Is China ready to replace US?

S P SETH

By hanging their dirty laundry for open display during the recent the fiscal crisis, the US political establishment rightly invited some serious criticism of its dysfunctional system. And the most telling came from Xinhua, the official Chinese news agency. Its commentary called on  “the befuddled world  [by events in the US] to start considering building a de-Americanized world”, including a new international reserve currency. Hitting the US hard by blaming it for the global economic crisis in the first place, the Xinhua said, “The world is still crawling its way out of economic disaster thanks to the voracious Wall Street elites.” Not letting off the US easily and highlighting risks to China’s investments in the US currency, the Xinhua pointed out that, “The cyclical stagnation in Washington for a viable bipartisan solution over a federal budget and an approval for raising debt ceiling has again left many nations’ tremendous dollar assets in jeopardy and the international community highly agonized.”

One can’t entirely blame the Chinese for lecturing the Americans, having been subjected to criticism from the US over a whole range of issues, though not without substance. Apart from exulting at the US political embarrassment, the Chinese have a real stake in the proper management of the US economy because they have invested over $ 1 trillion in US treasury notes and bonds. And any US default would have seriously damaged their investment in what has been generally regarded as, good as gold, US currency instruments. They should, therefore, be pleased, for that reason alone, that the US has come back from the brink, at least for the time being.

However, one may ask if the Chinese are really serious about “a de-Americanized world”, with a new international reserve currency? They certainly would like that but they have never spelled out the alternative. As Professor Jin Canrong of International Studies at Remin University has reportedly said, “We have talked about it for many years…. But in fact, the majority of China’s foreign currency reserves are still in US dollars.” Amplifying it, he added, “Since the late 1980s China has raised the idea of establishing a new world order, both politically and economically, but no one has any idea what that could be. China has been a beneficiary [of the present system], so what is the reason to change it?”

And how has China been the beneficiary? Because China’s currency wasn’t freely convertible, it has been able to keep its exchange rate artificially low, giving it an enormous competitive advantage in pricing of its goods for export; as well as from low (depressed) wages at home. But it hasn’t been an entirely one-way street. China’s low valued exports helped to control inflation in developed countries, not only through direct export of cheap Chinese goods but also with the US and western outlets setting up their own production lines in China to take advantage of its low production costs. Of course, China’s massive exports enabled it to build up large trade surpluses. But, by investing these surpluses in US treasury notes and the likes, it made available the same as credit to the United States and other developed countries.

Even though the US and other western countries often complained about their trade deficits, and sought revaluation of the Chinese currency to make trade competitive and balanced, they were never serious about taking on China on this, principally because it kept inflation under control in their countries. It is important to realize that inflation had been the curse of economies in developed and developing countries but that largely ceased to be an issue in rich countries with low consumer prices of Chinese goods and availability of credit for almost anything and everything. Partly, of course, the credit availability was the China magic with their surpluses invested in US dollars and, partly, a number of western countries and the United States decided to venture into floating all kinds of credit instruments creating an illusion of ever-increasing economic prosperity. The former US Federal Reserve chairman, Alan Greenspan, called it irrational exuberance but he kept the credit flowing as if the economy was on autopilot, not needing any regulation or direction. And we now know what happened, and the resulting global financial crisis is still causing havoc, with periodic political and financial gridlock in the United States. China, though, has so far weathered relatively well through the global crisis.

Ever since the 9/11 terrorists attacks in the US and the subsequent invasions of Afghanistan and Iraq, things haven’t gone too well for the United States. In the midst of it all it experienced the worst recession since the economic depression of the thirties. Even as the US has been pre-occupied with these wars, China has been consolidating its position and expanding its political horizons, particularly in the Asia-Pacific region, laying claims to a number of islands and waters around them in the South China Sea and the East China Sea. But its sovereignty there is contested by a number of regional countries, some of them with security pacts with the United States. But for the US presence and involvement in the Pacific, China would hope to sort it out with its regional neighbors.

China seemed to be cruising along well in its region with the US stuck in its wars in Afghanistan and Iraq. However, Obama’s 2111 announcement of the US “pivot” to Asia with a renewed and and expanded commitment to the region, complicated China’s regional strategy. Beijing would hope that the US’ financial and political problems, over time, constrict it increasingly from over-extending its reach in Asia-Pacific. It is not so much a matter of the US presence and involvement as the perception regionally of its seriousness and capacity to stand by its allies against China. And this recently took a hit when President Obama couldn’t even attend the Asia-Pacific Economic Cooperation (APEC) summit in Bali in Indonesia, and the East Asia summit in Brunei because of the crisis at home over the budget and the debt limit. Even though Obama’s absence was understandable but the US image as a dysfunctional superpower didn’t go well in the region. It is this perception that might push regional countries into making peace with China on the latter’s terms.

But even if this were to happen over whatever period of time, China is not prepared yet to replace the US dollar as the world’s reserve currency or a basket of currencies. With European economies in doldrums, and Japan still seeking to emerge from its two decades’ long economic stagnation, it would be difficult to put together a credible basket of international currencies to replace US dollar. And, as for China, it is economically and politically not yet in a position to become the world’s currency repository. In other words, the world might have to live with the US dollar as the world’s reserve currency for an indeterminate period.    

This article was first published in the Daily Times.