The WSJ reported on April 21 that the Trump administration has again included a $55 billion U.S. quota increase for the IMF in its fiscal 2027 budget request — a proposal originally initiated under Janet Yellen.
According to the Journal, China is particularly keen for Congress to approve the increase, as it would expand the Fund’s permanent resources and help Beijing manage the growing burden of its distressed overseas loans.
As economist Noah Smith pointed out, that is far from a sign of Chinese strength. If anything, it implies the Belt & Road experiment is faltering and that China lacks the capital (not just liquidity) to bail out the system single-handedly.
I flagged the story Wednesday on X, but failed to integrate it into my earlier swap line analysis because it slipped my mind.
In hindsight, it is an important development that needs to be accounted for in its own right as it has a significant bearing on the swap line debate.
For one, it powerfully reinforces the central point made in the previous piece: quota-based (and SDR-style) multilateral liquidity extensions typically come at America’s expense, meaning that, as a rule, it’s not in Washington’s interest to support such initiatives unless its terms and conditions are to be truly respected. In a scenario where Washington’s institutional-level influence is waning, it makes much more sense for it to begin reframing the whole system around direct bilateral relationships, as it now appears to be doing.
To understand why this is the case, it’s important to understand that the mechanics of supranational lending differ from those of conventional lending.
How the IMF actually works
The IMF isn’t a creditor in the usual sense of the word. Rather, it acts as a special bilateral currency swap agent. Its mission, when it chooses to accept it, is to enable the settlement of international payment obligations through negotiated means (and concessions!) so that when countries are at risk of default, their creditors don’t resort to wars, seizures, or outright annexations to make good on what they believe they are owed. They take power more subtly. Usually, by gaining influence over how economies are managed.
When IMF programs are initiated for borrower countries, they are funded in special drawing rights (SDRs).
The IMF describes SDRs as “potential claims on freely usable currencies, valued against a basket of the USD, euro, yuan, yen, and the pound.” Unlike conventional currencies, SDRs represent a steady-state system. That means the overall amount of outstanding SDRs never changes unless new allocations are granted. Such extensions, however, are very rare. They have only ever happened four times in IMF history.
All countries that are part of the IMF system are apportioned a quota of SDRs based on their relative size and position in the global economy. As a result, the richest countries in the world, the US, Japan, China, Germany, and France, have the largest allocations. The poorest have the least.
When IMF loans are extended, countries with hard-currency surpluses and lending capacity transfer their SDR allocations to countries with hard-currency shortfalls. Once obtained, shortfall countries take those SDRs to designated lender countries and transform them into the hard currency that they need. In terms of outright SDR positioning, nothing really changes. All SDRs that are lent out usually return to the original source.
In technical terms, lender countries finance such loans by creating central bank reserves at will. These are later sterilised to maintain monetary stability, usually using central bank assets. The associated fiscal effect of such financing (aka the cost to the lending sovereign in balance-sheet terms) is, however, usually accounted for in the government budget.
For the most part, the arrangement is economically equivalent to rich countries bumping up poor countries that stand at the back of a proverbial bread queue to ensure they definitely get the bread they need when they require it. However, the queue’s organiser (aka the IMF) does not necessarily assure this by delivering more bread into the system as a whole. Rather, it achieves it by allowing poor nations to cut in line at the expense of other queuers on the proviso that they use the related relief to become better contributors to the system in the future.
In theory, bad loans, such as those extended to Argentina for the longest time, cost all contributors to the system in terms of forgone liquidity. In practice, the country that bears the brunt of the cost is America.
Still, forbearance, even for habitual defaulters, is usually in the IMF’s interest. The only real alternative to continued loan renegotiation is explicit annexation or forced regime change, which, let’s face it, is both expensive and politically sensitive domestically. Beyond that, there is only isolation, but this too often triggers humanitarian or refugee crises, which also bear costs for the international system.
That’s why, as a rule, the IMF lends its resources on the expectation that receiver countries implement reforms to make their countries more productive and successful over time, and thus more capable of paying back such loans in the long run. In practice, however, the effect is a transfer of economic control to Washington, which often triggers perceptions on the borrower side that its sovereignty is being eroded and that it is being turned into a vassal state.
In the eyes of the system, however, all nations that habitually find themselves at the back of the liquidity queue only do so because of the fundamental mismanagement of their domestic economies. Distributing liquidity with no conditionality, therefore, equates to moral hazard. More bluntly, it sends a message to countries that extracting more value from the global financial system than they put in bears no consequence.
While loan conditionality can, over time, chip away at borrowers’ political power, the intent is entirely to drive growth for the benefit of the whole system. Once reforms kick in and the country begins to pull its weight economically — ideally becoming a net contributor to the system — the IMF is more than happy to hand back control.
However, it’s also the case, that the mechanics of the system are complicated and not very well understood by the public. As for the technicalities of how SDRs work? Even members of the IMF themselves struggle to make sense of them. In 2008, for example, Ken Rogoff, formerly the IMF’s chief economist, admitted to me in on-the-record correspondence to my CNBC email that despite being in charge of writing the fund’s SDR report, even he didn’t know much about the system. “It is basically not very meaningful in the absence of a consensus to have a world currency,” he wrote.
But the comment was no doubt obtuse.
Any expansion of SDRs has a self-evident bearing on America’s fiscal capacity. The more SDRs are distributed in one-off allocations to poor countries, the more opportunity there is for net system extractors to get ahead of the line of net system producers, and, as a result, ahead of Americans with dollars. All this, we should add, without the usual supervision and conditionality tied to loan programmes.
Such US-specific costs mean that this time round, a cost-conscious Trumpian America First administration is unlikely to bankroll another SDR allocation to help serial extractors continue to “free ride”.
So why the $55bn quota increase?
SDRs are just a mechanism for distributing available system funds. They’re not how the system itself is funded (aka how much queue-barging capacity rich countries are prepared to assign to the system as a whole).
SDR expansions, as last happened in 2021, merely assign additional queue-barging rights to everyone in the system. In theory, no one is better or worse off, because in relative terms, everyone’s allocation has gone up equally. In practice, countries that don’t use their allocations, such as America (because they have no need for other currencies) absorb the dilutive effects disproportionately.
It’s useful to think of the effects in theme park terms.
In normal conditions, everyone has to queue for rides. At the same time, there is value in queue-cutting. That means there is value in a theme park issuing fast-pass tickets to those who can afford it. Fast pass tickets are like dollars. They always let you get to the front of the queue. But they only retain value for as long as they remain scarce. Poor people can’t afford fast-pass tickets, so they always have to wait in line.
When SDR allocations happen, they are equivalent to everyone in the park receiving sets of fast-pass tickets, regardless of whether they’ve paid for them or not. This is to ensure everyone has a chance at achieving prosperity.
Allocations, however, dilute the value of pre-existing fast-pass tickets, which tend to accumulate in the hands of the most prosperous park goers. Allocations, as a consequence, are not normal IMF procedure. But it’s also not in the interest of prosperous ticket holders to clog up all the rides, because doing so generates resentment. Resentment risks revolution within the system, and destabilisation of the whole system. That’s why ticket holders are often prepared to lend their tickets out, especially if they have an excess of them. That equates to a conventional IMF programme. In such circumstances, the overall supply of tickets does not go up, so the intrinsic value of the tickets is preserved.
But while SDRs do the hard work of distributing pre-existing value, this is not how loans in the system are explicitly funded.
Funding is either through prepaid capital into the system (known as quota resources) or via country-specific commitments in so-called New Arrangements to Borrow (NAB). The former is a type of equity arrangement paid in by everyone in proportionally with their quota, while the latter is a loan.
These arrangements effectively cap the IMF’s lending capacity at any given point, aka how many fast-pass tickets are available for lending at any given time. There is, however, an important distinction between the two types of financing. When loans are extended from paid-up quota resources, the US (aka the park’s manager) does not benefit from veto power over how the funds are allocated. This is because Washington’s voting share represents only 16 percent of the overall votes needed to okay distributions. However, when loans are extended through pre-committed funds rather than equity, it does, since 85 percent approval is required for the IMF to sign off on new arrangements.
Under the current IMF proposal that US lawmakers are still to sign off on, all IMF members are lined up to contribute a one-off equity injection into the system in SDR terms. This is usually paid in “own currency terms” at current valuations. However, since most currencies don’t have fast-pass power, the only funding that really matters is what comes from SDR basket-supplying members. And even then, what matters most, due to the special fast-pass power of the dollar, is the American contribution.
If passed, the current proposal would see the US transfer $55 billion of fast-pass dollar funds into a pot it has much less distributive control over.
Many lawmakers are indifferent to the transfer, since it would not really impact America’s overall budgetary commitment to the IMF. In theory, the funds are already set aside in the Exchange Stabilization Fund under NAB commitments, ensuring no net budget appropriation is needed. The only negative impact for Washington is that resources are shifted away from lending instruments where America retains a veto to those where American influence is less pronounced.
The WSJ, however, argues this is still a bad deal for America because the associated loss of control has meaningful consequences for American soft power internationally.
Notably, the move benefits China because it allocates capital to a pot over which Beijing has more influence. This could allow China to allocate IMF funds to BRI countries on far more lenient terms than otherwise.
However, China’s eagerness to get the deal done hints at its relative economic fragility.
For many, it is the strongest signal yet that Beijing cannot easily fund BRI bailouts out of its own pocket.
The obvious question then is why would the Trump administration, which is notoriously hostile to China, retain the proposal in its 2027 budget request, given it not only dilutes American control but originated under Biden administration? Further still, why has Treasury Secretary Scott Bessent publicly reaffirmed support for the measure?
Liquidity wars
One plausible explanation is that the whole arrangement connects to a liquidity showdown between China and America. In that sense, it possibly represents a calculated US response to what might otherwise be termed a Chinese ransom attack.
In effect, America could be making a limited, low-visibility prepayment to help China indirectly manage its distressed overseas loans. If that’s the case, what the deal really constitutes is a discreet one-off swap arrangement with an adversary in plain sight.
But why would China need dollars? And why would America agree to watered-down control?
Again, confusion over the difference between liquidity and solvency plays its part.
Like the UAE, China is a dollar-asset-rich sovereign. That, however, does not mean it is necessarily dollar liquidity rich. Much of the dollar liquidity it has access to is tied up in managing the valuation of its currency.
Currently, the combination of an acute domestic economic slowdown and the Iran crisis is straining China’s usual access to dollar cash flows more than normal. This has become especially acute since sanctioned crude has come back into circulation in dollar markets. While sanctions were in place, China benefited from a de facto monopsony in the energy market, allowing it to dictate terms in ways that benefited its economy. Counterparts such as Russia, Venezuela, and Iran not only had to accept yuan payments but also incurred the cost of selling crude at steep discounts relative to international prices.
One of the direct effects of sanctions, therefore, was a de facto boon to the Chinese economy in the form of cheap energy.
Now that the boon has been removed, Beijing is facing a similar dollar liquidity crunch to that of the UAE. It can only overcome this in a handful of ways.
One is to convince the world to accept yuan payments instead of dollars. While propaganda efforts on this front remain active, they are failing to have the desired effect. The yuan’s role in international payments may be increasing, but most yuan users are not prepared to hold value long-term in yuan instruments. Even within the BRI sphere of influence, many prefer to transform yuan holdings for alternative stores of value, notably dollar stablecoins or gold. This is one of the reasons the price of gold in yuan terms is soaring disproportionately to all other currencies. This increasingly risks the stability of the Chinese economy and the PBOC’s capacity to control its FX rate, since gold — unlike other forms of capital — is easily arbitraged smuggled across systems when there is a premium in one jurisdiction over another.
China’s second option is to sell down its dollar assets. This, however, is equally suboptimal, not just because it could trigger a global financial crisis but because the long-term effects on the RMB’s value remain uncertain. In the short run, fire sales could strengthen the RMB against the dollar, but in the long run, the country’s ability to control its own exchange rate may be significantly compromised, thereby unhinging its ability to run a planned economy. Notably, a sharply stronger RMB would puncture China’s export-oriented model during an already weak period, revealing the country is insolvent, not just illiquid. That, in turn, could lead to a longer-term economic crash that eventually collapses the yuan regardless.
China’s third option is to print local currency to exchange for dollars on the market, but this, too, would also significantly weaken the RMB and, again, signal that Beijing has lost control of its currency.
Fourth, it could repo its dollar assets. This, however, would impact SOFR rates, potentially prompting Federal Reserve interventions that work against its long-term interests, notably by igniting more US-based financial repression to offset its own.
Finally, China could raise dollars on international capital markets, but this would undermine the “yuan is ascending” narrative and risk China becoming beholden to external creditors and bond vigilante discipline.
All of these negative externalities pose a problem not just for the US, but for the IMF more broadly as an institution.
Realistically, it is not in anyone’s interest to see China’s economy collapse in a disorderly manner, given its share of global trade.
This is why it seems reasonable that the US might be prepared to cut a deal to avoid a scenario of mutual assured financial destruction.
The motivations for doing so are similar to those that motivated Washington to bail out the international financial industry in 2008. Not doing so is existentially threatening for the system as a whole.
Unlike in 2008, however, America is not prepared to make that support limitless.
As it stands, China would get a one-shot cash infusion from the US ESF on very favorable terms. This would allow Beijing to maintain clout in jurisdictions America struggles to influence, without losing face. In exchange, Beijing would agree not to engage in distressed US asset sales and, one would imagine, slowly reform its system.
America’s relative loss of control over the resources, meanwhile, needn’t be an issue.
In the worst-case scenario, China squanders the money, fails to reform, and sets itself up for a military confrontation with the West. In that scenario, the $55 billion transfer proves a valuable investment for America because it buys time for the West to prepare for war and shift supply chains accordingly. In such a scenario, China would have to be sanctioned anyway, an outcome that would see it isolated from the international monetary community, just as the USSR was. The IMF — a peacetime institution — would likely have to be reformed or dismantled anyway.
In its place, America would strike bilateral dollar swapline deals with its allied network. Everyone else would be forced to rely on financing from an increasingly economically distressed and militarized China.
In the best-case scenario, however, China uses the $55 billion injection to reform the system, stops pushing its planned economy on others, and acquiesces to international governance and human rights norms. If, over the longer run, Beijing embraces democratic norms and establishes itself as a trusted member of the international community, it could even create the conditions for a peaceful resolution of the Taiwan question.
Ultimately, it matters not that America loses control over how this money is distributed by China, since conventional IMF loan “conditionality” terms could never be imposed anyway. China’s nuclear and military might assures that only carrots, not sticks, can make a difference.
Based on the trade-offs at hand, while the $55 billion may look uncomfortably like a ransom payment or geopolitical shakedown, in relative terms, it can still pay off for America eventually.
