The Contest of the Century

by Geoff A. Dyer

  When various efforts at mediation failed, the only solution was to go to the United Nations. On May 2, 2012, the UN Security Council unanimously approved Resolution 2046, which called for an immediate halt to fighting between Sudan and South Sudan. The resolution was remarkable for a number of reasons.

  First, China approved a measure that not only heavily criticized Sudan, a country which for nearly two decades had been almost a client state, but it also threatened to impose sanctions under Chapter VII of the UN Charter, the sort of meddling punishment that Beijing is usually so reluctant to inflict on other countries. That alone indicates how China’s position on outside interference can bend out of all recognition when its own interests are at stake.

  But the timing was also interesting. Two months before the Sudan vote, China and Russia had vetoed a resolution that included a much vaguer threat of possible sanctions on the Syrian regime, a position that the U.S. ambassador to the UN described as “disgusting.” Two months later, they vetoed a similar resolution on Syria again, prompting Hillary Clinton to denounce Beijing and Moscow as “despicable.” The Syrian vetoes garnered all the attention and seemed ample evidence of the emerging authoritarian axis. It was these Syria votes at the UN that prompted Michael Ignatieff to say of China’s and Russia’s worldview: “This is not your world, they want us to know, and history is not moving in your direction. You will have to reckon with us. We shall indeed.” Yet, in between the bitter standoffs over Syria, the UN vote on Sudan was compelling evidence that the historical forces are also pulling China in a different direction from the one Ignatieff imagines, one in which it has little choice but to immerse itself in the messiness, the compromises, and, most of all, the meddling that conflict resolution demands. The dispute between Khartoum and Juba is far from resolved, but in the breakup of Sudan, China has found itself the indispensable outside power in a country whose politics it barely understood but could not escape.

  Just like a new president or prime minister taking office, one of the luxuries of being the new great power is the chance to promise a break from the vices of the old order and its addiction to cynical power plays. For several decades after it started to become a global force, America’s leaders insisted they could help shape the world without behaving like the old European powers. Fifty years after Rudyard Kipling wrote the poem “White Man’s Burden” in reference to the violent American conquest of the Philippines in the 1890s, President Franklin Roosevelt was still castigating Europe for its imperial misbehavior. By the same logic, it will be quite a while before Beijing changes its rhetoric about nonintervention. The policy is just too useful and too central to China’s self-image. Yet, over time, China will find itself compelled to get its hands dirty on a more regular basis, to play the local power broker, to pick sides, maybe even to send in its military for more than just peacekeeping operations. None of this means that China and the U.S. will always be on the same side, as they ended up in South Sudan. But China’s ideological aversion to outside intervention will start to fade.

  Section III

  ECONOMICS

  8

  Taking On the Dollar

  IN 2009, I had lunch in Hong Kong with a lawyer who was describing to me his many professional woes. We were sitting at the bar of an Italian restaurant in Pacific Place, a complex of tinted-glass office towers in the Admiralty District of the city with a cavernous shopping mall down below. Outside the restaurant, wealthy women flitted between the Chanel and Louis Vuitton stores, their high heels echoing on the marble floors. The set lunch of Caprese salad followed by linguine with crab was perfectly executed, but my lunch companion was not enjoying the meal. He launched into a lengthy whinge about how his business was all disappearing to Shanghai, which the Chinese central government wants to turn into the country’s main financial center. Companies were listing their shares in Shanghai, instead of Hong Kong, he complained. Multinationals were shifting their headquarters to Shanghai, and fund managers were also moving up there. Hong Kong was suffering the gradual erosion of its role as China’s conduit to the international financial world. “And another thing,” he said, almost without pausing for breath. “Our landlord wants to raise our rent by fifty percent.”

  I have been traveling to Hong Kong regularly for much of the last decade, and on each visit I hear the same foreboding about the future of the city and the same fears about the lethal competition from Shanghai. It is the second-most-common complaint, after the pollution being blown down from the factories in southern China. Admittedly, Hong Kong did suffer two huge body blows, from the 1997 Asian financial crisis and the SARS outbreak in 2003, which possibly colors some of the grumpiness. Yet the soul-searching always seems out of place, a narrative that is rebuked by the constant bustle and progress. More than most other cities, Hong Kong adapts. To the visitor it always seems to be booming, with new high-rises, new malls, and new slivers of land reclaimed from Hong Kong Harbor. And the rents just keep going up.

  The next new business opportunity for Hong Kong is already starting to take shape, and it could be a huge one. Beijing is putting in place an ambitious plan to allow the Chinese currency to play a larger role in the global economy, and Hong Kong is the launchpad. It is the first place where the Chinese currency, the renminbi, can be freely traded by Chinese and non-Chinese companies. There is also now a market in Hong Kong for corporate bonds issued in the Chinese currency, known as “dim sum bonds,” which allows people to put some of their savings into securities denominated in renminbi. (One of the first issuers was the McDonald’s Corporation, which must now sell Big Macs in China to repay the dim sum.) The financial world is abuzz with talk about the start of a momentous shift. HSBC predicts that by 2015 at least half of China’s trade with the developing world will be in renminbi, around $2 trillion. “We could be on the verge of a financial revolution of truly epic proportions,” says Qu Hongbin, HSBC’s China economist. “The world is slowly, but surely, moving from greenbacks to redbacks.” The Washington-based economist Arvind Subramanian predicts that the Chinese renminbi could become “the premier reserve currency by the end of this decade, or early next decade.” Hong Kong has found a new role. It could be the international hub for the world’s new global currency.

  This might sound like arcane business-speak, the kind of thing that is of interest to financial professionals but not to anyone else. Yet, in reality, the question of whether the renminbi will supplant the dollar is one of the central contests that will determine the shift of power from West to East over the course of the next few decades, a delicate combination of high finance and geopolitics. The political influence of the U.S. dollar is the often overlooked anchor of American global influence. Just as the period of British pre-eminence from around 1850 to 1914 was sustained by the central role of sterling, American global reach in the post–World War II era has been underwritten by the pervasiveness of the U.S. dollar, which is used in 85 percent of cross-border business. The dollar’s position as the main reserve currency is both cause and effect of American power, a symbol of confidence in the world’s most productive economy and a manifestation of America’s position at the center of a series of economic, political, and military relationships at the heart of the international system. American politicians sometimes like to talk about the U.S. as the “indispensable” nation, a phrase that never fails to grate on foreign audiences, but in the case of the dollar it is quite apt. The dollar’s role in the world is a reflection of continuing trust in Washington as the guardian of the global order.

  Washington is drowning in warnings about the end of the dollar era. Edward Luttwak, a hardheaded scholar of military strategy, downplays the military threat from China, but adds: “The real challenge to American and Western strategy is far more subtle: a slow, not uncomfortable slide into subordination in a China-centred world, with the renminbi as its currency.” The National Intelligence Council, which publishes the U.S. government’s official intelligence estimate, forecasts that “the fall of the dollar as
the global reserve currency… would be one of the sharpest indications of a loss of U.S. global economic position, strongly undermining Washington’s political influence too.” If the dollar does start to lose that position to the renminbi, it would indicate that a real power shift was taking place and that China was assuming a central role in the world’s political and economic affairs. Since the financial crisis, there has been a lot of talk about a “currency war,” a somewhat faux dispute about U.S. and Chinese efforts to weaken the value of their currencies that was coined by the Brazilian finance minister. The real “currency war” for the next few decades is the contest for the title of global reserve currency.

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  The privilege of issuing the main reserve currency is more than just symbolism. The advantages are enormous. All governments borrow money, even in the very best-managed economies, and if a country does not have enough savings at home, the Finance Ministry will have to borrow abroad in someone else’s currency. When countries face economic problems, these overseas borrowings often become the weak link. If markets start to lose confidence in a government and its policies, it becomes much harder to roll those debts over, or to issue new bonds. The country’s currency also starts to weaken sharply as investors get cold feet. The government then faces a double whammy—it loses access to new international funding, and the cost of its existing debt suddenly shoots up, because its currency is now worth less. Imports also become more expensive, putting further pressure on dwindling sources of foreign currency. Many of the economic crises that developing countries have faced in recent decades have followed this pattern.

  Yet America has been shielded from such troubles. The U.S. dollar is overwhelmingly the preferred unit for business and financial transactions around the world. Global trade is lubricated by dollars—99 percent of all foreign-exchange transactions in both South Korea and Chile, two big exporting nations, are sales of local currency for dollars. For the world’s central banks—the biggest, most conservative, and most influential investors on the planet—the U.S. dollar remains the principal anchor of their foreign-currency reserves. It is the same in the black market economy. When Somali pirates or Mexican drug lords demand payment, it is U.S. dollars they want to receive. Because the dollar is used so widely in commerce and investment, and because it is such a trusted store of value—it is “as good as gold,” as the saying goes—foreigners are only too happy to buy bonds from the American government that are issued in its own currency. As a result, the biggest and most liquid bond market in the world by far is the U.S. Treasury bond market. Even if the dollar suddenly gets weaker, this does not affect the American government in the same way it would affect other countries, because the U.S. repays foreign investors in the same currency it collects in tax revenues. That makes the position of the U.S. dollar a hugely powerful tool. It gives an important competitive advantage to American companies and banks, which get to do business in their own currency and avoid the vagaries of foreign-exchange markets. And it allows the U.S. government to live beyond its means without facing the punishment that other governments inevitably suffer. Washington can finance its global power projection with a credit card that has no limit. “Deficits don’t matter,” as Dick Cheney liked to say.

  Except that, eventually, they do. Even for America, there are limits to the sorts of deficits it can run. At some stage, the credibility of the U.S. dollar will be called into question—and with it the underpinnings of America’s global position. To be fair, there have been many dollar scares in the past that proved to be unfounded. When I was studying in Washington in the 1990s, my dissertation supervisor was David Calleo, who was one of the leading voices in the school of thought sometimes called “imperial overstretch.” He wrote persuasively about the ructions caused by Lyndon Johnson’s budget deficits in the 1960s, which were needed to finance the Vietnam War, and the subsequent stresses the dollar came under in the 1970s, when Nixon eventually abandoned the convertibility of the dollar into gold. Yet the dollar’s primacy survived the episode. To Europeans who worried about the risk of inflation, then treasury secretary John Connally retorted: “It is our currency and your problem.”

  The same pressures returned during the Reagan years and the arms race with the Soviet Union. The Soviets eventually blinked first, their economy imploding under the burden of heavy defense spending, but America’s finances also came under intense pressure, prompting a new bout of predictions that American dominance and the dollar era that financed it were coming to an end. Paul Kennedy had a massive publishing success at the time with his Rise and Fall of the Great Powers, a tome about imperial overstretch over the centuries which captured the prevailing mood. Again, the pessimism proved short-lived. The end of the Cold War and the supreme confidence of the early years of the George W. Bush administration made these sorts of predictions seem alarmist, almost foolish, and in the boom years of the mid-2000s they were brushed aside as a kind of intellectual defeatism. Yet, after a decade of two expensive wars and the biggest financial crisis since the 1930s, which forced the government to run a deficit of $1.1 trillion in 2012, America’s outstanding government debt is now almost as large as the economy itself—something that has not happened since the Second World War. The credibility of the dollar is once again being called into doubt, and the idea of “imperial overstretch” is very much back in vogue. In the financial world, some talk about when rather than if there will be a dollar crisis. It is precisely at this moment of uncertainty in the fate of the U.S. currency that China has chosen to start claiming a bigger role for the renminbi in the global economy.

  THE DOLLAR TRAP

  “How do you deal toughly with your banker?” Hillary Clinton asked, shortly after she became secretary of state. Since the start of the financial crisis, a new phantom has started to loom over U.S.-China relations: the massive amounts of American government debt that are now in China’s hands. China has the largest foreign-exchange reserves in the world, at around $3.3 trillion, and overtook Japan in 2008 to be the largest overseas holder of U.S. debt. Although the exact composition of China’s reserves is a state secret, analysts who have sifted through the available information estimate that around two-thirds of those reserves are in U.S. dollar assets. The likely result is that China owns around $2 trillion of U.S. government debt. “Never before has the United States relied on a single country’s government for so much financing,” as economist (and later White House official) Brad Setser put it. “Political might is often linked to financial might and a debtor’s capacity to project military power hinges on the support of its creditors.”

  The handover of global responsibilities from the U.K. to the U.S. was a long and drawn-out process, but the final blow was delivered because Britain owed too much money to Washington. In 1956, when the U.S. wanted to show its displeasure at the British invasion of the Suez Canal, Eisenhower refused to let the IMF issue an emergency loan which Britain needed to defend its currency. Fearing a complete financial collapse, Britain pulled out its soldiers from the Canal Zone. British influence in the world was never the same again. If China could turn this financial power into real political leverage, it would have dramatic consequences for both America’s economic policy and its ability to exert influence around the world. It would give Beijing the hold over Washington that the U.S. once held over its own great-power predecessor.

  China is well aware of the potential significance. Every now and then, there have been comments from low-level Chinese officials raising the potential threat. In 2007, Xia Bin, who was then a leading economist at a government think tank called the Development Research Center, caused an international fuss when he suggested that China’s dollar holdings should be used as a “bargaining chip.” When the U.S. announced it would sell more arms to Taiwan in 2010, three senior PLA officers—Major General Zhu Chenghu, Major General Luo Yan, and Senior Colonel Ke Chunqiao—told the Xinhua News Agency that China should retaliate by selling U.S. government debt, which could lead to a sharp rise in U.S. in
terest rates. According to American diplomats, the threat to sell dollar assets has also occasionally hung over conversations about the Dalai Lama. The more nationalistic sections of the Chinese press call it “the nuclear option”—threatening to dump dollar bonds in order to change American policy. Or, as Gao Xiqing, the head of China’s sovereign-wealth fund, told the American journalist James Fallows: “I won’t say kowtow, but at least be nice to those countries that lend you money.”

  In the U.S., this potential threat from China has now been a feature in two presidential elections. When he was running for the 2008 presidential nomination, then senator Joe Biden warned, in a Democratic debate, about the risks of having China finance U.S. debt. We need to “make sure that they no longer own the mortgage on our home.” Hillary Clinton, also then a senator and a presidential candidate, piped in: “I want to say ‘Amen!’ to Joe Biden, because he’s 100 percent right.” In 2012, the theme returned with a vengeance. In May, there was a standoff in Beijing over the blind activist Chen Guangcheng, who, having escaped house arrest and taken refuge in the U.S. Embassy in Beijing, announced that he wanted to leave China for the U.S. Paul Ryan was asked if the U.S. still had any influence over China in such a dispute. The Republican vice-presidential nominee answered: “When you depend on another country like China for the cash flow in your country and for your debt, there is not a lot you can do when you are asked to stand up to them on a principled matter such as this.” Ryan somewhat misread the situation: the next day Chen was given permission to move to New York.