On the Economist article: To join or not to join

On April 8, 2015, the Memorandum of Understanding was signed in the presence of AIIB member countries. However, as large industrial nations such as the United States and Japan were not in attendance, should they have been?

The US media has largely covered whether the US should be involved in the AIIB. A previous Keene’s Corner (Bloomberg Briefs: Economics Asia) Q&A highlights the situation well.

  1. Q: Speaking of China, what are we to make of the UN and the IMF saying its currency (the RMB) is no longer undervalued?
    1. I suppose that everybody has got their own opinion about what is fair value. People us different models. The IMF has been hinting at this for a while. But the real focus is whether the RMB is going to be included in the IMF’s SDR basket. This is very important because this is a part of the internationalization of the Chinese currency and the IMF will make the decision later this year. It looks like more countries want the Chinese to be included in the SDR, including the Germans.
  2. Q: Should Americans feat that? In referring to the IMF SDR basket.
    1. We really cocked up that AIIB decision and how we present it to the world. I think that we really have to make a choice. We either make room at the economic table for the Chinese, or we have to fight them – not necessarily military, but I think that it’s in our interest to figure out ways to turn a zero-sum game into a non-zero-sum game and make room at the table for them. We should fear them. The U.S. does well when we think someone is chasing us, when someone is about to eat our lunch. It boosts our own competitive drive. But for the next generation, trying to make room at the table for the Chinese, it will probably be the number one economic priority.

And so to address the question, to join or not to join?

Earlier in March, 32 countries (first movers) signed up to the AIIB, including Australia, South Korea, Germany and Great Britain the most notable, as the latter two effectively control the euro and British pound respectively. As of February 2015, the SDR basked was composed of the USD, EUR, GBP and JPY at 42%, 37%, 11% and 10% respectively. This means Japan and the US are the only two nations of the SDR basket who have not joined the AIIB and this could pose as a hairline fracture waiting to be pose problems in the future.

However, in terms of multilateral development banking, the US effectively runs the International Monetary Fund (IMF) and World Bank, while Japan effectively runs the Asian Development Bank (ADB). So why should Japan get involved with the AIIB? I would argue that Japan is only able to run the ADB as a result of the US, while the US genuinely does operate the IMF and World Bank, especially given its veto power (big IMF decisions require an 85% majority vote and the US holds 17%). So would Japan lose out as a result of becoming allies with China? In the short term, yes, but in the longer term? No, it would be a win.

As Keene’s Corner highlights: liberalization of the RMB is very important to the Chinese and will also help fast track the RMB in becoming the world reserve currency in the future, if their intentions are so. However, the RMB will face issues with the IMF in that it is not defined as a “freely usable currency,” that is, a SDR component by the IMF’s balance-of-payments definition. Furthermore, the direct international monetary effect from the RMB’s inclusion could arguably be seen as the SDR only accounts for 5% of the global official reserve asset holdings.

Currency liberalization? According to SWIFT Watch, as of January 2015, global inbound and outbound traffic was USD (43.41%), EUR (27.75%), GBP (8.24%), JPY (2.79%) and CNY (2.05%). As we can see, the euro has done extremely well since its inception in January 1, 1999, and it seems the RMB has much work to do in order to be competitive in being the third largest currency. This further poses the question what grand scheme China has in recently acquiring LME Holdings Limited?

So will Japan choose to join next month? As the Economist highlights, “Japan is the last big holdout in the region. It is in a quandary. In early June, Mr Abe’s Liberal Democratic Party will issue a report setting out agreements for and against joining.” I’m sure Japanese officials had plenty of chance to discuss this issue if not through back channels, at the OECD Forum earlier this week.

Although slightly malicious, Japan should join the AIIB regardless of whether China has ill intentions with its strategy and implementation. Furthermore, “if the (Japanese) government decides not to join the AIIB, and no deal is reached on the Trans Pacific Partnership, Japan could see its economic influence in the region fade further.” I do not believe there is an $8 trillion funding gap, just a gap that China is seizing to begin stretching its legs, a move that has the US sweating.

The above is extracted from my working paper, “The Asian Infrastructure Investment Bank: Can multilateral development banking ever be Kaldor-Hicks efficient?”

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