged modus operandi of the People’s Republic will ensure that they will be passengers in terms of the way forward, rather than up front at the helm, which is where their $3 trillion of reserves would suggest they really should be.
Clive Corcoran is an FSA registered investment adviser providing private client wealth management services, as well as being an author, financial educator/mentor and an independent trader. He has written “Long/Short Market Dynamics: Trading Strategies for Today’s Markets” (Wiley, 2007) and two textbooks, “Financial Markets, and Portfolio Construction Theory” and “Wealth Management”. He currently is a director of Morphology Management Inc. which has developed a systematic trading platform. Clive has been a regular analyst/contributor to CNBC Europe and other broadcast outlets. Previously he was the founder and CEO of a personal and business management company for entertainment professionals that operated in Los Angeles, London, Munich and Toronto.