The AIIB And The U.S. Opposition To It’s Creation by Bill O’Grady of Confluence Investment Management
China has founded an infrastructure bank, the Asian Infrastructure Investment Bank (AIIB), to compete with the World Bank (WB) and the Asian Development Bank (ADB). The U.S. has opposed the creation of this bank but, despite administration opposition, 57 nations have joined it, including 14 members of the G-20. A chorus of commentators have suggested that the founding of this bank may mark the end of U.S. hegemony.
In this report, we will describe the AIIB, including its members and capitalization. Next, we will cover the conventional wisdom surrounding the bank, and follow up with our analysis of the real impact of the bank. We will conclude with potential market ramifications of this framework.
The AIIB
In October 2013, China proposed a new infrastructure bank. Initially, with the exception of India, China was only able to attract small Asian nations. However, over U.S. objections, the U.K. Chancellor of the Exchequer, George Osborne, announced that his nation would join the AIIB. This announcement led to a plethora of developed nations signing on to the new bank. After Britain’s announcement, numerous other European countries announced their membership in the new bank. Perhaps the biggest snub to the U.S. was Israel’s decision to join the bank. Even Taiwan tried to become a charter member, but China rejected the application because the mainland views Taiwan as a province of China.
The AIIB will be capitalized at $100 bn, of which China will contribute $50 bn, making it smaller than the WB, capitalized at $223 bn, and the ADB, at $163 bn. Still, the ADB estimates that the region needs $8.0 trillion in infrastructure development, so the additional funds should be welcome.
The U.S. opposes the creation of the AIIB because it competes with existing development banks. The administration fears the new bank will lack proper controls to prevent corruption and protect the environment. China was frustrated with its small representation in Bretton Woods-era bodies like the IMF and the WB. China’s voting power at the former is a mere 6.068% and 4.42% at the latter. Given that China is the second largest economy on the planet, it feels it should have greater power in these organizations. This position led China to found the AIIB.
The Conventional Wisdom
According to the pundit class, the founding of the AIIB is “kind of a big deal.”1 China believed that the U.S. had a stranglehold on the Bretton Woods-era institutions and was using them to project power. The U.S. has been considering reforms for the WB and IMF that would give China greater representation. However, no U.S. administration has actually pushed for these changes in Congress and there is a perception that the U.S. wanted to keep the preponderance of power among itself and its close allies, Japan and Western Europe. In effect, the lack of reform is a way for the U.S. to effectively contain China and prevent it from reaching its true potential. There is some truth to this allegation. The left in Congress loathes to give power to China and the right doesn’t really like multilateral institutions. Thus, legislation to make changes tends to fall low on any president’s priority list.
When China proposed the AIIB, the Obama administration leaned on developed nation allies to avoid joining the bank. The administration had been reasonably successful at this effort until Britain decided to break ranks.
The British decision to join the AIIB was driven by the hope that London will be a major clearing market for the Chinese yuan (CNY) once that currency becomes freely convertible. The U.K. was worried that if it stayed out of the AIIB then other financial centers might win out. Once the U.K. made its decision, several other European nations moved to join as well, worried they would miss out on whatever benefits might accrue.
The British decision opened the floodgates of membership. In fact, according to reports, even the Chinese were stunned by the scramble to become members.2 Conspicuous in their absence, only Japan and the U.S. have declined to join.
There is no doubt the Obama administration handled the AIIB situation poorly. Its ham-fisted response to China’s decision to create the bank has turned into a major diplomatic embarrassment. To have major allies like Germany, Britain, Australia and South Korea join over American objections makes the U.S. look weak. Although we don’t usually engage in “oughts,” it would have been much simpler for the U.S. to join the bank. If the administration was really concerned about oversight, it will have more by being a member than not being a member.
The huge response to the AIIB has led to a number of commentators projecting that this event may mark the beginning of China’s ascendency and America’s decline. Some have speculated that this bank will dramatically expand China’s influence in Asia as it uses its growing financial clout to tie the region more closely to its economy.
The Reality
These projections are probably overblown. As Ho-Fung Hung noted recently in the New York Times,3 the AIIB actually represents a retreat of sorts. China has tended to avoid multilateral agreements in favor of bilateral arrangements. In one-on-one situations, given China’s size, it can more easily dominate the relationship. However, over the past few years, China has managed to botch many of these situations. From 2001to 2011, the RAND Corporation estimated that China had lent $671 bn to developing nations, an amount that dwarfs the capital of the AIIB. However, China put conditions on this lending that forced nations to use Chinese contractors and products. These stipulations have led to deep resentment in many nations, mostly notably in Africa. For example, in Zambia’s 2011 election, voters elected a candidate on an anti-China platform. Lamido Sanusi, the former governor of the Central Bank of Nigeria, suggested that China’s activities in Africa were merely a “new form of imperialism.” Africa isn’t the only region to take umbrage with China. Myanmar has tried to improve relations with the U.S. to overcome its dependence on Chinese investment. It also suspended Chinese-funded dam projects in the country due to local opposition.
In addition to these problems, China’s aggressive actions taken in its coastal waters have further damaged its reputation. Activities such as putting an oil rig in disputed waters around Vietnam, creating islands in the South China Sea to expand its reach, and the nearly constant incursions into Japan’s airspace have raised serious concerns about China’s belligerence. Tensions have increased to the point where former U.S. adversaries, like Vietnam, are welcoming U.S. Navy visits to its harbors.
Ho-Fung argues that the creation of the AIIB is really a form of retreat. The backlash that China is experiencing in its foreign investment and regional security policy is driving it toward the use of soft power. Soft power, using culture, trade and aid to improve a nation’s standing and help in projecting power through cooperation, is partly why the U.S. established the IMF and the WB in the first place. Japan’s establishment of the ADB in the mid-1960s was done for similar reasons. China likely intends to use the AIIB to promote itself less aggressively. It is always important to remember that bilateral or unilateral arrangements are more efficient