http://www.theatlantic.com/doc/print/200801/fallows-chinese-dollars
The $1.4 Trillion Question
Stephen Schwarzman may think he has image problems in America. He is
the co-founder and CEO of the Blackstone Group, and he threw himself a
$3 million party for his 60th birthday last spring, shortly before
making many hundreds of millions of dollars in his company's IPO and
finding clever ways to avoid paying taxes. That's nothing compared
with the way he looks in China. Here, he and his company are
surprisingly well known, thanks to blogs, newspapers, and talk-show
references. In America, Schwarzman's perceived offense is greed—a sin
we readily forgive and forget. In China, the suspicion is that he has
somehow hoodwinked ordinary Chinese people out of their hard-earned
cash.
Last June, China's Blackstone investment was hailed in the American
press as a sign of canny sophistication. It seemed just the kind of
thing the U.S. government had in mind when it hammered China to use
its new wealth as a "responsible stakeholder" among nations. By
putting $3 billion of China's national savings into the initial public
offering of America's best-known private-equity firm, the Chinese
government allied itself with a big-time Western firm without raising
political fears by trying to buy operating control (it bought only 8
percent of Blackstone's shares, and nonvoting shares at that). The
contrast with the Japanese and Saudis, who in their nouveau-riche
phase roused irritation and envy with their showy purchases of Western
brand names and landmark properties, was plain.
Six months later, it didn't look so canny, at least not financially.
China's Blackstone holdings lost, on paper, about $1 billion, during a
time when the composite index of the Shanghai Stock Exchange was
soaring. At two different universities where I've spoken recently,
students have pointed out that Schwarzman was a major Republican
donor. A student at Fudan University knew a detail I didn't: that in
2007 President Bush attended a Republican National Committee
fund-raiser at Schwarzman's apartment in Manhattan (think what he
would have made of the fact that Schwarzman, who was one year behind
Bush at Yale, had been a fellow member of Skull and Bones). Wasn't the
whole scheme a way to take money from the Chinese people and give it
to the president's crony?
The Blackstone case is titillating in its personal detail, but it is
also an unusually clear and personalized symptom of a deeper, less
publicized, and potentially much more destructive tension in
U.S.–China relations. It's not just Stephen Schwarzman's company that
the laobaixing, the ordinary Chinese masses, have been subsidizing.
It's everyone in the United States.
Through the quarter-century in which China has been opening to world
trade, Chinese leaders have deliberately held down living standards
for their own people and propped them up in the United States. This is
the real meaning of the vast trade surplus—$1.4 trillion and counting,
going up by about $1 billion per day—that the Chinese government has
mostly parked in U.S. Treasury notes. In effect, every person in the
(rich) United States has over the past 10 years or so borrowed about
$4,000 from someone in the (poor) People's Republic of China. Like so
many imbalances in economics, this one can't go on indefinitely, and
therefore won't. But the way it ends—suddenly versus gradually, for
predictable reasons versus during a panic—will make an enormous
difference to the U.S. and Chinese economies over the next few years,
to say nothing of bystanders in Europe and elsewhere.
Any economist will say that Americans have been living better than
they should—which is by definition the case when a nation's total
consumption is greater than its total production, as America's now is.
Economists will also point out that, despite the glitter of China's
big cities and the rise of its billionaire class, China's people have
been living far worse than they could. That's what it means when a
nation consumes only half of what it produces, as China does.
Neither government likes to draw attention to this arrangement,
because it has been so convenient on both sides. For China, it has
helped the regime guide development in the way it would like—and keep
the domestic economy's growth rate from crossing the thin line that
separates "unbelievably fast" from "uncontrollably inflationary." For
America, it has meant cheaper iPods, lower interest rates, reduced
mortgage payments, a lighter tax burden. But because of political
tensions in both countries, and because of the huge and growing size
of the imbalance, the arrangement now shows signs of cracking apart.
In an article two and a half years ago ("Countdown to a Meltdown,"
July/August 2005), I described an imagined future in which a
real-estate crash and shakiness in the U.S. credit markets led to
panic by Chinese and other foreign investors, with unpleasant effects
for years to come. The real world has recently had inklings of similar
concerns. In the past six months, relative nobodies in China's
establishment were able to cause brief panics in the foreign-exchange
markets merely by hinting that China might stop supplying so much
money to the United States. In August, an economic researcher named He
Fan, who works at the Chinese Academy of Social Sciences and did part
of his doctoral research at Harvard, suggested in an op-ed piece in
China Daily that if the U.S. dollar kept collapsing in value, China
might move some of its holdings into stronger currencies. This was
presented not as a threat but as a statement of the obvious, like
saying that during a market panic, lots of people sell. The column
quickly provoked alarmist stories in Europe and America suggesting
that China was considering the "nuclear option"—unloading its dollars.
A few months later, a veteran Communist Party politician named Cheng
Siwei suggested essentially the same thing He Fan had. Cheng, in his
mid-70s, was trained as a chemical engineer and has no official role
in setting Chinese economic policy. But within hours of his speech, a
flurry of trading forced the dollar to what was then its lowest level
against the euro and other currencies. The headline in the South China
Morning Post the next day was: "Officials' Words Shrivel U.S. Dollar."
Expressing amazement at the markets' response, Carl Weinberg, chief
economist at the High Frequency Economics advisory group, said, "This
would be kind of like Congressman Charlie Rangel giving a speech
telling the Fed to hike or cut interest rates." (Cheng, like Rangel,
is known for colorful comments—but he is less powerful, since Rangel
after all chairs the House Ways and Means Committee.) In the following
weeks, phrases like "run on the dollar" and "collapse of confidence"
showed up more and more frequently in financial newsletters. The
nervousness only increased when someone who does have influence,
Chinese Premier Wen Jiabao, said last November, "We are worried about
how to preserve the value" of China's dollar holdings.
When the dollar is strong, the following (good) things happen: the
price of food, fuel, imports, manufactured goods, and just about
everything else (vacations in Europe!) goes down. The value of the
stock market, real estate, and just about all other American assets
goes up. Interest rates go down—for mortgage loans, credit-card debt,
and commercial borrowing. Tax rates can be lower, since foreign
lenders hold down the cost of financing the national debt. The only
problem is that American-made goods become more expensive for
foreigners, so the country's exports are hurt.
When the dollar is weak, the following (bad) things happen: the price
of food, fuel, imports, and so on (no more vacations in Europe) goes
up. The value of the stock market, real estate, and just about all
other American assets goes down. Interest rates are higher. Tax rates
can be higher, to cover the increased cost of financing the national
debt. The only benefit is that American-made goods become cheaper for
foreigners, which helps create new jobs and can raise the value of
export-oriented American firms (winemakers in California, producers of
medical devices in New England).
The dollar's value has been high for many years—unnaturally high, in
large part because of the implicit bargain with the Chinese. Living
standards in China, while rising rapidly, have by the same logic been
unnaturally low. To understand why this situation probably can't go
on, and what might replace it—via a dollar crash or some other
event—let's consider how this curious balance of power arose and how
it works.
Why a poor country has so much money
By 1996, China amassed its first $100 billion in foreign assets,
mainly held in U.S. dollars. (China considers these holdings a state
secret, so all numbers come from analyses by outside experts.) By
2001, that sum doubled to about $200 billion, according to Edwin
Truman of the Peterson Institute for International Economics in
Washington. Since then, it has increased more than sixfold, by well
over a trillion dollars, and China's foreign reserves are now the
largest in the world. (In second place is Japan, whose economy is, at
official exchange rates, nearly twice as large as China's but which
has only two-thirds the foreign assets; the next-largest after that
are the United Arab Emirates and Russia.) China's U.S. dollar assets
probably account for about 70 percent of its foreign holdings,
according to the latest analyses by Brad Setser, a former Treasury
Department economist now with the Council on Foreign Relations; the
rest are mainly in euros, plus some yen. Most of China's U.S.
investments are in conservative, low-yield instruments like Treasury
notes and federal-agency bonds, rather than showier Blackstone-style
bets. Because notes and bonds backed by the U.S. government are
considered the safest investments in the world, they pay lower
interest than corporate bonds, and for the past two years their annual
interest payments of 4 to 5 percent have barely matched the
5-to-6-percent decline in the U.S. dollar's value versus the RMB.
Americans sometimes debate (though not often) whether in principle it
is good to rely so heavily on money controlled by a foreign
government. The debate has never been more relevant, because America
has never before been so deeply in debt to one country. Meanwhile, the
Chinese are having a debate of their own—about whether the deal makes
sense for them. Certainly China's officials are aware that their stock
purchases prop up 401(k) values, their money-market holdings keep down
American interest rates, and their bond purchases do the same
thing—plus allow our government to spend money without raising taxes.
"From a distance, this, to say the least, is strange," Lawrence
Summers, the former treasury secretary and president of Harvard, told
me last year in Shanghai. He was referring to the oddity that a
country with so many of its own needs still unmet would let "this $1
trillion go to a mature, old, rich place from a young, dynamic place."
It's more than strange. Some Chinese people are rich, but China as a
whole is unbelievably short on many of the things that qualify
countries as fully developed. Shanghai has about the same climate as
Washington, D.C.—and its public schools have no heating. (Go to a
classroom when it's cold, and you'll see 40 children, all in their
winter jackets, their breath forming clouds in the air.) Beijing is
more like Boston. On winter nights, thousands of people mass along the
curbsides of major thoroughfares, enduring long waits and fighting
their way onto hopelessly overcrowded public buses that then spend
hours stuck on jammed roads. And these are the showcase cities! In
rural Gansu province, I have seen schools where 18 junior-high-school
girls share a single dormitory room, sleeping shoulder to shoulder,
sardine-style.
Better schools, more-abundant parks, better health care, cleaner air
and water, better sewers in the cities—you name it, and if it isn't in
some way connected to the factory-export economy, China hasn't got it,
or not enough. This is true at the personal level, too. The average
cash income for workers in a big factory is about $160 per month. On
the farm, it's a small fraction of that. Most people in China feel
they are moving up, but from a very low starting point.
So why is China shipping its money to America? An economist would
describe the oddity by saying that China has by far the highest
national savings in the world. This sounds admirable, but when taken
to an extreme—as in China—it indicates an economy out of sync with the
rest of the world, and one that is deliberately keeping its own
people's living standards lower than they could be. For comparison,
India's savings rate is about 25 percent, which in effect means that
India's people consume 75 percent of what they collectively produce.
(Reminder from Ec 101: The savings rate is the net share of national
output either exported or saved and invested for consumption in the
future. Effectively, it's what your own people produce but don't use.)
For Korea and Japan, the savings rate is typically from the high 20s
to the mid-30s. Recently, America's has at times been below zero,
which means that it consumes, via imports, more than it makes.
China's savings rate is a staggering 50 percent, which is probably
unprecedented in any country in peacetime. This doesn't mean that the
average family is saving half of its earnings—though the personal
savings rate in China is also very high. Much of China's national
income is "saved" almost invisibly and kept in the form of foreign
assets. Until now, most Chinese have willingly put up with this,
because the economy has been growing so fast that even a suppressed
level of consumption makes most people richer year by year.
But saying that China has a high savings rate describes the situation
without explaining it. Why should the Communist Party of China
countenance a policy that takes so much wealth from the world's poor,
in their own country, and gives it to the United States? To add to the
mystery, why should China be content to put so many of its holdings
into dollars, knowing that the dollar is virtually guaranteed to keep
losing value against the RMB? And how long can its people tolerate
being denied so much of their earnings, when they and their country
need so much? The Chinese government did not explicitly set out to
tighten the belt on its population while offering cheap money to
American homeowners. But the fact that it does results directly from
explicit choices it has made—two in particular. Both arise from
crucial controls the government maintains over an economy that in many
other ways has become wide open. The situation may be easiest to
explain by following a U.S. dollar on its journey from a customer's
hand in America to a factory in China and back again to the T-note
auction in the United States.
The voyage of a dollar
Let's say you buy an Oral-B electric toothbrush for $30 at a CVS in
the United States. I choose this example because I've seen a factory
in China that probably made the toothbrush. Most of that $30 stays in
America, with CVS, the distributors, and Oral-B itself. Eventually $3
or so—an average percentage for small consumer goods—makes its way
back to southern China.
When the factory originally placed its bid for Oral-B's business, it
stated the price in dollars: X million toothbrushes for Y dollars
each. But the Chinese manufacturer can't use the dollars directly. It
needs RMB—to pay the workers their 1,200-RMB ($160) monthly salary, to
buy supplies from other factories in China, to pay its taxes. So it
takes the dollars to the local commercial bank—let's say the Shenzhen
Development Bank. After showing receipts or waybills to prove that it
earned the dollars in genuine trade, not as speculative inflow, the
factory trades them for RMB.
This is where the first controls kick in. In other major countries,
the counterparts to the Shenzhen Development Bank can decide for
themselves what to do with the dollars they take in. Trade them for
euros or yen on the foreign-exchange market? Invest them directly in
America? Issue dollar loans? Whatever they think will bring the
highest return. But under China's "surrender requirements," Chinese
banks can't do those things. They must treat the dollars, in effect,
as contraband, and turn most or all of them (instructions vary from
time to time) over to China's equivalent of the Federal Reserve Bank,
the People's Bank of China, for RMB at whatever is the official rate
of exchange.
With thousands of transactions per day, the dollars pile up like crazy
at the PBOC. More precisely, by more than a billion dollars per day.
They pile up even faster than the trade surplus with America would
indicate, because customers in many other countries settle their
accounts in dollars, too.
The PBOC must do something with that money, and current Chinese
doctrine allows it only one option: to give the dollars to another arm
of the central government, the State Administration for Foreign
Exchange. It is then SAFE's job to figure out where to park the
dollars for the best return: so much in U.S. stocks, so much shifted
to euros, and the great majority left in the boring safety of U.S.
Treasury notes.
And thus our dollar comes back home. Spent at CVS, passed to Oral-B,
paid to the factory in southern China, traded for RMB at the Shenzhen
bank, "surrendered" to the PBOC, passed to SAFE for investment, and
then bid at auction for Treasury notes, it is ready to be reinjected
into the U.S. money supply and spent again—ideally on Chinese-made
goods.
At no point did an ordinary Chinese person decide to send so much
money to America. In fact, at no point was most of this money at his
or her disposal at all. These are in effect enforced savings, which
are the result of the two huge and fundamental choices made by the
central government.
One is to dictate the RMB's value relative to other currencies, rather
than allow it to be set by forces of supply and demand, as are the
values of the dollar, euro, pound, etc. The obvious reason for doing
this is to keep Chinese-made products cheap, so Chinese factories will
stay busy. This is what Americans have in mind when they complain that
the Chinese government is rigging the world currency markets. And
there are numerous less obvious reasons. The very act of managing a
currency's value may be a more important distorting factor than the
exact rate at which it is set. As for the rate—the subject of much
U.S. lecturing—given the huge difference in living standards between
China and the United States, even a big rise in the RMB's value would
leave China with a price advantage over manufacturers elsewhere. (If
the RMB doubled against the dollar, a factory worker might go from
earning $160 per month to $320—not enough to send many jobs back to
America, though enough to hurt China's export economy.) Once a
government decides to thwart the market-driven exchange rate of its
currency, it must control countless other aspects of its financial
system, through instruments like surrender requirements and the
equally ominous-sounding "sterilization bonds" (a way of keeping
foreign-currency swaps from creating inflation, as they otherwise
could).
These and similar tools are the way China's government imposes an
unbelievably high savings rate on its people. The result, while very
complicated, is to keep the buying power earned through China's
exports out of the hands of Chinese consumers as a whole. Individual
Chinese people have certainly gotten their hands on a lot of buying
power, notably the billionaire entrepreneurs who have attracted the
world's attention (see "Mr. Zhang Builds His Dream Town," March 2007).
But when it comes to amassing international reserves, what matters is
that China as a whole spends so little of what it earns, even as some
Chinese people spend a lot.
The other major decision is not to use more money to address China's
needs directly—by building schools and agricultural research labs,
cleaning up toxic waste, what have you. Both decisions stem from the
central government's vision of what is necessary to keep China on its
unprecedented path of growth. The government doesn't want to let the
market set the value of the RMB, because it thinks that would disrupt
the constant growth and the course it has carefully and expensively
set for the factory-export economy. In the short run, it worries that
the RMB's value against the dollar and the euro would soar, pricing
some factories in "expensive" places such as Shanghai out of business.
In the long run, it views an unstable currency as a nuisance in
itself, since currency fluctuation makes everything about business
with the outside world more complicated. Companies have a harder time
predicting overseas revenues, negotiating contracts, luring foreign
investors, or predicting the costs of fuel, component parts, and other
imported goods.
And the government doesn't want to increase domestic spending
dramatically, because it fears that improving average living
conditions could paradoxically intensify the rich-poor tensions that
are China's major social problem. The country is already covered with
bulldozers, wrecking balls, and construction cranes, all to keep the
manufacturing machine steaming ahead. Trying to build anything more at
the moment—sewage-treatment plants, for a start, which would mean a
better life for its own people, or smokestack scrubbers and related
"clean" technology, which would start to address the world pollution
for which China is increasingly held responsible—would likely just
drive prices up, intensifying inflation and thus reducing the already
minimal purchasing power of most workers. Food prices have been rising
so fast that they have led to riots. In November, a large Carrefour
grocery in Chongqing offered a limited-time sale of vegetable oil, at
20 percent (11 RMB, or $1.48) off the normal price per bottle. Three
people were killed and 31 injured in a stampede toward the shelves.
This is the bargain China has made—rather, the one its leaders have
imposed on its people. They'll keep creating new factory jobs, and
thus reduce China's own social tensions and create opportunities for
its rural poor. The Chinese will live better year by year, though not
as well as they could. And they'll be protected from the risk of
potentially catastrophic hyperinflation, which might undo what the
nation's decades of growth have built. In exchange, the government
will hold much of the nation's wealth in paper assets in the United
States, thereby preventing a run on the dollar, shoring up relations
between China and America, and sluicing enough cash back into
Americans' hands to let the spending go on.
What the Chinese hope will happen
The Chinese public is beginning to be aware that its government is
sitting on a lot of money—money not being spent to help China
directly, money not doing so well in Blackstone-style foreign
investments, money invested in the ever-falling U.S. dollar. Chinese
bloggers and press commentators have begun making a connection between
the billions of dollars the country is sending away and the domestic
needs the country has not addressed. There is more and more pressure
to show that the return on foreign investments is worth China's
sacrifice—and more and more potential backlash against bets that don't
pay off. (While the Chinese government need not stand for popular
election, it generally tries to reduce sources of popular discontent
when it can.) The public is beginning to behave like the demanding
client of an investment adviser: it wants better returns, with fewer
risks.
This is the challenge facing Lou Jiwei and Gao Xiqing, who will play a
larger role in the U.S. economy than Americans are accustomed to from
foreigners. Lou, a longtime Communist Party official in his late 50s,
is the chairman of the new China Investment Corporation, which is
supposed to find creative ways to increase returns on at least $200
billion of China's foreign assets. He is influential within the party
but has little international experience. Thus the financial world's
attention has turned to Gao Xiqing, who is the CIC's general manager.
Twenty years ago, after graduating from Duke Law School, Gao was the
first Chinese citizen to pass the New York State Bar Exam. He returned
to China in 1988, after several years as an associate at the New York
law firm Mudge, Rose (Richard Nixon's old firm) to teach securities
law and help develop China's newly established stock markets. By local
standards, he is hip. At an economics conference in Beijing in
December, other Chinese speakers wore boxy dark suits. Gao, looking
fit in his mid-50s, wore a tweed jacket and black turtleneck, an
Ironman-style multifunction sports watch on his wrist.
Under Lou and Gao, the CIC started with a bang with Blackstone—the
wrong kind of bang. Now, many people suggest, it may be chastened
enough to take a more careful approach. Indeed, that was the message
it sent late last year, with news that its next round of investments
would be in China's own banks, to shore up some with credit problems.
And it looks to be studying aggressive but careful ways to manage huge
sums. About the time the CIC was making the Blackstone deal, its
leadership and staff undertook a crash course in modern financial
markets. They hired the international consulting firm McKinsey to
prepare confidential reports about the way they should organize
themselves and the investment principles they should apply. They hired
Booz Allen Hamilton to prepare similar reports, so they could compare
the two. Yet another consulting firm, Towers Perrin, provided advice,
especially about staffing and pay. The CIC leaders commissioned
studies of other large state-run investment funds—in Norway,
Singapore, the Gulf States, Alaska—to see which approaches worked and
which didn't. They were fascinated by the way America's richest
universities managed their endowments, and ordered multiple copies of
Pioneering Portfolio Management, by David Swensen, who as Yale's chief
investment officer has guided its endowment to sustained and rapid
growth. Last summer, teams from the CIC made long study visits to Yale
and Duke universities, among others.
Gao Xiqing and other CIC officials have avoided discussing their plans
publicly. "If you tell people ahead of time what you're going to
do—well, you just can't operate that way in a market system," he said
at his Beijing appearance. "What I can say is, we'll play by the
international rules, and we'll be responsible investors." Gao
emphasized several times how much the CIC had to learn: "We're the new
kids on the block. Because of media attention, there is huge pressure
on us—we're already under water now." The words "under water" were in
natural-sounding English, and clearly referred to Blackstone.
Others familiar with the CIC say that its officials are coming to
appreciate the unusual problems they will face. For instance: any
investment group needs to be responsible to outside supervisors, and
the trick for the CIC will be to make itself accountable to Communist
Party leadership without becoming a mere conduit for favored
investment choices by party bosses. How can it attract the best
talent? Does it want to staff up quickly, to match its quickly
mounting assets, by bidding for financial managers on the world
market—where many of the candidates are high-priced, not fluent in
Chinese, and reluctant to move to Beijing? Or can it afford to take
the time to home-grow its own staff?
While the CIC is figuring out its own future, outsiders are trying to
figure out the CIC—and also SAFE, which will continue handling many of
China's assets. As far as anyone can tell, the starting point for both
is risk avoidance. No more Blackstones. No more CNOOC-Unocals. (In
2005, the Chinese state oil firm CNOOC attempted to buy U.S.–based
Unocal. It withdrew the offer in the face of intense political
opposition to the deal in America.) One person involved with the CIC
said that its officials had seen recent Lou Dobbs broadcasts
criticizing "Communist China" and were "shellshocked" about the
political resentment their investments might encounter in the United
States. For all these reasons the Chinese leadership, as another
person put it, "has a strong preference to follow someone else's lead,
not in an imitative way" but as an unobtrusive minority partner
wherever possible. It will follow the lead of others for now, that is,
while the CIC takes its first steps as a gigantic international
financial investor.
The latest analyses by Brad Setser suggest that despite all the talk
about abandoning the dollar, China is still putting about as large a
share of its money into dollars as ever, somewhere between 65 and 70
percent of its foreign earnings. "Politically, the last thing they
want is to signal a loss of faith in the dollar," Andy Rothman, of the
financial firm CLSA, told me; that would lead to a surge in the RMB,
which would hurt Chinese exporters, not to mention the damage it would
cause to China's vast existing dollar assets.
The problem is that these and other foreign observers must guess at
China's aims, rather than knowing for sure. As Rothman put it, "The
opaqueness about intentions and goals is always the issue." The
mini-panics last year took hold precisely because no one could be sure
that SAFE was not about to change course.
The uncertainty arises in part from the limited track record of
China's new financial leadership. As one American financier pointed
out to me: "The man in charge of the whole thing"—Lou Jiwei—"has never
bought a share of stock, never bought a car, never bought a house."
Another foreign financier said, after meeting some CIC staffers, "By
Chinese terms, these are very sophisticated people." But, he went on
to say, in a professional sense none of them had lived through the
financial crises of the last generation: the U.S. market crash of
1987, the "Asian flu" of the late 1990s, the collapse of the Internet
bubble soon afterward. The Chinese economy was affected by all these
upheavals, but the likes of Gao Xiqing were not fully exposed to their
lessons, sheltered as they were within Chinese institutions.
Foreign observers also suggest that, even after exposure to the Lou
Dobbs clips, the Chinese financial leadership may not yet fully grasp
how suspicious other countries are likely to be of China's financial
intentions, for reasons both fair and unfair. The unfair reason is
all-purpose nervousness about any new rising power. "They need to
understand, and they don't, that everything they do will be seen as
political," a financier with extensive experience in both China and
America told me. "Whatever they buy, whatever they say, whatever they
do will be seen as China Inc."
The fair reason for concern is, again, the transparency problem. Twice
in the past year, China has in nonfinancial ways demonstrated the
ripples that a nontransparent policy creates. Last January, its
military intentionally shot down one of its own satellites, filling
orbital paths with debris. The exercise greatly alarmed the U.S.
military, because of what seemed to be an implied threat to America's
crucial space sensors. For several days, the Chinese government said
nothing at all about the test, and nearly a year later, foreign
analysts still debate whether it was a deliberate provocation, the
result of a misunderstanding, or a freelance effort by the military.
In November, China denied a U.S. Navy aircraft carrier, the Kitty
Hawk, routine permission to dock in Hong Kong for Thanksgiving, even
though many Navy families had gone there for a reunion. In each case,
the most ominous aspect is that outsiders could not really be sure
what the Chinese leadership had in mind. Were these deliberate taunts
or shows of strength? The results of factional feuding within the
leadership? Simple miscalculations? In the absence of clear official
explanations no one really knew, and many assumed the worst.
So it could be with finance, unless China becomes as transparent as it
is rich. Chinese officials say they will move in that direction, but
they're in no hurry. Last fall, Edwin Truman prepared a
good-governance scorecard for dozens of "sovereign wealth"
funds—government-run investment funds like SAFE and the CIC. He
compared funds from Singapore, Korea, Norway, and elsewhere, ranking
them on governing structure, openness, and similar qualities. China's
funds ended up in the lower third of his list—better-run than Iran's,
Sudan's, or Algeria's, but worse than Mexico's, Russia's, or Kuwait's.
China received no points in the "governance" category and half a point
out of a possible 12 for "transparency and accountability."
Foreigners (ordinary Chinese too, for that matter) can't be sure about
the mixture of political and strictly economic motives behind future
investment decisions the Chinese might make. When China's president,
Hu Jintao, visited Seattle two years ago, he announced a large
purchase of Boeing aircraft. When France's new president, Nicolas
Sarkozy, visited China late last year, Hu announced an even larger
purchase of Airbuses. Every Chinese order for an airplane is a
political as well as commercial decision. Brad Setser says that the
Chinese government probably believed that it would get "credit" for
the Blackstone purchase in whatever negotiations came up next with the
United States, in the same way it would get credit for choosing
Boeing. This is another twist to the Kremlinology of trying to discern
China's investment strategy.
Where the money goes, other kinds of power follow. Just ask Mikhail
Gorbachev, as he reflects on the role bankruptcy played in bringing
down the Soviet empire. While Japan's great wealth has not yet made it
a major diplomatic actor, and China has so far shied from, rather than
seized, opportunities to influence events outside its immediate realm,
time and money could change that. China's military is too weak to
challenge the U.S. directly even in the Taiwan Straits, let alone
anyplace else. That, too, could change.
A Balance of Terror
Let's take these fears about a rich, strong China to their logical
extreme. The U.S. and Chinese governments are always disagreeing—about
trade, foreign policy, the environment. Someday the disagreement could
be severe. Taiwan, Tibet, North Korea, Iran—the possibilities are
many, though Taiwan always heads the list. Perhaps a crackdown within
China. Perhaps another accident, like the U.S. bombing of China's
embassy in Belgrade nine years ago, which everyone in China still
believes was intentional and which no prudent American ever mentions
here.
Whatever the provocation, China would consider its levers and weapons
and find one stronger than all the rest—one no other country in the
world can wield. Without China's billion dollars a day, the United
States could not keep its economy stable or spare the dollar from
collapse.
Would the Chinese use that weapon? The reasonable answer is no,
because they would wound themselves grievously, too. Their years of
national savings are held in the same dollars that would be ruined; in
a panic, they'd get only a small share out before the value fell.
Besides, their factories depend on customers with dollars to spend.
But that "reassuring" answer is actually frightening. Lawrence Summers
calls today's arrangement "the balance of financial terror," and says
that it is flawed in the same way that the "mutually assured
destruction" of the Cold War era was. That doctrine held that neither
the United States nor the Soviet Union would dare use its nuclear
weapons against the other, since it would be destroyed in return. With
allowances for hyperbole, something similar applies to the dollar
standoff. China can't afford to stop feeding dollars to Americans,
because China's own dollar holdings would be devastated if it did. As
long as that logic holds, the system works. As soon as it doesn't, we
have a big problem.
What might poke a giant hole in that logic? Not necessarily a titanic
struggle over the future of Taiwan. A simple mistake, for one thing.
Another speech by Cheng Siwei—perhaps in response to a provocation by
Lou Dobbs. A rumor that the oil economies are moving out of dollars
for good, setting their prices in euros. Leaked suggestions that the
Chinese government is hoping to buy Intel, leading to angry
denunciations on the Capitol floor, leading to news that the Chinese
will sit out the next Treasury auction. As many world tragedies have
been caused by miscalculation as by malice.
Or pent-up political tensions, on all sides. China's lopsided
growth—ahead in exports, behind in schooling, the environment, and
everything else—makes the country socially less stable as it grows
richer. Meanwhile, its expansion disrupts industries and provokes
tensions in the rest of the world. The billions of dollars China pumps
into the United States each week strangely seem to make it harder
rather than easier for Americans to face their own structural
problems. One day, something snaps. Suppose the CIC makes another bad
bet—not another Blackstone but another WorldCom, with billions of
dollars of Chinese people's assets irretrievably wiped out. They will
need someone to blame, and Americans, for their part, are already
primed to blame China back.
So, the shock comes. Does it inevitably cause a cataclysm? No one can
know until it's too late. The important question to ask about the
U.S.–China relationship, the economist Eswar Prasad, of Cornell,
recently wrote in a paper about financial imbalances, is whether it
has "enough flexibility to withstand and recover from large shocks,
either internal or external." He suggested that the contained tensions
were so great that the answer could be no.
Today's American system values upheaval; it's been a while since we've
seen too much of it. But Americans who lived through the Depression
knew the pain real disruption can bring. Today's Chinese, looking back
on their country's last century, know, too. With a lack of tragic
imagination, Americans have drifted into an arrangement that is
comfortable while it lasts, and could last for a while more. But not
much longer.
Years ago, the Chinese might have averted today's pressures by
choosing a slower and more balanced approach to growth. If they had it
to do over again, I suspect they would in fact choose just the same
path—they have gained so much, including the assets they can use to do
what they have left undone, whenever the government chooses to spend
them. The same is not true, I suspect, for the United States, which
might have chosen a very different path: less reliance on China's
subsidies, more reliance on paying as we go. But it's a little late
for those thoughts now. What's left is to prepare for what we find at
the end of the path we have taken.
