The Hollow Order
Rebuilding an International System That Works
In March 2009, a few months after the outbreak of the global financial crisis, the governor of China’s central bank, Zhou Xiaochuan, published an essay on the bank’s website. Zhou criticized the international monetary system for “the inherent deficiencies caused by using credit-based national currencies” and praised the Special Drawing Right (SDR), the synthetic currency created by the International Monetary Fund (IMF). The SDR “serves as the light in the tunnel for the reform of the international monetary system,” Zhou wrote.
Zhou’s call for a greater role for the SDR attracted attention around the world. Many observers viewed his comments as a sign of China’s readiness to challenge the U.S.-dominated international monetary order. Indeed, several years later, in 2015, China got its own currency, the renminbi (RMB), admitted to the SDR basket, which the year before had included only the dollar, the pound sterling, the yen, and the euro. Some Western analysts saw that measure, too, as a sign of China’s interest in challenging the international monetary system.
In fact, Zhou’s 2009 statement was not as revolutionary as it seemed. His comments reflected China’s long-standing position that the SDR should play a greater role in the international monetary system, making it less detrimental to developing countries and easing some of the instability produced by its dependence on national currencies as reserves. That position says more about China’s national identity than about its interest in challenging the U.S.-dominated international monetary system.
THE EMERGENCE OF THE SDR
The international monetary system created at the end of World War II was based on fixed exchange rates and a strong link between the dollar and gold. By the early 1960s, the economist Robert Triffin had identified a major weakness in this system: the country that issued the global reserve currency (in this case, the United States) had to supply the world with liquidity in its currency—but to do so, it had to run balance-of-payments deficits, which would erode the world’s confidence in the currency. Over the course of the decade, the so-called Triffin dilemma became a widely recognized reality. In 1969, to address the problem, the IMF created the SDR to supplement the U.S. dollar as a source of international liquidity; in 1970, it made its first allocation of SDR 9.3 billion. (The value of the SDR fluctuates with the value of the currencies on which it is based.)
The new synthetic currency was a marginal factor in the international monetary system—and it became only more so over time. Indeed, from the 1970s to the 1990s, the share of SDRs in global nongold reserves declined from nine percent to between one and two percent. By the early years of this century, the SDR seemed mostly irrelevant.
That trend underwent a dramatic reversal in the aftermath of the global financial crisis. Many observers, such as the political economist Eric Helleiner, credited Zhou’s comments for the revived interest. But did Zhou’s views really represent a radical break from China’s earlier approach to the reform of the global monetary system? History suggests otherwise.
CHINA JOINS THE CLUB
By the time the People’s Republic of China joined the IMF in 1980, the original Bretton Woods system had gone through tumultuous changes. The United States had broken the link between gold and the U.S. dollar in 1971, rendering moot the original purpose of the SDR—that is, to supplement the dollar under a fixed exchange rate. In 1978, the IMF set forth the objective of making the SDR a principal reserve currency; the next year, it made a second allocation of about SDR 12 billion.
In its first years as a member of the IMF and the World Bank, Beijing showed itself to be a modest, cooperative newcomer. When it came to the SDR, China tended to rely on reports and studies issued by the IMF’s staff, largely agreeing with their recommendations. But over the years that followed, Beijing began to lobby for the allocation of more SDRs, a more equitable distribution of the synthetic currency, and an expanded use of the SDR more generally.
Why did China push for these policies? In the early 1980s, Chinese representatives at the IMF contended that Western official development assistance was not meeting the growing financing needs of most poorer countries. China argued that more SDR allocations could reduce those countries’ need to borrow abroad, help them expand their imports, and let their economies grow. Around a decade later, in a 1992 speech at the IMF, China’s representative to the organization, Che Peiqin, made a similar case. Che argued that countries in sub-Saharan Africa and eastern Europe had seen a considerable decline in the ratio of nongold reserves to imports. Without easy access to the international capital markets, they struggled to restore their reserve ratios, at the expense of imports and growth. It would be in the interest of all, Che argued, to make more official resources available to those states.
After the Asian financial crisis of 1997–98, foreign direct investment in developing economies was slowing, the balance of payments among many poorer countries was taking a hit, and such countries were facing high costs to borrow in international markets. So China again called for more SDR allocations. Increasing the allocation of SDRs, Beijing argued, would help stabilize the international financial system by providing a safeguard against liquidity crises among developing countries.
The distribution of SDRs was another focus of Chinese policy. According to the IMF’s Articles of Agreement, new allocations of SDRs would be distributed according to members’ IMF quotas, meaning that developed countries, which hold the biggest quotas, would get more SDRs than would developing countries. China took issue with this distribution, and on several occasions, Beijing’s representatives to the IMF called for the organization to redistribute some of the SDRs so that they would benefit developing countries.
The first two drivers of China’s interest in SDRs—liquidity and distribution—thus took preference over what today’s observers regard as the core of Chinese policy: expanding the role of the SDR in the international monetary system.
Yet that third theme was present as far back as 1986. In a speech at the IMF in that year, China’s representative, Huang Fanzhang, argued that because creditworthy countries (generally developed ones) could augment their reserves by borrowing in the market without having to undertake specific adjustment measures, they could delay correcting the imbalances that had led to the borrowing until they had reached a point where they had to take tough measures. Huang also pointed out that financial markets tend to overreact, oscillating between overlending and panicking. That meant that the SDR held great potential to improve the management of international liquidity: by increasing the share of the SDR in international reserves, the reserve-generating process would become less volatile, since it would be less dependent on private capital markets.
In 1989, China’s representative to the IMF, Dai Qianding, called on the agency to broaden the use of the SDR by permitting private entities to employ it and by simplifying the processes by which it could be used. In the long term, Dai told the IMF, “there is no firm assurance in relying on a national currency as an international reserve asset,” so it was appropriate to explore making the SDR the international monetary system’s principal reserve asset. In 1994, Wei Benhua, the Chinese representative at the IMF, went further. “We must make efforts in moving toward the objective of making the SDR the principal reserve asset of the international monetary system,” he said.
CHALLENGING WHAT’S IN THE BASKET
Since 1980, the SDR basket had included the currencies of the five IMF members with the largest exports of goods and services between 1975 and 1979: the U.S. dollar, German mark, French franc, Japanese yen, and British pound sterling. (The mark and the franc were replaced by the euro after the introduction of that currency.) In the 1980s and 1990s, China went along with the method and basket used by the IMF to decide the value and the interest rate of the SDR.
But China’s position began to change in the years that followed. In 2005, a statement China submitted to the IMF criticized the IMF for using “backward-looking indicators” in developing the SDR basket and suggested that the institution discuss China’s rapid growth as an exporter. The implication was clear: the IMF should consider the RMB for inclusion in the SDR basket. By 2009, after Zhou’s statement, Chinese representatives at the IMF again argued that in order to improve the liquidity and attractiveness of the SDR as a reserve asset, IMF staff should study how to broaden the role of the SDR, expanding and realigning the currencies in the SDR basket.
In 2010, in a review of the SDR basket, the IMF rejected the RMB’s attempt to enter. But China did not give up. At the G-20 summit in St. Petersburg in 2013, Chinese President Xi Jinping again called on the IMF to reform the SDR basket, and in 2015 the Chinese government intensified its push. Finally, in November 2015, the IMF decided to accept the RMB into the SDR basket, assigning it 10.92 percent of the total weight, below the U.S. dollar and the euro, but above the yen and the pound sterling.
CURRENCY POLITICS IN CONTEXT
Contrary to widely held impressions, then, Zhou’s 2009 statement was not a major departure from China’s long-standing positions regarding the SDR or the dollar-led order. Instead, it represented a reprisal of ideas that Beijing had pushed for decades: namely, that the international monetary system was burdened by its dependence on private capital markets and a few national currencies, the dollar chief among them.
What was notable about Zhou’s statement was not its content but its timing. In the late 1990s, when the IMF decided to allocate more SDRs for the first time since the early 1980s, China’s economy was the world’s seventh largest, ranking behind Italy’s. By 2009, however, China’s GDP had become the third largest in the world, after the United States’ and Japan’s. More important, the global financial crisis, which originated in the United States, had dealt a heavy blow to the prestige of many developed countries: China stood almost alone as the world’s remaining major engine of growth. So when Zhou had something to say about reforming the international monetary system, the world listened—even though Chinese representatives had been saying similar things for quite a while and even though others, such as a commission of economists led by the American Joseph Stiglitz, were making similar proposals about the SDR.
NATIONAL IDENTITY AND CHINA’S SDR POLICY
China’s long-standing support for the SDR can’t be neatly explained in terms of its economic interests. For years, the Chinese government advocated new SDR allocations and a more equitable SDR distribution, arguing that those changes would help developing countries deal with their balance-of-payments problems. From the early 1980s to the early 1990s, when China had limited export capacity and was itself a developing country, this position could have benefited China. But since the early 1990s, China has been a massive exporter, with a current account surplus to match. Its support for the expansion of the SDR thus seems to have diverged from its own economic interests. It is also unclear how China’s economic goals are being served by Beijing’s calls to make the SDR a more reliable and stable source of international liquidity, thereby eventually making it the world’s principal reserve asset. In fact, there is good reason for Beijing to eschew a bigger role for the SDR. A more important SDR would spell a decline in the dollar’s role and value, and that would cost China, which is a major holder of dollar assets.
Nor is this all. In order for the RMB to enter the SDR basket, it would need to meet the IMF’s standards of being “widely used” and “freely usable.” China had to take some big steps toward financial liberalization to get it there. Some analysts cautioned that these radical adjustments would bring considerable risks to China’s financial system. Others pointed out that the RMB’s inclusion in the SDR basket would neither turn the RMB into a major reserve currency nor make the SDR a substitute for the U.S. dollar.
After Beijing began to push for the RMB’s entry into the SDR basket in the first decade of this century, the prevailing opinion in China remained cautious. Although some argued that the SDR would gain more relevance once it included China’s currency, many commentators continued to point out the SDR’s limitations, and influential observers, such as the former central bank governor Dai Xianglong, predicted that the future of the international monetary system would involve a number of national currencies rather than a suprasovereign one such as the SDR.
If Beijing’s SDR policy seems inexplicable in light of the country’s material interests, it makes a good deal of sense when China’s national identity is taken into account. When Beijing joined the IMF in 1980, it identified as a member of the developing world, and it stuck to that identity in international forums. Indeed, according to research by the political scientists Harold Karan Jacobson and Michel Oksenberg, Chinese officials at both the World Bank and the IMF were under instructions from Beijing not to raise demands that might be seen as costly to any developing country. Supporting the SDR as a tool of economic development went hand in hand with China’s identification with the global South.
Since the late 1990s, another identity has gradually taken hold in the Chinese imagination: that of a major power. Beijing’s performance during the Asian financial crisis played a big part. As its neighboring countries’ currencies took a dive in 1997 and 1998, China faced tremendous pressure to devalue the RMB. It refused to do so, and although Chinese exports suffered heavily, Beijing drew praise from around the world, affirming its self-perception as a “responsible great power.” Then came the years after 2007, when China hosted the Olympics, sent its first astronauts to walk in space, and preserved the growth of its economy as the United States fell into its worst financial crisis in decades. Joining the SDR basket may have involved financial risks, but it also promised an intangible reward in the form of international prestige. In late 2015, when the IMF finally approved the Chinese currency’s entry into the SDR basket, it was warmly celebrated in China. For China’s leaders and for the Chinese public, the news was a clear sign of China’s rising international status.
China’s advocacy of a greater role for the SDR in the international monetary system since the global financial crisis, then, has not been as revolutionary as it seems. Nor is it necessarily meant to challenge the dollar-dominated order. Beijing’s SDR policy has been more about affirming China’s national identity than about advancing its material interests.