Just as Americans should not be surprised by China’s urge to build a grand navy, they should also not be blindsided by Beijing’s ambitious plans to turn the renminbi into a global currency. After all, this is precisely what America did at a similar stage in its development, when it wanted to start turning its economic scale into greater international influence. Whereas America’s plan was written by an elite band of Wall Street and Washington figures, China’s global-currency push has been orchestrated by a small group of the Communist Party elite. (The party’s senior officials also often plot new strategies at its own beachside retreat, Beidaihe, a few hours east of Beijing.) Given America’s current troubles and China’s inexorable growth, it is tempting to think that something similar might happen again over the coming decade or two, when it is quite likely that China will become the biggest economy in the world. But for history to repeat itself, and for the renminbi to eclipse the dollar, two very substantial conditions will need to be met. China will have to tear up its economic model, and America will need to let it happen. Both are possible, but neither is inevitable.
GRIDLOCK
As to the second condition, there certainly is no shortage of reasons for thinking that the U.S. could be heading for the sort of crisis that would shake the foundations of the dollar era. The litany is a familiar one—high debt levels, chronic budget deficits, political gridlock, spiraling entitlement spending, and crumbling infrastructure. In some ways, the status of the dollar is actually making things worse. The U.S. government’s ability to keep borrowing from abroad allows it to put off taking some of the tough decisions that will eventually need to be taken. Some Americans worry that having a reserve currency is the equivalent of a “resource curse,” the sort of natural advantage that leads to indulgent, ineffectual government.
Yet, despite all these problems, the fate of the U.S. dollar still lies largely within the control of the U.S. government. Big shifts in the international monetary system take place rarely, and then usually only in response to dramatic events. Once gained, the position of reserve currency is not easily lost. The system is a reflection of the collective confidence and force of habit of millions of economic agents around the world and only changes from one anchor to another when there is little alternative. The loss of influence suffered by the British pound is one example. The decade starting in 1914, which was the period in which the U.S. dollar began to stake its claim at the heart of the international monetary system, was also the decade that included the First World War, an event which all but bankrupted Great Britain. With the value of sterling plummeting from 1915, all of a sudden Brazilian coffee traders started pricing their goods in dollars, and Dutch tulip-bulb farmers wanted export credits to be issued in dollars. The Second World War finished the job on Britain’s finances and completed the process of transition from sterling to the dollar. The ascendance of the dollar required not only the decisive plan that was devised on Jekyll Island, but also a collapse of confidence in sterling.
Now, admittedly, it is not completely out of the question that the U.S. will suffer a similar financial convulsion. In the summer of 2011, some members of the U.S. Congress seemed quite happy to use the threat of default as a short-term political tactic. The subsequent downgrading of U.S. government debt by Standard & Poor’s was a stark warning about the potential erosion of confidence in the dollar. Ever since then, Washington has been living from one budget crisis to another. Yet even this 2011 mini-crisis served to demonstrate the unique position that America holds in the international financial system. In such moments of nervousness, investors seek a safe haven, and the place they looked to was, ironically, the U.S. Treasury bond market. In the very week when America’s credit rating was downgraded, the price of American debt actually rose by near-record levels. There are huge incumbent advantages to being the principal reserve currency that are not easily dismantled. If the U.S. can muddle through its current troubles and present a coherent long-term plan for bringing its debts under control, the U.S. dollar will retain a central role, if for no other reason than inertia. That is politically easier said than done, of course, but the correct response to the Chinese challenge to the dollar is nothing more and nothing less than good housekeeping. The U.S. holds its fate in its own hands.
STATE CAPITALISM
The China model of economic management had its finest moment in November 2008. Lehman Brothers had collapsed two months earlier, sending the Western economic world into the sort of panic not seen since the 1930s. Over the next few weeks, the brutal consequences for China started to mount. In southern and eastern China, the areas where most of the export factories are concentrated, tens of thousands of migrant workers would line up every day at railway stations to return home to their villages, their jobs having disappeared almost overnight. Seeing a potential threat to its legitimacy, the Chinese party-state snapped into action. In November, Beijing announced a massive economic stimulus plan with a headline figure of $586 billion to backstop the collapsing economy. The Chinese government’s main planning agency—the National Reform and Development Commission—is based in the northwest of the city, in a neighborhood that has three or four modest hotels. For several weeks after the government announced the stimulus plan, every conference room in these hotels was booked by local government officials from around the country who came to present their best “shovel-ready” projects. From dawn to dusk, planning officials surveyed the plans for construction and infrastructure, giving a quick yes or no. The state-owned banks then provided the initial financing, and work began as quickly as possible. Roads, bridges, airports, and tunnels were built in record time. It was probably the biggest-ever emergency public-works program.
It turns out that China had the perfect “model” to respond to the sort of economic crisis that seems to happen every eighty years. When foreign analysts talk about Chinese “state capitalism,” they are usually referring to the presence of state-owned businesses in many areas of the economy. But the real key to the system is the way the financial system works. China was able to respond so quickly to the crisis because of the control the state has over the big four banks, which are responsible for between a third and a half of new credit in the country. The government was able to use its direct influence over the banks to funnel credit quickly to infrastructure projects. In the U.S., when the crisis hit, bank lending all but seized up as uncertainty took hold of economic decisions. In China, bank lending exploded. In 2009, the country’s banks issued twice as many new loans as they had written the year before. These banks had spent the previous five years getting stock-exchange listings, attracting foreign shareholders, and publishing ambitious statements about corporate governance. But, for all the talk that they were becoming more independent, when it came to the crunch they took a political order from the top and opened the credit floodgates. As China rebounded much more quickly from the global financial crisis than any other major economy, the normally disciplined Premier Wen Jiabao let slip a somewhat triumphalist note. China’s economic model, he said, allowed the government to “make decisions efficiently, to organize effectively, and to concentrate resources to accomplish a large undertaking.”
Yet this same brand of state capitalism is also the main obstacle to China’s developing a major global currency. The project to take the renminbi global is actually a pivotal moment in modern China, because it presents the leaders with an almost existential choice. For the renminbi to become an internationally accepted currency and a trusted store of value, China will need to make the sort of root-and-branch economic and financial reforms that would transform the way the economy is run. The scale of the changes that China would need to implement to achieve this goal makes the problems facing the U.S. at the moment look modest in comparison.
At the moment, Beijing is trying to square an economic circle. Although China is now the biggest exporter of manufactured goods in the world, the reason few people use the renminbi to settle trade transactions is that Beijing maintains a high wall of capit
al controls that protect its economy from the fickleness of international financial markets. As a result, it is still very hard to take Chinese currency in and out of the country, and for foreigners to invest money in China’s financial markets. This is where Hong Kong comes in—it is a perfect halfway house, an offshore laboratory where Beijing can experiment with allowing its currency to be widely held without the risk of a destabilizing financial blowback. But the offshore market in Hong Kong can only take the renminbi so far, because the volumes will always be limited. To turn the renminbi into a currency that even the world’s deeply conservative and cautious central banks would feel comfortable holding, China would need to tear down some of those barriers, allowing money to move freely in and out of the country. In other words, to boost the credibility of its currency, China would need to open itself up to international capital in just the way that New York does. This would not be a simple technical change: it would mean a revolution in how China runs its economic affairs.
Opening the economy to financial flows would put huge strains on the Chinese economic model. Beijing would have to dismantle many of the tools that allow it to funnel huge volumes of cheap credit to its favored investment projects. One reason the state banks have such a stranglehold on the financial system is that Chinese citizens have little choice but to put a large part of their savings into the banks. To a large extent, they are captive bank-depositors. But in a more open financial system, Chinese citizens would have many more options about how and where to invest their money. Banks would have to compete for deposits by offering higher returns, which would slash the profits they made from lending. And in order to retain the confidence of depositors, they would also have to be much more transparent about the risks they were taking with loans to pet government projects.
The Chinese authorities also use the tight control they have over the banking system to effectively set interest rates in the economy—another powerful tool that allows them to shape macroeconomic policy and keep credit cheap. But the power of the banks would be diminished by another necessary change. If foreign investors are going to hold a significant share of their assets in renminbi, they will need access to a large, liquid, and credible Chinese bond market. The global role of the dollar is underpinned by the huge U.S. government bond market, which gives investors an easy way to buy and sell large volumes of securities. It is that liquidity that makes it such a reliable store of value. Yet, in a large and transparent bond market, the price of credit is set by the market, not by government fiat. In essence, the decision to open up the economy to foreign capital would transform the position of the big state-owned banks. They would need to be run on much more stringent commercial principles and could no longer be used as piggy banks for other state-owned companies. And in the process, the Communist Party would lose a vital element of its current political control over the economy.
China would also need to transform the way it manages its exchange rate—another revolution in economic policy making. If China were to allow capital to flow more easily in and out of the country, it would have to adopt a much more flexible exchange rate in order to manage the volatility. China would probably end up floating its currency, at least partially. That means it would become much harder for Beijing to depress the value of its currency artificially to help its exporters—another central element of the economic model of the last few decades.
The implications do not end there. If foreign investors are going to park large sums of money in the Chinese financial system, then China would also need a much more independent legal system. Why invest in a Chinese security if a Communist Party official can tell a court what to decide in any legal disputes that might arise? The system of making economic policy would also need to be much more transparent. At present, it is not clear who actually makes decisions about interest rates in China, let alone why they are made. The central bank almost certainly does not make these decisions. But is it the premier? The Finance and Economics Leading Small Group? The Politburo? Or the Communist Party Standing Committee? If the world’s central banks are going to put a large part of their reserves into Chinese government bonds, they will want to know more about the key economic decisions.
Over time, the Chinese renminbi will doubtless increase in importance and is likely to rank alongside the euro, the yen, and the British pound as one of the second-string reserve currencies, accounting for 10 to 20 percent of global reserves. But if it is to supplant the U.S. dollar and establish itself as the principal safe-haven currency, the harsh reality for China is that it has two options. It can keep its particular model of state capitalism. Or it can have a global reserve currency. But it cannot have both.
And that is, of course, the central irony of this whole discussion. The project to make the renminbi into an international force has been dressed up in the geopolitics of dethroning the U.S. dollar, a reflection of both the frustrations of the economic elite and the popular resentment of the U.S. Yet this project requires precisely the economic and political reforms that U.S. leaders have been calling for in China over the last couple of decades. Many of the frictions over economic issues that have built up between the U.S. and China in recent years would disappear if Beijing introduced these policies. The exchange-rate controversy would evaporate as China adopted a more market-based currency policy. And Beijing would be much less able to use its banks to subsidize its own companies with cheap loans—one of the core issues behind the current fears about a new wave of “state capitalism.”
Indeed, some believe this has been the hidden agenda all along of Zhou Xiaochuan, the central-bank boss. Along with a group of other reform-minded officials, he has been trying for much of the last decade to get China to gradually open its financial system, which he thinks is essential for improving the efficiency of investment in China and maintaining high growth over the coming decades. But at almost every stage, he has been frustrated by the caution and conservatism of his Communist Party bosses, some of whom have legitimate complaints about financial capitalism, and some of whom fear an American conspiracy to weaken the Chinese economy. The push to take the Chinese currency global could end up as Zhou’s Trojan Horse—a policy proposal which appears at first sight to have a nationalist, anti-American agenda but which, if followed through, will actually involve groundbreaking liberalization of the economy, the sort of things that American Treasury secretaries want to see happen. In its bid to end the dominance of the dollar, China could end up taking down its great financial wall much more quickly than Beijing would like. Challenging America’s exorbitant economic privileges brings its own very high costs.
9
Post-American Globalization
FOR PETER BOSSHARD, the end of the Cold War was the moment when people finally started to pay attention. A Swiss national with a Ph.D. from Zurich University, Bosshard has spent most of his adult life trying to get foreign banks and engineering companies to rethink their support for large dams in developing countries. He would explain patiently why he thought these projects were white elephants that brought little benefit to the countries in question, other than to the officials who were able to cream off some of the contracts, while causing enormous damage to the surrounding environment. For years, his warnings were suffered in polite silence. Yet, after the fall of the Berlin Wall, development and environmental issues started to move centerstage. This was the era of the big UN conferences in Cairo, Rio, and Beijing on human rights and climate change, and Bosshard saw the mood shift. “People began to return my phone calls,” he says.
One of the unexpected consequences of the end of the Cold War was the space it opened for activists. The 1990s became the era of the international NGO—the nongovernmental groups that lobby, campaign, and occasionally harass politicians and companies over issues in the developing world. During the Cold War, many of these NGOs struggled to find any oxygen, given that aid and finance to developing countries were wrapped up in the political expediency of bipolar competition. That started to change when the Wall fe
ll. All of a sudden, clever young graduates wanted to work for Oxfam or ActionAid, instead of McKinsey. Bosshard, who wears wire-rimmed spectacles and Birkenstocks, is a soft-spoken engineer whose fluent English still carries a European accent. Since 2002, he has run International Rivers, an NGO based in a small office in Berkeley, California. “No one could accuse us anymore of doing Moscow’s bidding,” he says.
Before long, dams became one of the main political battlefields in this new wave of international activism. From the 1960s, large hydropower dams had been pushed as a silver bullet for developing economies. Under the leadership of Robert McNamara, the former U.S. defense secretary who had helped prosecute the Vietnam War, the World Bank put large amounts of resources behind these projects. The dams also became major earners for engineering multinationals such as Switzerland’s ABB, one of the biggest companies in the world for much of the 1980s and 1990s. But with the end of the Cold War, activist NGOs started to point loudly to the failures and the high costs attached. As many as eighty million people had been displaced by large dams in the previous three decades, they claimed, many of whom did not manage to find a new livelihood. Bosshard, who fell in love with rivers while walking in the Alps as a child, started to go after the banks backing the projects, accusing them of “environmental money laundering.” Under heavy pressure, the World Bank dramatically scaled back its lending to large dams. One senior executive complained in the mid-1990s that dams were “responsible for 95 percent of our headaches.” Once the World Bank pulled out, most private banks also stood back. By the end of the 1990s, funding had dwindled so much that companies such as ABB exited the sector. The global approach to dam building had been completely transformed. It was one of the most successful lobbying campaigns by an NGO anywhere in the world. Then along came China.
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