What U.S. Fiscal Woes Teach China

What U.S. Fiscal Woes Teach China
Op-Ed Diplomat
While the current U.S. economic tensions are likely to hurt Washington's democracy and human rights agenda as far as Beijing is concerned, they are also likely to help China's international financial situation.
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As the largest foreign buyer of US government securities, China can only fret as the value of its holdings is held hostage to a fractured political process in Washington. But while the longer-term implications of these developments are likely to hurt the United States’ democracy and human rights agenda as far as China is concerned, ironically, they will help its international financial situation.

On the political front, China’s leadership will quietly welcome comparisons with the relative ease with which its system is able to move on collective action within a tightly-controlled political process. This will reinforce self-serving messages as the Communist Party celebrates its 90th anniversary, especially as the party has been under considerable pressure lately to redefine itself, as its society is no longer isolated, rural, and poor, but is now globally integrated, urban, and fixated on wealth accumulation.

And, while China struggles to achieve a ‘soft landing’ from its economic stimulus programme, the fiscal problems in the United States will be used as a reminder to its restless constituents that democracy doesn’t guarantee that the right compromises will evolve to support the common good. Nor will the problems in Europe in forging a collective sharing of looming default burdens, or the continued decline of the Japanese economy, strengthen the case for liberalizing China’s political system. Indeed, all this will make it even harder to bridge the cultural divide that separates China from the West over the way they view global issues.

But on the economic front, recent developments are likely to push China’s leadership to move more aggressively to reshape the policies relating to the country’s exchange rate and trade regime that have exacerbated tensions with the United States over the past decade. The United States’ fiscal woes will reinforce the view that it makes little sense for China to continue generating trade surpluses that must then be used to buy US securities, which may only diminish in value over time. Any lingering notion that mercantilist tendencies still drive Chinese policymakers should now be discarded.

Some estimates suggest that with unchanged external policies, China’s foreign exchange holdings could increase from the current $3.2 trillion to $5 trillion by 2015. But with the prospects of all three major reserve currencies under a cloud, parking such amounts in foreign securities is unappealing, making it unlikely that these levels will materialize.

China’s overseas direct investments—which amounted to less than $5 billion seven to eight years ago, but now run around $60 billion annually—are another option for channelling these surpluses. But sensitivities among OECD countries make it unlikely that China can find enough attractive opportunities in the resource- and technology-based industries to make this a serious alternative. While growth in overseas investments will be brisk in the coming years, this won’t satisfy China’s desire to diversify its holdings, and returns would still be vulnerable to exchange rate fluctuations.

As a result, China’s leadership no longer sees much to be gained from accumulating foreign reserves. Its former preoccupation with job creation from export production makes less sense as its population ages and the labour force begins to shrink within the next few years. Increasingly, the challenge is to meet the job expectations of unemployed college graduates as their numbers have doubled over the past decade, instead of just trying to create largely menial positions. The pressure is now on to develop more high-valued services and knowledge-intensive product lines—with quality rather than quantity being the primary concern.

For these objectives to be achieved, though, more rapid appreciation of the renminbi rate will help rather than hurt. But exchange rate changes alone won’t be enough. Much more important is reversing the tax, subsidy, and interest rate policies that discourage the requisite high-value service activities from emerging.

The shift away from mercantilist objectives will be reinforced by the desire to move more rapidly to internationalize use of the renminbi. The authorities see greater use of the renminbi abroad as a means of insulating themselves from the instability and declining value of the dollar, euro, and yen. They also welcome the prestige factor and advantages in having the renminbi as an international reserve currency. But they face the predicament that the preconditions for being an international currency are that it must be freely traded in global markets, with its value and availability subject to market forces rather than government controls.

For the moment, China will push much harder for the renminbi to be used for settling trade and services transactions, but continue to be cautious about freeing up capital flows. As such, the world will probably see the emergence of a hybrid-type global currency that will be used relatively freely to settle current account transactions, but remain controlled in terms of the volume and purpose of renminbi-denominated capital flows. This would, in principle, still allow China to retain tight control over its monetary policies and exchange rate adjustments.

However, these artificial separations can’t be sustained. China is moving down a slippery slope and, over time, the pressures to liberalize capital flows and allow the value of the renminbi to be shaped by market forces will prove to be overwhelming. This will force the country to accelerate the process of creating the necessary institutions and regulatory safeguards for the renminbi to be a true international currency. In doing so, it will complement other policies that will help reduce China’s trade imbalances.

And the current US fiscal woes will have at least one beneficial side-effect—they will help to lower the tensions that have arisen during the recent ‘currency and trade wars’ between the two countries.

End of document

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The Carnegie Asia Program in Beijing and Washington provides clear and precise analysis to policy makers on the complex economic, security, and political developments in the Asia-Pacific region.



Source http://carnegieendowment.org/2011/08/06/what-u.s.-fiscal-woes-teach-china/4kkf

In Fact



of the Chinese general public

believe their country should share a global leadership role.


of Indian parliamentarians

have criminal cases pending against them.


charter schools in the United States

are linked to Turkey’s Gülen movement.


thousand tons of chemical weapons

are in North Korea’s possession.


of import tariffs

among Chile, Colombia, Mexico, and Peru have been eliminated.


trillion a year

is unaccounted for in official Chinese income statistics.


of GDP in oil-exporting Arab countries

comes from the mining sector.


of Europeans and Turks

are opposed to intervention in Syria.


of Russian exports to China

are hydrocarbons; machinery accounts for less than 1%.


of undiscovered oil

is in the Arctic.


U.S. government shutdowns

occurred between 1976 and 1996.


of Ukrainians

want an “international economic union” with the EU.


million electric bicycles

are used in Chinese cities.


of the world’s energy supply

is consumed by cities.


of today’s oils

require unconventional extraction techniques.


of the world's population

will reside in cities by 2050.


of Syria’s population

is expected to be displaced by the end of 2013.


of the U.S. economy

is consumed by healthcare.


of Brazilian protesters

learned about a massive rally via Facebook or Twitter.


million cases pending

in India’s judicial system.

1 in 3


now needs urgent assistance.


political parties

contested India’s last national elections.


of Egypt's labor force

works in the private sector.


of oil consumed in the United States

is for the transportation sector.


of Chechnya’s pre-1994 population

has fled to different parts of the world.


of oil consumed in China

was from foreign sources in 2012.


billion in goods and services

traded between the United States and China in 2012.


billion in foreign investment and oil revenue

have been lost by Iran because of its nuclear program.


increase in China’s GDP per capita

between 1972 and today.


billion have been spent

to complete the Bushehr nuclear reactor in Iran.


of Iran’s electricity needs

is all the Bushehr nuclear reactor provides.



were imprisoned in Turkey as of August 2012 according to the OSCE.

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