TELEGRAPH 2.6.09
The trillion dollar question: China or America?
Who is going to come out of the economic crisis stronger and with the
whip hand - China or America, asks Niall Ferguson.
By Niall Ferguson
Two years ago, economist Moritz Schularick and I coined the word
"Chimerica" to describe what we saw as the key relationship in the
then-booming global economy: China plus America. Cheap Chinese labour
was making US corporations highly profitable. Spendthrift American
consumers, in turn, were keeping Chinese corporations busy with
export orders. And the Chinese monetary authorities were converting
export surpluses into dollar denominated reserves with the aim of
preventing their own currency from appreciating. The unintended
consequence was a multi-billion dollar credit line to the United
States, financing America's deficit at rock-bottom rates.
It was those low long-term rates - combined with monetary policy
errors by the Fed, excessive bank leverage and reckless financial
engineering - that inflated the American property bubble, the
bursting of which triggered this crisis.
To simplify the story, think of an unhappy marriage in which one
partner does all the saving, while the other does all the spending.
(We all know at least one couple like that.) But then the partner
with the retail therapy habit maxes out on his/her credit cards. At
the same time, the parsimonious partner finds her/his job under
threat. What previously was a stable relationship is suddenly on the
rocks.
In February, the People's Daily acknowledged the "global importance
and influence" of Chimerica, but warned of an impending "period of
chillness". Could this be one of those great turning points in
history, when the balance of power tilts decisively away from an
established power and towards a rising challenger? It is possible.
Financial crises often accelerate the gradual shifting of the
geopolitical tectonic plates; they are to history what earthquakes
are to geology.
It was inflation that undermined the foundations of Habsburg power
and opened the way for the Dutch Republic. It was the disastrous
Mississippi Bubble of 1718-19 that fatally weakened ancien régime
France, while Britain survived the contemporaneous South Sea Bubble
with its fiscal system intact. For most of the nineteenth century,
financial crises in the United States had only marginal effects on
the City of London. By 1907, however, a Wall Street crash could send
a shockwave across the entire British Empire, a harbinger of a new
era of American power.
Something similar may be happening as a consequence of the American
financial crisis that began nearly two years ago. The flapping of a
butterfly's wings may trigger a hurricane in the Home Counties; in
much the same way, a crisis in the market for subprime mortgages
could signal the waning of US hegemony and the advent of a Chinese
century. Just visit the nearest bookshop if you don't believe me.
There, alongside Fareed Zakaria's prophetic The Post-American World,
you'll soon find Martin Jacques's darkly visionary When China Rules
the World.
Just consider the impact of this crisis on the United States and China.
According to the International Monetary Fund, the US economy will
contract by 2.8 per cent this year - while China's is forecast to
grow by more than 6 per cent.
The US stimulus package - worth $787 billion - has had rather a muted
impact. The economy will do better in the current quarter than in the
last one. But house prices are still falling at close to 20 per cent
year on year. The rate of foreclosures per month is still rising. And
a crisis in commercial real estate could blow a new hole in the
balance sheets of US banks.
Moreover, no amount of stimulus can swiftly reduce the debt burden
weighing down America's over-leveraged consumers. According to Bank
Credit Analyst research, for household debt to return to a more
sustainable level, real consumer spending would need to grow at no
more than 1.3 per cent a year between now and 2013. If that
calculation is correct, the Obama administration will have to junk
its predictions of 3 per cent growth next year and 4 per cent the
year after that.
China's stimulus is worth less in dollar terms - $585 billion - but
Beijing is clearly getting more bangs for its bucks. In April, fixed
investment surged by nearly 34 per cent. Net imports of iron ore
leapt by a third, and imports of oil by just under 14 per cent. It's
a measure of China's new economic influence that commodity traders
attribute much of the recent upward pressure on oil, copper and other
raw material prices to Chinese purchases. Indeed, China's growing
presence in commodity markets in sub-Saharan Africa and South America
- not just as a buyer, but also as an investor - has an almost
imperial character to it.
Of course, China has not been wholly unscathed by the astonishing
collapse of exports that struck Asian economies in late 2008 and
early 2009. Many more Chinese than American workers have lost their
jobs since this crisis began. Yet I do not believe (as some Sino-
pessimists do) that the regime in Beijing faces a serious threat of
social unrest. Like other rising powers in past centuries, China is
imbued with a remarkable sense of patriotism that is not just a
product of Communist Party propaganda. People are proud of their
country's economic miracle over the past 30 years. After two wretched
centuries, they believe China is on the way back. People whose
grandparents survived the Great Leap Forward and whose parents
endured the Cultural Revolution can surely cope with a decline in the
growth rate from 11 to 6 per cent.
In short, it may be time to start believing the projections made by
Jim O'Neill and his colleagues at Goldman Sachs, who predicted just a
few years ago that China's gross domestic product could equal that of
the United States by 2027. Three years ago, China did not have a
single bank among the world's top 20, measured by market
capitalisation. Today the top three are all Chinese. In 2006, the
United States had seven of the top 20 banks, including the top two;
today it has three, and the biggest, JP Morgan Chase, is rated fifth.
Even before its economy becomes the world's biggest, China can play a
much more assertive role in its relations with the United States. The
spouse with the money generally wins the argument, after all.
Especially when the argument is about the other spouse's debts.
And what debts! The US federal government's deficit this year will be
$1.84 trillion - roughly half of total expenditure and nearly 13 per
cent of GDP. Not since the Second World War has the gap between
income and spending been so huge. Moreover, the Congressional Budget
Office anticipates that total debt will nearly double in the decade
ahead. With the lion's share (around 70 per cent) of their $2
trillion of international reserves held in the form of US bonds, the
Chinese are understandably alarmed by this tsunami of red ink. Last
week's financial market action - which saw both bonds and the dollar
drop sharply - will have caused palpitations in Beijing. [In an
egocentric way we here have noted that the pound has risen strongly
towards $1.70. That is the wrong reaction. The dollar has plummeted
to $1,70 against the pound -cs]
To be sure, China is still piling up those dollar-denominated bonds.
In March alone, China's holdings of US Treasuries rose $23.7 billion.
But Deutsche Bank recently predicted that Chinese reserves will rise
by only $100 billion this year, compared with $418 billion last year.
You don't need a Nobel prize in economics to know that $100 billion
won't finance much of a $1.84 trillion deficit.
We know pretty much what Treasury Secretary Timothy Geithner is
hearing in Beijing this week because the Chinese have been grumbling
about American profligacy for months. "We have lent a huge amount of
money to the United States," Wen declared in March. "Of course we are
concerned about the safety of our assets. To be honest, I am a little
bit worried." Soon after that, on the eve of the G20 Summit in
London, the Chinese central bank governor Zhou Xiaochun proposed that
the US dollar might eventually be replaced as the world's main
reserve currency.
"The United States is making policy decisions purely according to
domestic considerations and is giving little thought to the outside
world," complained Zhang Ming, an economist at the Chinese Academy of
Social Sciences, in April. "This being so, the Chinese government
should prepare its defences. We can keep buying US debt but we have
to attach some conditions."
The big question is: what conditions? For Mr Geithner knows the truth
of the old adage: when you owe the bank a small amount, the bank has
the power. But when you owe the bank a huge amount, it's the other
way round. Luo Ping, a director-general at the China Banking
Regulatory Commission, put it nicely in an interview back in
February: "Except for US Treasuries, what can you hold? US Treasuries
are the safe haven. For everyone, including China, it is the only
option. We hate you guys. Once you start issuing $1 trillion to $2
trillion [of bonds] we know the dollar is going to depreciate, so we
hate you guys, but there is nothing much we can do."
"We hate you guys?" Now that really does have the ring of marital
breakdown. Let's hope Mr Geithner is good at ducking crockery. Like
divorces, major shifts in the balance of power are seldom amicable.
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Niall Ferguson's 'The Ascent of Money: A Financial History of the
World' is published in paperback by Penguin this week
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