Economics and Power - The Loss of US Power

Regular readers will know that I avoid discussion of wider political issues with regards to the economic crisis, but events are suggesting that the two are becoming ever more closely entwined. In particular, I have long been concerned at the appearance of an aggressive nationalist agenda in China, and wrote an article expressing my concerns a long while ago:

What is very clear is that China, and the Chinese government, are actively pursuing a policy of unfair trade at home and abroad. Quite simply, they are using economics as a tool of power rather than just enrichment.

Later in the same post, I discussed an article in which it was apparent that China was intervening to prop up the $US:

'China has resorted to stealth intervention in the currency markets to amass US dollars, using indirect means to hold down the yuan and ease the pain for its struggling exporters as the global slowdown engulfs the economy...'

My comment on the news was as follows:

There are many motivations that could be given to justify this action, some of which are more forgiving than others. It might be argued by apologists for China that they are doing this to protect the value of the $trillion+ reserves of $US. However, such a move can only delay the day of reckoning for the $US, so I do not believe that this would be why the policy is being enacted. Furthermore, it is just multiplying the problem of increasing the holdings of a currency that is structurally weak, meaning that the problem that it is trying to solve would just be getting more acute. However, I agree with the article that China is using unfair means to subsidise exports.

I later added that China had already made indirect threats to destroy the $US:

On a related subject, in an article a while ago the Telegraph, it was reported that senior Chinese officials were willing to use dollar sales as a way of exerting power over the US. In short, the Chinese have the power to destroy the $US by selling the currency, and therefore have huge economic power over the US. The Chinese government later denied the policy, but those familiar with Chinese culture will know that using such methods of presenting a threat is not unusual.

You may wish to read the full post (including some of the notes in which I respond to some reader comments) before continuing with this post. It outlines some of the aggressive 'mercantilist' policy pursued by China. You may also wish to see my article on China from July of last year, in which I outlined/predicted my view of the future of the Chinese economy through the crisis (a less worrying post). The reason I am returning to the subject is that I recently dug out a report that suggests that Chinese Banking Regulators were aware over two years ago that the US was going to suffer a financial crisis:

The Xinhua News Agency has a headline news story about a recent statement by Liu Ming-kang, chairman of the China Banking Regulatory Commission, claiming that the Commission anticipated the current financial crisis over two years ago.

The report goes on to say:

“With almost everyone immersed in the excitement of (financial) innovation and large-scale liquidity for the past two or three years, the China Banking Regulatory Commission long ago predicted that the current financial crisis was soon to occur, as well as the fact that its occurrence was inevitable. We gave early warnings. In June
2006, at a symposium jointly held in Beijing by the Bank of Communications and HSBC, we warned the industry that they must guard against the liquidity risks caused by inappropriate financial innovation - derivative products in particular. At the same time, the CBRC adopted quasi-periodic adjustment and regulatory counter-measures, and warned financial institutions in the Chinese banking industry on numerous occasions of risk, demanding that they adopt strict preventative measures during this period of constant economic growth.”

That China could see the disaster coming but still continued to invest in an economy that it knew was going to suffer major trauma is most unusual. Why did they seek to prop up the $US, and why increase their reserves?

I observed some time ago that the UK suddenly, for no clear reason, changed the diplomatic status of Tibet to a status that was more to China's liking. I wrote the following:

Another indication of the state of desperation is the official UK change of status of Tibet to a status that appeases China. As one article points out, a cynical interpretation of such an action would be that the UK has 'sold' the status of Tibet - in other words this change of policy has been exchanged for a better prospect of continuing Chinese credit for the UK (possibly indirectly by ensuring that the IMF is able to fund a UK bailout).

We now have a fascinating article from the Times of India, in which they detail the many ways in which China is flexing economic muscles:

The financial crisis is proving to be a major diplomatic opportunity for China on three levels: placating a desperate United States with purchases of its treasury bonds, buy accolades from poor nations with promises of more funds and extend the international influence of the Renminbi.

The article goes on to detail the many ways in which China is using economic weight to create influence more widely, and I therefore recommend a full reading of the article. In a recent trawl through various articles I also found that China announced a new initiative in Asia to use the RMB for settlement of trading with several neighbours, in a move which suggests that the Chinese government is looking to initiate a reserve currency status for the RMB. The timing of the announcement was December 24th 2008, a time when most Western agencies would not be paying attention (sorry, could not find the original Reuters article about this, so the link is to a less reputable source). The timing of the announcement at Christmas is a good way to bury a story for Western analysts and politicians.

On top of all this, we now have a rash of news stories (e.g. here) about Chinese proposals to develop an IMF based reserve currency, and even more discussion of the growing importance of the RMB (as in the Times of India article), including as a potential reserve currency. I recently speculated on the ways in which China might utilise the economic crisis, and a forthcoming $US crisis to introduce the RMB as a replacement for the $US as the world reserve currency:

Inevitably, such a large fall/collapse in the $US will see the undermining of the status of the $US as a reserve currency. The Euro is now in a position of such instability that it will not have the potential to act as a replacement. The Japanese Yen might have some potential as a replacement, but the RMB will be better positioned as the strongest contender. In particular, the Japanese will likely act to rescue the $US during the crisis, but will fail to stem the tide, and undermine the credibility of/weaken the Yen in the process.

If China was to follow such a course, it would put itself in the position of being the major world economic power, or would do so at least in principle.

What we have been witnessing of late is a game of cat and mouse, in which China both warns the US against irresponsibility in the management of their economy, whilst at the same time offering reassuring noises about continued purchases of treasuries. Such purchases are the only serious remaining lifeline for the US government to continue with the various bailouts and stimuli. In the meantime, the US government has started quantitative easing, including the purchase of treasuries. The US looks like it is increasingly concerned that the previous and main sources of financing government debt are about to dry up.

Then we come to the crunch.

China appears to be testing its power in the disputed region of the South China Sea, in particular the area surrounding the Spratly Islands. After unarmed clashes with a US ship (probably a spy ship), the tensions are rising:

A day later, Admiral Timothy Keating, head of the U.S. Pacific Command, sounded a strong alarm, calling the incident “a troubling indicator” that China isn’t “willing to abide by acceptable standards of behavior or rules of the road.” The country’s “behavior as a responsible stakeholder has yet to be consistently demonstrated,” he told the Senate Armed Services Committee.

Some of China’s neighbors may be similarly concerned. On March 11, Xinhua News Agency reported that China dispatched a 4,450-ton fisheries patrol boat to protect its interests in the South China Sea, which include the disputed -- and potentially oil-rich -- Spratly Islands. More vessels may be added to the mission, the state-run China Daily newspaper reported.

Whilst some analysts point to a similar incident at the start of the Bush presidency, I am not convinced that this is similar. There are strong economic interests at stake in the Spratly region, and the action of the Chinese government does not appear to be comparable.

At this stage, I think that you may be guessing where this is all leading. A good starting point is to ask why China kept pouring funding into the US whilst being able to see the coming economic storm? Why did they keep lending ever more money into an increasingly precarious economy? Why are they now courting countries with the offer of the RMB as a new stable currency for exchange? What are the private demands being made of the US government for continued purchases of treasuries? We can all remember the recent Clinton visit to China, in which she offered her thanks for China's continuing purchase of treasuries....we do not know the subjects of private discussion.

Sceptics might point to the Chinese proposal for an IMF reserve currency, but it is difficult to see how this might work. The proposal might be interpreted as a smoke screen whilst they establish the RMB as the replacement for the $US as the world reserve currency?

It is possible to make a summary from the more recent news and some of the news identified in older posts. If we take the activity in aggregate, it looks very much like a plan for China to extract the maximum out of their new found economic power. They will play the US as far as they can, extract as many concessions as possible - use the power to show that they are now the country with the real influence. As soon as the US is finally in a corner and comes out to confront China, they will simply floor the $US. At that point, as I discussed in my speculative post, they will go on a shopping trip, and pick up all the technologies, all the companies that they need to take their place at the front of the world economy, and as the new economic power in the world:

With the US in shock, China can then use the remaining holdings of $US to go on a shopping spree into the US. In particular, China can offer to enter the markets with an offer of salvation - but at the cost of unopposed access to purchase the companies that might provide a leap into the high added value industries with technology or specialist skills. They will not put it this way but, in a climate of economic panic, they will be in a position of calling the shots, as the only significant player able to halt the slide. As a result of the panic, they will be able to buy even good companies at fire sale prices. As such, they will be able to use whatever $US assets they still hold to take a major leap up into added value industries.

I have worried for a long time about the rise of China, and remember an interview with a Chinese admiral (sorry, no link, it was about two years ago and I can not find the interview on the BBC website), who went 'off message' with a discourse that appeared to contradict the official line of 'peaceful rise'. I have avoided anything more than some suggestions of concern about the economics of China on this blog, but see a clear pattern in the emergence of China. It is not a friendly rise. I do not think there is any master plan in the actions, but rather opportunistic exploitation of situations that have arisen. The US has watched on as their economic power has withered. In my earlier posts, I have mentioned that the US (and the world) needed to face down China's threat to the $US, to prevent the situation deteriorating.

The situation has now deteriorated....

When I made my post speculating how China might deal with the coming $US crisis, I emphasised that the post was speculation. As I look at the pattern of China's actions over the last few years, I am concerned that I am no longer speculating but identifying a pattern. I strongly recommend that you take a look at my previous posts, which outline more detail on Chinese policy.

However, I am trying to piece together a picture from many sources of information, and it is quite possible that my interpretation is wrong. It is quite possible that China is acting without any other intention than trying to navigate through each new stage of the crisis to minimise the impact upon their own situation. This is possible, but.....

Note 1: I have several times wanted to join in the excellent debate in the comments section of my last post, but have been distracted by this post. It has been interesting to follow the elements of the debate, and a shame I have not had time to throw in my own contribution. In particular the debate started by Lord Keynes is now too involved for anything but a long answer, and I can only put so much time in....

Note 2: MattinShanghai - excellent link to Rolling Stone. A very good read, but with some caveats about the comments on regulation. The issue of Glass-Steagall Act keeps popping up as one of the problems in the crisis, and I hope to address this question at some point. Matt - did you note the nobleman analogy? Nice to see that others have come up with a similar analogy to the aristocrat which I have used.

Note 3: Lemming, yes, the US bailouts will be used (to a large extent) to support returns to overseas depositors (not the stereotypical little old ladies)...I have no reason to think that the situation is different from that in the UK. You may want to read the link above which, although it does not answer your question, sets and interesting context.

Boing: A very quick reply. One of the key points being made in this blog is that the stimuli simply can not work as they seek to replace consumer over-spending with government over-spending. Over-spending is what got us into the trouble. As for the bailouts, these are simply trying to replace overseas direct lending to banks with indirect lending from overseas investors, but directed through government. Alternatively, they print money to make up for the disappearing overseas investors. And as Lemming mentions (see above) in the comments section of the last post, much of that money is flowing straight out of the banks into the hands of overseas banks/institutions/individuals.....