CHINAwatch

How the United States and China could help stabilize the world's monetary and economic systems

My friend Professor Steve Hanke warns in his article of the Cato Institute that the schizophrenic monetary polices of the Fed - "When it comes to the big elephant in the room — bank money — she (Yellen) is very tight. But, when it comes to state money, she is loose" - cause huge hot money flows to emerging economies and greatly destabilize the world's monetary system.

His analysis serves to underpin the fact that the United States continues to use its ""exorbitant privilege" as the world's unchallenged arbiter of fiat money, treating the world's monetary system as a greenback-centric "closed" universe, thereby acting as a global destabilizer.  

Professor Hanke refers to Prof. Ronald McKinnon's argument in "The Unloved Dollar Standard: From Bretton Woods to the Rise of China"-  (Oxford University Press, 2012) that "China has been a major stabilizing force. China has injected stability into the international sphere by smartly, and ironically, linking the Chinese yuan (more or less tightly) to the U.S. dollar since 1995".

To maintain global stability, Professor Hanke suggests that the greenback should now form a closer union with the Euro, trading with each other in a narrow range and committing to defend each other, while the Asian dollar block should strengthen its ties to the greenback. Other emerging economies could choose either to tie to the greenback or the euro. Professor Hanke's formula is designed to avert the disruptive effects of a global "currency war"".

While such a formula has many merits to commend itself, it ignores certain new, game-changing, global realities.

First, the Chinese yuan (the RMB) has eclipsed the greenback as the world's ipso facto "reference currency", according to Professor Subramanian of the Petesen Institute for International Economics ("Eclipse - Living in the Shadow of China's Economic Dominance, September 2011). Click here This is supported by the fact that China has already displaced the US as the largest trading nation. There are now 126 countries which have China as the largest trading partner, compared to only 76 in the case of the United States. Admittedly the vast majority of world trade is still being conducted using the greenback. But the RMB is gaining traction as an international currency. It has already displaced the euro as the world's most used trading currency. This momentum is being driven by China promoting RMB internationalization through currency swaps and issue of more RMB-denominated investment products. All indications point to the RMB becoming a fully-convertible currency within about five to ten years. Click here The days of an Asian dollar block are therefore numbered.

Second, likewise, the European Union has displaced the United States as China's largest trading partner. There is no reason why the EU should choose to defend the greenback unless it coincides with her main economic interests. This is not to mention the growing divergence in views between the EU and the US about their respective roles in a changing world.

What should help in stabilizing the world's economic and monetary systems is for the United States to re-balance its economy towards more savings and less consumption while China is actively doing the opposite. That way, the United States could export more to China while retaining more savings to re-build its crumbling infrastructure. Additionally, the United States must also re-sharpen its economic competitiveness through improving the educational level of its workforce.

Moreover, as the two countries are at very stages of advancement, America can no longer afford to compete at the lower levels of products that a country like China still manages to do best. America, however, is miles ahead of China in high technological and scientific innovations, which are being wooed by China with open arms. What stands in the way is continued suspicions of a Rising China, which translate into many US restrictions on high-tech exports to the Middle Kingdom.

If America can sell more to China (as in the case of Germany) as China consumes more , this could help reduce the need to rely on America's "exorbitant privilege", which in any case is destabilizing to the world's economic and monetary systems as it is past its sell-by date as a panacea for America's fortunes.

"Why It's Getting Harder for Beijing to Govern”

“How China Is Ruled - Why It's Getting Harder for Beijing to Govern” is the subject of an adaptation in Foreign Affairs (January/February, 2014) by Professor David M Lampton from his book “Following the Leader: Ruling China, From Deng Xiaoping to Xi Jinping”, University of California Press, 2014. Professor Lampton is George and Sadie Hyman Professor of China Studies and Director of SAIS-China at the Johns Hopkins School of Advanced International Studies. Click here 

Professor Lampton highlights a sea-change in how China is governed with better-educated and more open civil society, people power with a plurality of views and interests, and the imperative of responding to, rather than suppressing, people’s expectations except the most destabilizing of forces.  

This periodic sea-change was also heralded by an earlier report of the European Council for Foreign Relations (ECFR) (Mark Leonard, ed., November, 2012), epitomized by the following observations –

"China is trapped in its own success and needs to enter into a new era. After Mao’s political revolution (‘China 1.0’) and Deng Xiaoping’s economic revolution (‘China 2.0’), they are (the country is) expecting a ‘China 3.0’”. I have looked into what a China 3.0 would mean in “In face of multiple crises, China 3.0 needs to stay ahead with the times” Click here

Lampton's analysis is spot on with the key driver of change – the need to regain legitimacy in face of civil and economic plurality. The Communist Party of China (CPC) has been continually re-inventing itself to stay ahead.

To appreciate how the CPC works and how it hones its leadership, please visit "How China's leadership is tempered" here

Nevertheless, despite continual evolution, there is no sign that the CPC may contemplate eventual embrace of Western competitive multi-party democracy. The CPC does not believe that the Western model is suited to China, nor for that matter, it has always been effective in the West. Examples of government dysfunction caused by fractious party politics come to mind. Neither does Professor Lampton suggest that Western democracy is a pre-condition for preventing regime collapse

In fact, whether Western multi-party rule is necessary for China’s long-term sustainability was the subject of an earlier heated debate between Will Hutton and Martin Jacques over the latter’s controversial book “When China Rules the World”. Hutton argued that China would never be able to rule the world and would in fact eventually unravel if the country continued to resist Western democracy. On the other hand, while admitting China needs to become more liberal and enlightened, Jacques did not agree that the Western model is the only formula for China’s continuing survival, if not dominance. Click here

The Hutton/Jacques debate seems a little convoluted and confused by terminology at times. The real differences in opinions seem to boil down to the following questions –

(a)    Would China eventually become at least one of the world’s dominant countries?

(b)   Would a One-Party system be sustainable, and if so, how?

As for (a), I have provided an analysis In “Will China dominate the 21st century?” here

As for (b), perhaps it may be helpful to first answer the question whether "Western liberal democracy would be wrong for China". This very question took the form of a motion debate in London on 9 November 2012 sponsored by Intelligence Squared, a premier forum for debate and intelligent discussion. In the context of this question, the pros and cons of (b) are addressed at some length in my piece “China may not need to abandon one-party rule any time soon?” here

Coming back to Professor Lampton’s article in Foreign Affairs, governing a country the size of a continent with a population numbering a fifth of mankind has never been easy. Under Mao, it was the huge challenge of feeding so many mouths in face of unfriendly and vastly superior superpowers. Under Deng, it was the herculean task of unleashing the productivity of a behemoth steeped in abject poverty and bureaucracy. Under Xi, it is the harnessing of a rising tide of civil and economic aspirations to achieve China’s Renaissance amidst growing global uneasiness with China’s ascendance.

How China rises to her destiny and how the world responds to China will not be just a matter for China and her people, but as Napoleon once said, “When China wakes, she will shake the world.”