China’s Falling Growth and US Hopes for Stabilizing the Global Economy: Mind the Gap

in Program

By Dr. Richard Cronin


The Challenge

The accelerating meltdown of the global economic and
financial system has caught the United States off guard. China, now the
largest holder of US Treasury bonds, obviously plays an outsize role in
the ability of the US to finance its fast multiplying debt. China has
also become a mainstay of growth and stability in developing Asia.
Current US assumptions about China’s role in helping the US finance its
debt and avoiding a wider global economic and financial meltdown
especially need urgent reexamination. Deteriorating economic and
financial conditions in both the US and China challenge continuing
assumptions that China will continue to buy and hold US Treasury Bonds
and constitute a new engine of growth for Asian and other emerging
markets. The new US Administration also should worry about China’s
current struggle to maintain social stability – and the reverberations
from China’s falling growth rate throughout Asia. The challenge is this
– assuming the immediate threats to the US financial system can be
eased, how can the Obama Administration better mesh domestic US
economic policy needs with its wider Asian policy interests and slow or
reverse the current shift of economic power to Asia?


The Context

For years the United States and China have had a de
facto bargain that can be compared to the Asian concept of the equally
balanced yin and yang. We, the high consumption country, run a trade
deficit with them, the high savings country, and they in turn use their
bilateral trade surplus dollars to buy US Treasury and corporate bonds.
To date this has made perfect sense to Beijing. US Treasury bonds
provide safety in the current financial chaos and selling them now
would undercut the value of China’s remaining dollar assets. Converting
them into Yuan would put upward pressure on the Chinese currency, and
thereby undercut China’s goal of keeping its currency undervalued, its
exports competitive, and inflation under control. Even in the case of a
falling dollar, China thus far has had an incentive not to dump its
T-bill holdings lest it force the dollar even lower and depreciate the
value of its remaining bonds. But China already has set a longer term
course to rebalance its foreign reserves by holding more Euros and
Japanese Yen.

Now all bets are off. Current uncertainties have
caused China to join the global flight to safety over yield, but near
zero interest on T-bills and falling confidence in the ability of US
economic managers to stabilize the financial crisis and avert a deeper
recession are changing its calculus. China’s own GDP growth slid from
about 12 percent in 2007 to 9 percent. In November 2008 the World Bank
cut earlier economic growth forecasts to 7.5 percent for 2009, less
than the 8 percent Chinese officials believe is necessary for social
stability. Other estimates are even more pessimistic based on fourth
quarter 2008 performance. Recent protests by unemployed workers and
bankrupt small business owners have created fear within the ruling
Communist Party and prompted the government to announce an emergency 4
trillion Yuan (currently about $560 billion) stimulus package. About 75
percent of the so-called stimulus package is to come from state
corporations and banks already awash in red ink, and most of the rest
from repackaging spending that was already planned. In the words of
China Investment Corporation Chairman Lou Jiwei, “China can’t save the
world. It can only save itself.” It is increasingly doubtful whether
China can even do this.

China’s failure to stop or reverse its falling rate
of growth would have serious regional impact. For every 1 percent
change in Chinese GDP growth the rest of Asia’s growth rate changes by
an estimated one-half percent. Because Japan, South Korea and other
Asian trading partners now export more goods to China than to the US,
the fall in China’s growth rate will hurt its neighbors’ economies as
well. Because the legitimacy of many governments in developing Asia has
depended primarily on delivering a strong economic performance, the
sharp drop in imports by China and the combination of soaring food and
energy prices affects political stability.

Where to Start

The new Administration could shore up international confidence in
the US ability to cope with the current financial crisis and reinforce
Asian stability by taking the following first steps:


  • Immediately intiate a
    comprehensive review of the assumptions underlying the expressions of
    confidence that China will continue to buy and hold T-bills and other
    US securities

Such a review should be coordinated by the National
Security Council and involve broader policy representation than just
the Treasury, Federal Reserve and other departments concerned mainly
with economic and financial issues. China currently holds about 20
percent of US T-bonds while Japan and the rest of Asia hold another 27
percent. Chinese sovereign funds have already been badly burned on
investments in US financial institutions. China’s current “dollar trap”
could weaken if return became more important than the security of its
hard currency reserves, or if boosting domestic growth should become so
urgent that Beijing was ready to accept the inflationary impact of
using its hard currency holdings to support a flagging domestic
stimulus package. The return on US T-bills is already near zero. At
that rate, China has a growing incentive to move cautiously out of
dollar assets and into Euros or Yen, or simply put new surpluses into
these currencies.

  • Broaden the China-US Strategic Economic Dialogue and/or merge it with the Security Dialogue

The Treasury Department and other departments with
responsibility for foreign economic relations already work closely with
China’s economic managers in respect to T-bond issues, the trade
balance, and China’s de facto currency peg, but this is not enough. The
intelligence community needs to become involved to better understand
China’s economic policies and revisit the conventional wisdom that
China has no alternative but to park its foreign reserves in US
Treasury bonds. Also, statements by senior US policymakers frequently
reveal a sunny view of China’s growth prospects that does not comport
with those of analysts who look at the Chinese economy from a
political-economic perspective. Nor does the US-China dialogue focus
sufficiently on broader issues such as China’s ambitions for greater
influence in developing Asia. The intelligence community, especially
the NIC, the CIA and the State Department’s Bureau of Intelligence and
Research (INR), should conduct a Special National Intelligence Estimate
(SNIE) on China’s deepening economic and political ties to Southeast
Asia, including its fast-growing role in economic infrastructure
development in Southeast Asia and rising political influence.

  • Work to create more confidence in
    China and the rest of Asia that US policy will take into account their
    political and economic imperatives 

This also requires broadly based and coordinated
policy action, especially on the part of State and Treasury, and in the
US role in the ADB and World Bank. China and the rest of Asia
understand that their fates are linked to ours, but have long believed
– rightly or wrongly — that US policy is too self-centered and does
not sufficiently take their interests into account. This view goes well
beyond current economic and financial issues. For instance, in calling
for China to be a “responsible stakeholder” the Chinese and other
Asians ask who is to be the arbiter of responsibility. In the past,
this has been mainly a foreign policy problem, but now American
interests require persuading China and the rest of Asia that the US
understands that interdependence is a two-way street. That requires
better listening and more substance, and broader policy coordination.

  • Work to create more two-way trust between US and Chinese financial and economic managers

This requires more interaction between the Fed and
Treasury with the Bank of China and other Chinese economic managers.
Both the US and China especially need to be transparent about their
plans for stabilizing markets and stimulating their economies. The US
should ask for more feedback from China regarding its calculations for
determining where to put its hard currency surplus, and how the US can
maintain Chinese confidence without abandoning its domestic
stabilization policies.

  • Make a new effort to build trilateral policy dialogues and concerted cooperation with Japan and China

Japan continues to have a myopic view of its
interests and shun leadership on Asian and international financial
issues. Economic interdependence between China and Japan has not been
sufficient to cover historical and territorial disputes. More
substantively, Japan’s central bank operations typically pay much more
regard to perceived national self interest in influencing currency
valuations, for instance. With the global financial system and economy
poised at the brink, now is the time work with Japan to take a broader
view of its stake in the global financial system and to promote
trilateral policy dialogues and concerted cooperation among all three
countries. The Defense Department needs to be more in harmony with the
State Department on US-Japan alliance issues (and the ROK as well), and
the NSC needs to break down department walls and approach issues from a
political economic perspective rather than separate economic,
diplomatic and security channels. To change recent atmospherics in
US-Japan relations, the new Administration should demonstrate broader
understanding of Japanese perspectives and work to eliminate the
perception that the US is “bypassing” Japan in its dealings with China.

What’s on the Line


US financial and economic policy managers should
recognize and act on the most important challenge to the functioning of
the international system since the end of the Cold War. Already, the EU
countries have called for a major reevaluation of the entire Bretton
Woods system. The United States still has the ability to lead and
influence the financial, economic and even the global security order
despite the substantial diffusion of economic power in the direction of
Asia. The US cannot maintain its leadership without the cooperation of
China. Across-the-board engagement with China on the current financial
and economic crisis can contribute to a larger reliance on diplomacy
and other nonmilitary means of achieving stability in Asia and other
regions where China has become more active.


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