Letting the Fox in the Hen House: Why the U.S. Should Restrict Chinese Control of the IMF

Amidst the furor over the Sequester there is another critical policy issue being debated and it concerns the U.S. government’s role in the International Monetary Fund (IMF). The Obama administration is seeking Congressional authority to change the voting process at the IMF, and in particular, to give China a much larger role. But the last thing the U.S. government should be doing is strengthening the ability of China to shape IMF policy, especially given its unrepentant, mercantilist practices.

Established after WWII, the IMF was charged with overseeing the international monetary system and encouraging member countries to eliminate exchange restrictions that hindered trade. As a result, under IMF rules, each member country has agreed not to engage in “protracted, large-scale intervention in one direction in the exchange market.”

These are nice words but in practice they have been rendered largely meaningless. The IMF has proven unwilling to take action to curtail currency manipulation or similar egregious actions China and other nations have engaged in to distort global trade, hurt the U.S. economy and advance their domestic economic interests.

Case in point, the IMF’s Executive Board concluded its 2010 Article IV consultations with China mostly by praising the Chinese authorities. Amazingly the board stated that China’s “quick, determined, and effective policy response [to the global financial crisis] has helped mitigate the impact on the economy and ensured that China has led the global recovery.” Yes, China led the global recovery, but by massively subsidizing its export industries, both through currency manipulation as well as direct subsidies to its large, state-owned enterprise sector, thereby cranking up its mercantilist export machine and slowing the recovery in other nations, including America.

The IMF’s directors actually “welcomed China’s recent decision to return to the managed floating exchange rate regime,” even while they “agreed that the exchange rate is undervalued.” Thus, the IMF praised China for moving toward a more freely floating exchange rate regime, even as Chinese currency rates depreciated because it was committed to manipulating rates to effectively reduce the trade positions of global competitors.

To the extent that the IMF even views rampant foreign mercantilism as a problem, it sees it as caused by the victims, not the perpetrators. For example following the Great Recession, the IMF advised nations whose economies were damaged by innovation mercantilists to cut government spending (the standard IMF answer to virtually any problem) in order to devalue their currency and reduce demand for imports. This would then reduce innovation mercantilists’ exports and maybe help them see the error of their ways. Ah, a devious and subtle plan that has of course proven ineffective in stopping mercantilist practices and further hampered nations such as the United States.

But the IMF is not just blind to the growing problem of Chinese mercantilism it simply does not want to rock the boat. China is an increasingly prominent player in world monetary and trade markets and the IMF is actively working to improve its relations with the nation to further enhance market access and promote development. In fact, the IMF recently hired Min Zhu as special advisor to the IMF’s managing director. Zhu was most recently deputy governor of the People’s Bank of China.

Does Zhu urge the IMF to force nations like China to start playing by the rules? Of course not. Rather, he calls on the IMF to pressure America to give up on manufacturing: “You see most advanced economies are service-oriented, and emerging economies are manufacturing-oriented, partly reflecting the division of labor . . . [this] complementarity will make the world more productive and more sustainable, and the IMF should play a central role in this process.”

This is akin to having the deputy director of the Soviet Union’s central bank being appointed to the IMF in the 1960s and advising America to stop spending money on defense. But what’s worse is that in the 1960s, the IMF would have rejected Zhu’s recommendation that advanced economies give up on manufacturing, but now the IMF considers it sage advice.

China’s goal of gaining stronger representation in the IMF is in part to ensure that it neutralizes any remaining opposition within the Fund to its innovation mercantilist ways. So far, it’s been successful, but it wants further insurance. For example, a recent IMF staff report stated the Chinese renminbi was “substantially undervalued” and that this was contributing to China’s large trade surpluses. But China worked to block its official release.

If the IMF is truly committed to open trade and market-oriented policies it will need to make rolling back Chinese mercantilism a top goal, rather than expanding their influence and letting the mercantilist fox in the free-traders’ hen house.