The dominant narrative about last month’s fiscal melodrama in Washington emphasizes how political paralysis is quickening America’s strategic decline. In this case, however, the conventional wisdom has it wrong: The episode actually underscores the continuing advantages the United States enjoys in the global power sweepstakes, especially vis-à-vis China.
To be sure, plenty of illustrious commentators say otherwise. They see the US government shutdown and debt ceiling debate as another augury of how wildly dysfunctional domestic politics are subverting America’s global leadership. A good example is Kishore Mahbubani, the leading evangelist of the Asian century, who argued:
There is genuine shock in the minds of leading policymakers and thought leaders abroad that America’s political system, with all its checks and balances, could carry both the American economy and the global economy to the very edge of a financial precipice. People all around the world were genuinely scared that their lives would be destroyed by the reckless behavior in Washington D.C.
Laurence D. Fink, the chairman and chief executive officer of the BlackRock investment firm, similarly opined:
Based on conversations with leaders in business and government, in the US and beyond, I can tell you [confidence in America] was badly shaken during the 16 days of the government shutdown and the high-stakes poker over a debt-limit extension. While we can all breathe easier because the government is still making good on our obligations, it would be wrong to think we avoided doing real and potentially lasting damage to the economy, at home and worldwide.
And Richard Haass, the president of the Council on Foreign Relations, claimed that “American political dysfunction is hastening the emergence of a post-American world,” while Timothy Garton Ash, the noted European commentator, chimed in to say “that the erosion of American power is happening faster than most of us predicted – while the politicians in Washington behave like rutting stags with locked antlers.”
Compelling stuff, but also overwrought given the very small risk of a sovereign debt default. As the October 17th default trigger approached, many stock markets around the world were rising on the expectation that a last-minute debt agreement on Capitol Hill would be done, and the yield on 10-year US Treasury bills hardly moved. The fiscal battles coincided with the annual meetings of the World Bank and the International Monetary Fund in Washington.
Yet none of the world’s finance ministers gathered there voiced any real concern that the US was about to go barreling over the default cliff. Even Russia, with all of its interest in stirring up trouble for America, was sanguine. Its finance minister declared that US bonds “are reliable securities, and we do not plan very serious changes” in Moscow’s holdings of US government securities.
The reaction from Beijing was also especially telling. China is the largest foreign owner of US government debt and all told an estimated 60 percent of its US$3.65 trillion in foreign-exchange reserves is in dollar-denominated debt. As the shutdown/debt histrionics were playing out in Washington, Xinhua, China’s official news agency, published a blistering commentary that called for “building a de-Americanized world,” including…
“… the introduction of a new international reserve currency … to replace the dominant US dollar, so that the international community could permanently stay away from the spillover of the intensifying domestic political turmoil in the United States.”
A few days later, Xinhua took another shot when it editorialized that America’s founding fathers “would turn in their graves if they saw their [constitutional] design being kidnapped for political brinkmanship.”
Although it’s unclear whether the first Xinhua piece reflected the actual views of the Chinese leadership, what comes through is the author’s frustration that China, for all of its growing wealth, continues to reside in a US-dominated global order. Indeed, Beijing’s economic model all but guarantees this status, since it is based on making exports artificially competitive, which in turn generates vast foreign-currency holdings that China has no better place to invest than in the US. And even more exasperating for Chinese nationalists is that Beijing is constrained from all but minor sell-offs of its US securities since the resulting drop in the value of the dollar would saddle it with severe financial losses.
Nor are the calls to replace the US dollar as the premier world reserve currency very realistic, especially by the Chinese currency, the renminbi (RMB), whose convertibility remains highly restricted. True, Beijing is taking modest steps to raise the RMB’s impact in global finance. A RMB bloc also has emerged in East Asia and RMB trading in international markets has tripled in the last few years. And many expect Beijing to start making moves toward a fully-convertible RMB, a development that would certainly make it one of the top currencies used in world trade.
Nonetheless, the RMB still has a long way to go to become a world-class currency. According to a new report by the Bank for International Settlements, RMB trading still amounts to a very tiny fraction (only 2.2. percent) of daily global foreign-exchange turnover. And while the RMB is now the ninth most-traded currency in the world, it actually trails the Mexican peso and is just ahead of the New Zealand dollar.
Indeed, one of the key take-aways of the BIS report is that “The role of the US dollar as the world’s dominant vehicle currency remains unchallenged. [Foreign-exchange] deals with the US dollar on one side of the transaction represented 87% of all deals initiated in April 2013, about 2 percentage points higher than three years ago.”
The seething Xinhua piece and the hubbub it prompted in US circles are instructive, too, since they are reminiscent of another recent episode when commentators misjudged the balance of power between America and China.
Following the collapse of Lehman Brothers five years ago, the air was thick with talk about the superiority of the Chinese economic model and of US financial decline. One of the notions then making the rounds was that, with China now America’s main foreign creditor, Beijing would be able to translate its sizeable financial holdings into policy leverage vis-à-vis Washington.
The head of the China Investment Corporation, a sovereign wealth fund that manages part of China’s stockpile of foreign exchange, suggested as much when he asserted that the US economy is “built on the support, the gratuitous support, of a lot of countries. So why don’t you come over and …I won’t say kowtow, but at least, be nice to the countries that lend you money.”
Likewise, the danger of borrowing so heavily from China was a prominent theme in the 2008 US presidential campaign. Talking about the changed dynamics of the US-China relationship, candidate Barack Obama conceded that:
It’s very hard to tell your banker that he’s wrong. And if we are running huge deficits and big national debts and we’re borrowing money constantly from China, that gives us less leverage. It give us less leverage to talk about human rights, it also is giving us less leverage to talk about the uneven trading relationship that we have with China.
Once in office, Secretary of State Hillary Rodham Clinton picked up this line, privately fretting about “How do you deal toughly with your banker?” and suggesting to news media that traditional concerns about human rights had to be put aside in order to work with Beijing on the global economic crisis.
Yet at that very same moment, a senior Chinese banking official acknowledged in an extraordinary outburst that Beijing had no choice but to continue buying US government debt. As the Financial Times reported:
‘Except for US Treasuries, what can you hold?’ he asked. ‘Gold? You don’t hold Japanese government bonds or UK bonds. US Treasuries are the safe haven. For everyone, including China, it is the only option.’
[The official added, referring to the United States]: ‘We hate you guys. Once you start issuing $1 trillion-$2 trillion [in additional debt] . . .we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.’
A similar story applied when Zhou Xiaochuan, the head of the Chinese central bank, proposed in March 2009 a sweeping overhaul of global finance and urged the IMF to move toward a “super-sovereign reserve currency.” The move was seen by many analysts as a worrisome rebuke of US financial policies. Yet as Paul Krugman at the New York Times pointed out, Zhou’s proposal “was actually an admission of weakness. In effect, he was saying that China had driven itself into a dollar trap and that it can neither get itself out nor change the policies that put it in that trap in the first place.” Even more memorably, another commentator summed up the situation by saying: “China has an unloaded water pistol pointed at our heads.”
It’s also worth noting that in the nearly five years since Zhou’s proposal, China’s holdings of US government debt have roughly doubled.
There is no question that the United States needs to get its financial house in order. The Congressional Budget Office warns in a new report, for example, that America’s long-term fiscal posture looks increasingly shaky. But the conventional wisdom about last month’s tussles in Washington is mistaken: America’s place in the global pecking order is still secure.
(David J. Karl is president of the Asia Strategy Initiative, an analysis and advisory firm. He blogs about US foreign policy and global trends at Monsters Abroad.)