Martin Jacques - When China Rules the World

A measure of China’s growing impact on the world is the leverage that it enjoys in its relationship with the United States (notwithstanding the fact that the United States still enjoys a much larger GDP than China and an immensely higher GDP per head) as a result of the economic imbalances which lie at the heart of their relationship. China is comfortably the largest exporter to the US, with Americans displaying an enormous appetite for Made in China consumer products. As the United States exports relatively little to China, the latter has enjoyed a large and rising trade surplus which has grown very rapidly since 1999. [567] [567] Yu Yongding, ‘ China ’s Rise, Twin Surplus and the Change of China’s Development Strategy’, pp. 26–30. China has invested this surplus in various forms of US debt, including Treasury bonds, agency bonds and corporate bonds — in effect, a Chinese loan to the US — thereby enabling American interest rates to be kept artificially low to the benefit of American consumers and especially, until the credit crunch, holders of mortgages. Although the US was deeply in debt, China’s continuing large-scale purchase of Treasury bonds (which I will use as shorthand for various forms of US assets held by China) allowed Americans to continue with their spending spree, and then partially helped to cushion the impact of the credit crunch. In September 2008 China ’s foreign currency reserves totalled $1.81 trillion — a sum greater than the annual economic output of all but nine countries. [568] [568] ‘ China ’s Reserves Near Milestone’, Wall Street Journal , 17 October 2006. The rapid growth of its foreign exchange reserves has made China a colossus in the financial world. The importance of this has become even more apparent with the Western financial meltdown. While Western financial institutions, many Western companies and even some countries have found themselves starved of liquidity, China, in contrast, is blessed with an abundance of it. Strategically this puts China in a potentially powerful position to enhance its international financial and economic influence during the global recession, for example by buying foreign companies, especially oil and mineral firms.

How China deploys its reserves remains a matter of great concern, especially to the United States, since most are invested in US dollar-denominated debt. If China transferred significant amounts into other currencies — it is believed that it holds rather more than 60 per cent of its reserves in dollars (with less than 30 per cent in euros), though this is a tightly guarded secret [569] [569] Andrew Batson, ‘ China May Get More Daring With Its $1.07 Trillion Stash’, Wall Street Journal , 15 February 2007. — it would have the immediate effect of depressing the value of the dollar and forcing US interest rates to rise: the larger the sum transferred, the bigger the fall in the dollar and the larger the rise in interest rates. But the government is also faced with something of a dilemma. It would certainly make good economic sense for China to transfer a large slice of its reserves out of US Treasury bonds: the dollar’s value fell steadily in 2006- 8, then recovered somewhat, but there remains the strong possibility that its price might fall even further, perhaps precipitously so. China ’s vast dollar investments in US Treasury bonds furthermore earn miserable rates of return, which makes precious little sense for what is still a poor country. [570] [570] ‘ China Money Trouble: Where to Park It All’, International Herald Tribune , 6 March 2007. However, if it tries to transfer significant sums of its reserves into other currencies, thereby provoking a further fall in the value of the dollar, then the value of its own dollar reserves will also decline. China is in a catch-22 situation. The two great, but utterly unlike, economic powers of our time find themselves — at least for the time being — in a position of bizarre mutual dependence. [571] [571] ‘China Voices Alarm at Dollar Weakness’, Financial Times , 19 November 2007; Keith Bradsher, ‘Rising Cost of Buying US Debt Puts Strain on China’s Economy’, International Herald Tribune , 4 September 2008. This was graphically illustrated in the darkest days of the financial meltdown in September 2008, when it is believed that the Chinese were pressing the US government to rescue Fannie Mae, Freddie Mac and subsequently AIG out of concern for its holdings in them, and the Americans were understandably afraid that China might otherwise sell off some of its dollar reserves, with dire consequences for the value of the dollar and its role as a reserve currency. [572] [572] Also, Lex, ‘ China and Fannie Mae’, Financial Times , 17 July 2008.

Before these tumultuous events, China had already been exploring other ways of using its vast reserves. In early 2007 the government announced the formation of the China Investment Corporation, a new state agency to oversee investment of $200 billion of China ’s foreign currency reserves — similar to Temasek Holdings, the Singapore government’s successful investment agency, which manages a $108 billion global portfolio of investments. [573] [573] ‘ China Acts to Become Huge Global Investor’, International Herald Tribune , 10–11 March 2007. To test the water, the new agency placed $3 billion of its holdings with Blackstone, the US-based private equity group, thereby signalling Beijing ’s intention to switch some of its investments from US Treasury bonds into more risky equity holdings. [574] [574] ‘ Beijing to Take $3bn Gamble on Blackstone’, Financial Times , 18 May 2007. In fact it has since emerged that the State Administration of Foreign Exchange, which oversees China ’s reserves, has itself been investing rather more widely than was previously believed. [575] [575] ‘ China ’s Two Trillion Dollar Question’, editorial, Financial Times , 11 September 2008. These moves herald China ’s rise as a major global financial player. [576] [576] For a broader view of the rise of such funds, see Martin Wolf, ‘The Brave New World of State Capitalism’, Financial Times , 16 October 2007. In the second half of 2007, as the credit crunch began to bite, China Development Bank took a significant stake in the UK-based Barclays Bank [577] [577] ‘China Aids Barclays on ABN Amro’, Financial Times , 23 July 2007; ‘The Chinese Bank Plan is One to Watch’, Financial Times , 23 July 2007. and Citic Securities formed a strategic alliance with the US investment bank Bear Stearns before the latter went bust. [578] [578] ‘Bear Stearns in Landmark China Deal’, Financial Times , 22 October 2007. Three Chinese banks were also in talks about acquiring a stake in Standard Chartered, the UK-based emerging markets lender. [579] [579] ‘Chinese Banks Seek Stake in StanChart’, Financial Times , 18 November 2007. Earlier in 2007, the Bank of China was reported as being interested in acquiring a US bank; ‘Bank of China Seeking US Acquisition Targets’, South China Morning Post , 22 January 2007. But most of this came to nought as the Chinese increasingly realized the likely severity of the credit crunch and the potential threat it represented to any stakes in Western financial institutions that it might purchase. When the financial meltdown came in September 2008, the Chinese found themselves relatively little exposed. Nonetheless, the enormous funds enjoyed by Chinese banks, based on the fact that the average household saves more than a quarter of its income and has nowhere else to invest it, mean that Chinese banks will become an increasingly formidable global force.