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“How many rivers we had to cross, before we found our way?” - Carl Sagan
In recent months prominent US politicians and economists have expressed fears of a mercantilist turn in Chinese foreign policy and the possibility of the strategic use of currency, trade and investment flows by China to sabotage the US economy. However to a great degree such fears fail to take into account the economic interdependency of the two powers and the CCP regime’s political investment in global economic stability and growth. Indeed some analysts accuse the US of ‘talking shop’ at the dinner table of traditional security – muddying the waters of the traditional Sino-US strategic dialogue on East Asia with non-traditional security considerations.
Trade and Currency
In the deconstruction of the US response to these new threats this paper will first address the issue of Sino-US currency flows. Over the last decade or so since the 1997 Asian Financial Crisis, East Asian states have looked to build monetary autonomy and financial insulation through the procurement of foreign currency reserves – in particular the US dollar (Cohen 2008). China’s dramatic growth in trade competitiveness over this period was to a large degree dependent on the ‘New Bretton-Woods System’ (Wu, 2006). Chinese officials pinned the Renminbi to the US dollar at an arguably undervalued fixed exchange rate that kept export prices low and attracted foreign direct investment (FDI). In the wake of the Global Financial Crisis the issue of China’s burgeoning trade surplus with the US has become intertwined with debates over Chinas alleged currency manipulation. Political candidates in the US have taken to ‘China-bashing’ – claiming that job losses in the rust-belt are due to outsourcing to China (most have gone to other states) (Strasser, 2010). These claims are premised on the belief that an undervalued Renminbi is responsible for weak US export volumes and the trade deficit with China. However in March this year Professor Niall Ferguson of Harvard University testified to the House Ways & Means Committee that the main beneficiaries of the ending the renminbi/dollar peg would not be the US, but China’s trade competitors in emerging markets (Committee on Ways and Means, 2010). Ferguson also added that there was not only a danger of a “trade war or tariff war” akin to the ‘beggar thy neighbour’ competitive currency depreciations of the great depression but also a danger of a “currency war” (Committee on Ways and Means, 2010). Despite Professor Ferguson’s warnings, on the 29th of September the House of Representatives passed legislation approving extensive tariff powers on Chinese imports – yet to be approved by the senate (Sanger & Chan, 2010).
In contrast to the US, Japan has made efforts to recognize the interdependence of its economy and that of China. Talking in a press conference in a call for practical steps to repair Sino-Japanese relations post the September ‘trawler incident’, Japanese Chief Cabinet Secretary Yoshito Sengoku declared “the world economy has become one and is mutually interdependent. This is not just a risk for Japan” (Sieg, 2010). It should be noted that China’s exceptional export-orientated economic development has thus far been highly dependent on a stable world system built on the “rules and norms of non-discrimination and market openness” (notably under the WTO since 2001) (Ikenberry, 2008). Furthermore the legitimacy of Communist Party rule in China, particularly along the coastal provinces, has been greatly buoyed by consistent economic development. Hence it must be asked to what degree the Chinese ‘economic threat’ is the product of the ignorance and political manipulations of US officials.
Since the decline of the US economy post-9/11 China’s trade surplus with the United States has soared while it also accumulated vast sums of US dollar reserves in the form of US securities and debt. The result is that China now holds in reserve approximately $1.3 trillion US dollars which could potentially be used strategically (via mass sell-out) to “threaten manipulation of the value or stability” of the US dollar (Cohen, 2008, p 462). The Obama administration has thus far refrained from making any official statements on the risk of a currency war, although public discussion is running rampant. US lobbyist groups such as ‘Citizens Against Government Waste’ have funded television scare campaigns characterizing Chinese held US-debt as the first step in the ‘fall of the US’ (Goldkorn, 2010). Such developments are evidence of a deep suspicion in the United States of China’s declared peaceful development ambitions. In response China has recently gone to unusual lengths to publically express its side of the argument. On the 23rd of September Premier Wen Jiabao took the unprecedented step of an interview with CNN in which he expressed his hope for a quick US economic recovery (Barbara, 2010).
In addition to the above attempts at reassurance by China, there exist several major reasons why the threat of a currency war is highly unlikely to ever be fulfilled. Firstly, any depreciation in the dollar entails significant losses for China in terms of the decline in value of the reserve holdings of US dollars. This fact is well recognized by the Chinese and evidenced by the substantial increase in foreign purchases of U.S. Treasury securities from $156.8 billion in 2007 to $307.6 billion in 2008 (U.S. Department of Commerce, 2009). Such an increase was despite a drop in net foreign purchases of U.S. stocks from $182.4 billion to just $6.9 billion and of corporate bonds from $372.1 billion to $0.6 billion. Secondly, Chinese exporters are still heavily reliant on US consumption and therefore are unlikely to endorse any currency manipulations that will cripple their largest market (Conaway, 2009). Thirdly, despite recent US protests that the Renminbi is still ‘unfairly’ undervalued, continued upward revaluation of the Renminbi is the most likely future trend given the threat of inflation to the Chinese economy (China Stakes, 2009). Between 2004 and 2005 domestic monetary supply increased 14 per cent, loans expanded at 11 per cent, housing prices 10 per cent and land rent 8 per cent (Wu, 2006, p 36). In the long term such contagious monetary ‘overheating’ produces dangerous overcapacity in industry and speculative bubbles (the consequences of which East Asia felt in 1997 – something China will surely try to avoid). Hence China is not committed to propping up the dollar relative to the Renminbi indefinitely. Rather, China’s interests lie in maintaining a high value for the dollar globally and keeping the US economy (and consumption) in reasonable health.
Foreign Direct Investment
A final point of consideration to be made in assessing the Chinese ‘economic’ threat is the significance of Chinese and US investment flows. From 2003 onwards China has found an opportunity to make active use of its $2.27 trillion in foreign currency reserves by encouraging its firms to ‘go global’. Through the extension of government loans, Chinese SOEs have engaged in a strategic buyout of assets crucial to China’s future development; notably producers of coal, oil and iron ore in the developing world (notably – Nigeria, Angola and Brazil) (Cheng & Ma, 2007). Most recently China has made its first drive into the US energy market through the SOE China National Offshore Oil Corporation (CNOOC) with the purchase of four exploitation licenses in the Gulf of Mexico from Norweigan energy group Statoil (Sydney Morning Herald, Nov 4, 2009). The global financial crisis has only intensified this buyout process as multinational corporations run short of credit supply. Whether or not this outward FDI growth is part of a long-term mercantilist strategy to monopolize resource flows cannot yet be determined. It should be noted that given predictions of the growth in Chinese demand for these resources such investment is still consistent with a ‘peaceful rise’ thesis (Zheng, 2007). China’s youthful sovereign wealth cannot be invested in domestic assets without causing uncontrollable inflation. Furthermore, the amount of FDI inflow to China – of which the US, Germany and Japan are the greatest contributors, continues to dwarf Chinese outflows of FDI. Hughes & Hale claim that inward FDI may still be as high as 40% of China’s GDP (2003, p 38).
US discomfort with the idea of growing Chinese economic prowess may be to a great extent attributable to a fear of being ‘locked out’ of Asian trade and economic development. The establishment of a number of significant inter-Asian trade agreements including the China-ASEAN Free Trade Agreement (2010), Japan-ASEAN FTA (2008) and China-Taiwan Economic Cooperation Framework Agreement (2010) have produced an image of increasing Asian economic cooperation and interdependence (Economist, 2010, July, Vietnam News Agency, 2008). Joshua Cooper Ramo goes so far as to argue China is presenting an alternative development model or “Beijing Consensus” in which there is “no hegemonism, no power politics, no alliances and no arms races” only a binding economic order that will ultimately secure China’s dominance (Ramo, 2004, p 43). However economist Paul Krugman argues that, despite the publicity of US complaints, the ‘undervalued’ Renminbi does greatest harm to the smaller exporting nations of East Asia by ‘unfairly’ sapping FDI and export market share (2009). There is a limit to the ability of China’s neighbouring exporters to restructure around Chinese growth and although complementarities do exist “there may not be unlimited room for them to grow” (Albaladejo & Lall, 2004, p 145). In particular the US market for medium and high tech machine goods is increasingly dominated by Chinese exports at great cost to high-tech specialist nations Korea, Taiwan and Singapore. To this extent Chinese preferences for export market share increasingly threaten other middle-tier exporters rather than the US. Chinese exports are only a threat to the US to the extent that American producers continue to produce low-tech labour-intensive goods. It should also be noted that US companies continue to gain from savings in production costs by investing in China.
After a brief hiatus I return to address a series of very specific and significant debates in international affairs and subsequently argue why they shouldn't really be our concern anyway. This week I cover the varied responses to the Global Financial Crisis - Europe v.s. The United States. To get you started, a series of obtuse-looking diagrams courtesy of the recent European Central bank publication "Extraordinary Measures in Extraordinary Times".
To begin, let us interpret this wonderfully colourful series of sonagrams the ECB appears to have provided - delivering an image of fiscal health from deep within the womb of the central monetary authority. At first glance all parties have broadened their balance sheets, however, the Eurosystem has done so to a substantially lesser extent than the US Federal Reserve and Bank of England. While the US Federal Reserve, and to a lesser degree the Bank of England, has massively increased the purchase of securities and bonds, the Eurosystem, constrained by the overlapping authorities of national governments and the European Commission, has had to make do with more targeted refinancing operations via specific lending institutions. So what do these differences mean for liquidity in the real economy? How tight are the bonds between on-paper liquidity and the flow of investment into national industrial output and employment growth?
The most significant outcome is that fiscal stimulus in the US has been much less direct than that within the Eurosystem. The increased buy back of US securities has only ever been an indirect approach to increasing liquidity. While liquidity has technically increased, the actual flow of funds from lending institutions to commercial investment is not guaranteed. In addition the vitiating impact of the international drain on US liquidity cannot be underestimated. Chinese accumulation of U.S. debt and security assets has steadily increased over the past decade – estimates of current Chinese holdings run as high as 40% of U.S. foreign liabilities. One should note that foreign purchases of U.S. Treasury securities began their rapid increase before the GFC – increasing from $156.8 billion in 2007 to $307.6 billion in 2008 (U.S. Department of Commerce, 2009). Such an increase was despite a drop in net foreign purchases of U.S. stocks from $182.4 billion to just $6.9 billion and of corporate bonds from $372.1 billion to $0.6 billion. Thus for some time the primary holders of US treasuries have been foreign institutions. As such, the present usefulness of a securities buy-back as a liquidity tool within the US economy is not nearly as great as it would have been even five years ago. This, in conjunction with the rather erratic behaviour of the United States government in deciding when and which institutions to refinance or purchase outright (intervening in the case of AIG, but not with Lehman Bros.), has certainly muddied the waters surrounding the true state of U.S. liquidity and its potential to effect economic recovery.
In contrast to the American response, European intervention has been moderated by both national governments and a developing body of legislature empowering the European Commission. Without the option of large-scale securities repurchases, a repurchasing strategy in the Eurosystem was restricted to the bonds market. As such direct lending agreements between national governments and financial institutions have been the primary tool of stimulus. Direct government aid to lending institutions has therefore had to occur in a much more transparent and calculated fashion than would appear to be the case in the United States. In an attempt to prevent competition distortions within the EEC, national aid measures (including the refinancing and restructuring of banks) have been subject to European Commission approval. On the one hand this has slowed the financial aid package response, on the other, the aid that has gotten through has been highly structured and specifically directed. This is because EC approval is dependent on the submission of detailed viability or restructuring plans by the state involved. In the case of more substantial restructuring or recapitalisation (any more than 2% of the bank’s risk-weighted assets) these plans include explicit reports containing “all the information necessary to evaluate the bank’s viability, the use of the capital received and the path towards exit from reliance on State support” (ECB). Thus while the Euro recovery package arguably pales in respect to that of the US in scale, its quality as a guarantor of return on state investment is high. In other words, the overall Euro strategy is low-risk, low return in contrast to a US strategy that is high-risk, potentially higher return.
Thus as you read over the rather dim growth forecast for the Eurosystem in the next year (between 0 and 1% by most accounts), and compare these to forecasts for the U.S. (between 2.5 and 3%), fret not. The Eurosystem’s more conservative stimulus response and recent rapid return to talk of austerity economics (hastened by Greece’s woes) is likely to promote a recovery that is solid in its foundations – something investors will, in time, be willing to open their pockets to. In addition Eurosystem private bond purchases and strict refinancing agreements under the eye of the EC are assets that guarantee long-term reimbursement for state aid packages. The European outlook for the next year is not great, but it is perhaps clearer than that of Great Britain or the United States when all details are accounted for. The swathe of securities now held outright by the US Federal Reserve may not age as well as the returns of Eurosystem bond repurchases and refinancing agreements – especially if a revaluation of the Yuan is a precursor for falling Chinese demand of US assets.
If I may dare suggest it, the law of highest return may not hold out against international investors’ scepticism of the ability of the US to recover assets committed to the recovery. Furthermore, predictions for the overall health of the US economy will naturally also effect the value of US financial assets. To this end, a second quarter of negative U.S. job growth certainly suggests what is going in one end (liquidity packages) is no guarantee of what will come out the other.