The Contest of the Century

by Geoff A. Dyer

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  Paul Ryan was wrong for a reason. The supposed leverage that China derives from its dollar holdings is something of a myth—and China knows it. The curious thing about this discussion is that, although some Americans complain that the debt gives China excessive influence, China is increasingly angry at how little sway it has. In the years since the financial crisis, there has been a growing frustration in China that its U.S. bond holdings give it almost no leverage whatsoever. When the crisis broke, Beijing started to issue a series of warnings about American economic policy and its obligations to do right by China. “I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets,” Premier Wen Jiabao told a 2009 press conference. Beijing worried very loudly about the inflationary risks of the monetary expansion the U.S. Federal Reserve launched in response to the crisis. Chinese officials started to push for guarantees about repayment on their U.S. debt, especially in the troubled mortgage agencies Fannie Mae and Freddie Mac. It is possible that Chinese pressure had something to do with the timing of when the two mortgage agencies were brought under government control. But, by and large, China’s attempt to strong-arm the U.S. did not work. Beijing did not receive any formal guarantees, and it exerted no influence over American monetary or fiscal policy. The Fed has continued to do as it wishes. The Tea Party has more influence over the Fed than does the Chinese Communist Party.

  Larry Summers, the former U.S. Treasury secretary, once described the situation between the two countries as “mutually assured economic destruction.” Beijing has come to realize that it is trapped—trapped by the size of its exposure to the U.S., trapped by the reality of financial markets, and trapped by the logic of its own policies. In any month when China exports more than it imports, this leads to an inflow of foreign currency into the country. In order to prevent the value of the renminbi from rising, which would hurt its exports, the Chinese central bank buys up the dollar excess. China’s foreign-currency reserves are the direct product of this policy of keeping its currency artificially cheap, in order to boost exports. This was a choice made by China, not by anyone else. Indeed, large parts of the world have called on China to change its approach and to allow its currency to become more expensive. Having built up such a stockpile, China’s official money managers are then faced with limited options. The U.S. Treasury market is by far the largest and most liquid in the world. It is also the only one with the size to absorb the sort of volumes of reserves that China has been accumulating. China therefore has little choice but to recycle a large portion of its surpluses into U.S. government bonds.

  The harsh reality for China is that it has too much at stake to turn its back completely on U.S. bond markets. Economic interdependence makes it hard for China to rock the boat. At best, China can gradually scale back the rate at which it buys new American debt. But if China were to try and sell a substantial chunk of its U.S. bond holdings, it would send the market into a tailspin, and bond prices—including China’s own investments—would plummet. Such action would also force down the value of the U.S. dollar, making China’s exports less competitive and threatening hundreds of thousands of factory jobs. It would be a huge self-inflicted wound. This formula does not make sense for a regime whose legitimacy is tightly wound up in delivering economic results. China’s holdings give it theoretical leverage over the U.S., but it is leverage that it is technically difficult and politically suicidal to exploit. Beijing knows as much. “We hate you guys …” Luo Ping, a senior Chinese banking official, admitted in 2009. “US Treasuries are the safe haven. For everyone, including China, it is the only option.” He continued: “Once you start issuing $1 trillion–$2 trillion… we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.”

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  Luo Ping was only half joking. His mock anger was politically important because that sentiment became one of the starting points for the campaign to take the Chinese currency global. Frustrated at its inability to influence American economic policy, Beijing has started to think much more seriously about finding ways to rein in the influence of the dollar and Washington’s ability to run endless deficits. Resentment at the “dollar trap” helped launch a much broader Chinese critique about the place of the U.S. dollar in the international economy. If China could not influence the way the U.S. managed its economy, it would try and reshape the international financial system instead, and make the dollar less indispensable. Hu Jintao called in 2008 for a “new international financial order that is fair, just, inclusive and orderly.”

  The first sign that something was brewing in Beijing came from the governor of the Chinese central bank, Zhou Xiaochuan. Zhou is a chemical engineer by training but is considered one of the Communist Party’s intellectual heavyweights in the field of international economics. With his donnish air, he likes to tease journalists with the sort of delphic pronouncements that once made Alan Greenspan a cult figure—before the financial crisis, that is. In March 2009, six months after Lehman Brothers collapsed, the central bank started to put up on its Web site a series of long and detailed speeches and essays by Zhou that called for substantial reforms of the international financial system. Zhou had himself some fun at the expense of the Western investment banks, which had almost felled the global economy. He criticized the “herding phenomenon” among investors and the “inertia and sloppiness” that stopped executives from “asking tough questions.” But his broader message was aimed at the role of the U.S. currency. The international financial system, he said, needs a reserve currency “that is disconnected to individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.” In between the technical language of international financial policy, the message was clear: the world needs to become less reliant on the dollar.

  Zhou’s speech was the starting gun for China’s campaign to develop a more international currency. Since then, China has unveiled a steady series of reforms aimed at forging a bigger role for the renminbi. Using Hong Kong as a trial ground, the government in 2009 started to allow the use of the renminbi to settle international trade—the first stage in a plan to turn it into the main currency for trade in Asia and between developing countries. In 2011, it allowed renminbi bonds to be sold in Hong Kong, letting foreign investors buy assets denominated in the Chinese currency. Since then, Beijing has announced a slew of reform measures that will gradually make it easier to trade and invest in the Chinese currency. By the end of 2012, around 15 percent of China’s trade was being conducted in renminbi. The final stage would be to turn the renminbi into the sort of international safe haven that attracts the world’s central banks to park a substantial share of their reserves in the currency. That would be the real stamp of approval. In what was largely a symbolic gesture, Malaysia has already taken the first step, acquiring some renminbi bonds.

  Chinese policy makers usually couch the project in technical terms, pointing out that it will reduce the costs of doing business for Chinese companies and expand the opportunities for Chinese banks. But they also do little to hide their broader political objective of forging a new international system that is not dominated by the U.S. dollar. Li Ruogu, head of the China Export-Import Bank, argues that “the financial crisis … let us clearly see how unreasonable the current international monetary system is.” Another official told me: “We have the second-biggest economy in the world, so we should have a currency that enjoys many of the privileges that the U.S. also gains.” According to Zha Xiaogang, a researcher at the Shanghai Institutes for International Studies: “The shortcomings of the current international monetary system pose a big threat to China’s economy. With more alternatives, the margin for the U.S. would be greatly narrowed, which will certainly weaken the power basis of the U.S.” One Chinese academic even goes so far as to say that ending the dominance of the dollar is as important for Beijing’s ability to project po
wer as was “China becoming a nuclear power.”

  Attacking the power of the U.S. dollar is not a new form of geopolitical sparring. In the 1960s, General Charles de Gaulle sought to challenge American leadership of the West and to position himself in the middle ground between Washington and Moscow. One of his tactics was to withdraw France from the military arm of NATO. The other was to take aim at the dollar. Throughout the mid-1960s, as America became bogged down in Vietnam and its public finances came under pressure, de Gaulle gave a series of press conferences in which he called for an end to the primacy of the dollar and urged other countries to convert their holdings of U.S. currency into gold. And it was a French finance minister (and later president), Valéry Giscard d’Estaing, who famously complained in the 1970s that the benefits America derived from the dollar were “an exorbitant privilege.” “There was no doubting de Gaulle’s intention: to promote his drive to reduce US economic, military and cultural influence,” Time magazine said of his campaign. (As part of his effort to demonstrate independence from Washington, de Gaulle recognized the People’s Republic of China in 1964, a full seven years before Nixon and Kissinger made their celebrated opening to Beijing.) China sees a global role for its currency in a similar light to de Gaulle’s, as both good business and good power politics. Even though Beijing knows it will be a long process that could take several decades, some officials see it as a central part of a broader struggle to place limits on American power and to increase China’s own room for maneuver. In their minds, it is a rather nerdy, pointy-headed proxy war for influence.

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  When then U.S. treasury secretary Tim Geithner spoke to a group of students at Peking University in 2009, he was asked if China’s holdings of U.S. government debt were safe. Of course they are, he responded. The audience laughed. It is not just the Chinese elite who frets about the dollar. One of the surprising aspects of the Chinese reaction to the financial crisis has been the way in which seemingly technical issues about the international financial system have seeped into public debate. The U.S. dollar has become a flashpoint for some of the broader nationalist tensions that have been boiling up within China. In 2012, the car of the U.S. ambassador to China, Gary Locke, was surrounded by an angry mob of around fifty people who had been protesting at the nearby Japanese Embassy. One demonstrator grabbed the flag off the front of the car. Then the crowd shouted: “Give us back our money.”

  In Song Hongbing, China’s currency nationalists have found an unlikely cheerleader. A few years ago, Song was an unknown economist at a Chinese government think tank. But his 2007 book Currency Wars turned him into an unlikely star of the publishing world, selling half a million copies, and making him the spokesman for popular resentment at the dollar-based world. The book aims to be a sort of financial history, but it is really a hodgepodge of dubious stories about financial conspiracies down the ages, arguing that the Rothschild banking dynasty has been pulling the strings in the international financial system ever since the nineteenth century, when it made a fortune speculating on the outcome of the Napoleonic wars. He claims the Rothschild family wealth is now a hundred times greater than that of Bill Gates. One of his main targets is the fact that the regional U.S. Federal Reserve banks are technically owned by the private banks rather than the government. But Song also manages to recycle some ugly myths about the prominence of Jews in the financial sector and their alleged role in events ranging from Waterloo to the Asian financial crisis. Such insinuations did not prevent the book from generating buzz in some surprising places—two different sources told me that Premier Wen Jiabao had asked to read a copy of Currency Wars.

  Song’s background does not make him an obvious critic of American financial excess. While he was living in the U.S., he did some work creating financial-risk models for Fannie Mae and Freddie Mac, the two mortgage finance institutions at the center of the housing bubble. But the book seems to have tapped into popular suspicions that international finance is rigged against China and that the U.S. will debase its currency. His timing was impeccable: Currency Wars came out just before a massive financial crisis which was caused in part by the arrogance of a U.S.-based international financial elite. That has helped turn Song into an often quoted authority on the links between finance and politics. In the process, he has also helped popularize a certain strain of victim nationalism that sees the dominance of the dollar as one of the tools used to curtail China’s rise. “Before my book, people thought currencies were really an academic issue, but now they see it as a political issue, as a struggle for power,” Song told me. “The big power is the one who issues the money, who can define what money is. The currency war is a struggle, a fight for who controls the money and who can issue it.”

  One of the peculiar aspects of Song’s writings is that he shares many of his concerns with a section of the right wing in America. He has not only an intense aversion to the investor George Soros, but also a deep suspicion of the powers of the U.S. Federal Reserve. “Congress should have the power to issue money, not the Fed,” he told me. “No one audits the books of the Fed.” He added: “Ron Paul has very much the same view. Why is money issued by a small group of unelected people?” When I asked him why he was so obsessed about Jews in finance, such as Soros, he smiled a little uncomfortably and attempted the sort of compliment that runs its own risks of stereotyping. “I personally admire the Jews,” said Song. “They were prohibited from doing anything else, they could not own land, so money was the only way to succeed.”

  A bespectacled forty-something in a starched shirt with personalized cuff links, Song was clearly enjoying his success when I met him. He had opened a new consulting business, called the Global Business and Finance Institute, to give advice on international financial issues. A sequel to his book, Currency Wars 2, which describes plans by a small group of bankers to launch a new global currency, had been published, and a third volume is in the works. He had also just rented a suite of offices in Beijing near Dongzhimen Avenue, modern China’s new power center, which houses the imposing and slick headquarters of many of China’s largest state-owned companies. One side of the office was taken up by a new side business: a group of young computer programmers were designing a video game based on Currency Wars. Song described to me the outline for the game. The early stages would involve starting your own business and building up capital. If a gamer managed to reach the final stage, he would get to become a big hedge-fund speculator who could launch an attack on the U.S. dollar. “You can become the sort of financial big guy who has the resources to start a currency war,” he said. “Someone like George Soros.”

  JEKYLL ISLAND

  In November 1910, a group of the great and the good from America’s financial elite assembled after dark in a railway car at a quiet siding in Hoboken, just across the river from Manhattan. They used only their first names in front of the porters. When they reached Brunswick, Georgia, two days later, they took a boat to Jekyll Island and checked in at the private club partly owned by J. P. Morgan. They told people they were going duck hunting, and one of the party even carried a shotgun onto the train to keep up the pretense, although he had never used one in his life. But their real purpose was to draft legislation to completely shake up the country’s banking system. In the process, they also revolutionized the role of the U.S. dollar.

  The men at the secret meeting on Jekyll Island included Benjamin Strong, head of Bankers Trust; Henry Davison, who was J. P. Morgan’s right-hand man; Paul Warburg of Kuhn, Loeb; and Frank Vanderlip, a former journalist who was by then the boss of what became Citibank. They were joined by Senator Nelson Aldrich of Rhode Island, head of the Senate Finance Committee, whose daughter was married to John Rockefeller, son of the richest man in the country, and Abraham Piatt Andrew, assistant secretary of the Treasury Department. The most famous consequence of the meeting was the bill that created the Federal Reserve, America’s central bank. The 1907 financial crisis had exposed the vulnerabilities of the economy to such an extent tha
t the government effectively had to rely on J. P. Morgan to broker a solution—he called leading bankers to his Manhattan town house and would not let them leave until they had devised a rescue plan. As a result of the legislation they wrote, the Federal Reserve System took over that role of regulating and managing credit conditions in the country. Every modern economy in the world now has a central bank that plays the role of lender of last resort. But, given that sections of the American right believe the Fed is an example of excessive government interference, the Jekyll Island meeting is, to this day, viewed by some as an elite conspiracy against the interests of ordinary Americans. In 2010, the libertarian politician Ron Paul was the headline guest at a conference on Jekyll Island about the misdeeds of the Fed. “People are demanding that we not put up with a secretive organization like the Fed that prints all this money and causes all this mischief,” the former presidential candidate told the audience.

  Establishing the Fed was only one part of the 1910 Jekyll Island plan, however. The legislation they developed also created the legal instruments for the dollar to become an international currency—as it happens, a plan quite similar to the one China is now pursuing. They started by establishing procedures so that trade could be settled using U.S. dollars. Then they created the legal framework for the issuance of international U.S. dollar bonds. The impact was dramatic. According to the financial historian Barry Eichengreen, just one decade after the bill was passed in 1913, the U.S. dollar already accounted for a larger share of central-bank reserves than the British pound. It was also used in more bond issues and exceeded sterling in loans linked to trade by a factor of two to one. Even before the Jekyll Island plan was implemented, the American economy had the scale for the dollar to play a larger role in the global economy, but lacked the legal instruments and market infrastructure. Within just a decade of its approval, the status of the U.S. dollar had been transformed and sterling’s diminished.