In 1999, Senior Colonels Qiao Liang and Wang Xiangsui of the People’s Liberation Army (PLA) stirred up an international controversy with their book Unrestricted Warfare. Published by the PLA Literature and Arts Publishing House, it carried the mantle of official doctrine. It argued that in the new world of high-technology and globalization, war will not fade away as liberal Western economists predict. Instead, “war will be reborn in another form and in another arena, becoming an instrument of enormous power in the hands of all those who harbor intentions of controlling other countries or regions. In this sense, there is reason for us to maintain that the financial attack by George Soros on East Asia, the terrorist attack on the U.S. embassy by Usama Bin Laden....in which the degree of destruction is by no means second to that of a war, represent semi-warfare, quasi-warfare, and sub-warfare, that is, the embryonic form of another kind of warfare.” The inclusion of financial attacks with terrorism as part of a conflict in which “there are no rules, with nothing forbidden” has worried American bankers and Treasury officials ever since.
The Chinese officers asked, “Can using financial instruments to destroy a country's economy be seen as a battle?”
Finding an answer to that question took on renewed importance after London’s Daily Telegraph reported that Beijing had sent an “economic threat” to the United States. Economists Xia Bin and He Fan, of the State Council Development Research Center and the Chinese Academy of Social Sciences, were quoted as saying China could "liquidate its vast holding of U.S. treasuries if Washington imposes trade sanctions to force a yuan revaluation.” If Beijing triggered a dollar crash now, when the U.S. dollar is already weakening, it could cause a spike in U.S. bond yields, ruin the country's housing market and even slow down its economy. Shifts in Chinese policy are often announced through key think tanks and academies, as in the case of Unrestricted War.
After letting speculation run for several days, on August 12, the People’s Bank of China posed on its website an interview with the official Xinhua news service, in which an unnamed official says, “The U.S. financial market is huge and has high liquidity, and the dollar assets, including U.S. government bonds, are an important component of China's foreign exchange reserve investment.” The statement also proclaimed that “For China, safety, liquidity and investment returns are the main targets of its foreign exchange reserve management.” These economic goals would have to be abandoned to carry out the kind of financial attack hinted at earlier.
So what is one to make of this incident? In the Telegraph article, Ambrose Evans-Pritchard cited the use of the term “nuclear option” in the Chinese media for the financial threat. This should remind Americans of the October 1995 threat by Chinese General Xiong Guangkai to use nuclear weapons against the United States if it defended Taiwan. Any such attack would, of course, bring retaliation by Washington that would do immense damage to China. So while the threat did not appear credible as a rational strategy, it has still served to give those who want to appease China an argument to do so because Beijing might behave in an irrational self-destructive manner if pushed. For those inclined towards appeasement, the issue is not who would prevail in a confrontation, but how much damage would the U.S. suffer, even if it won. It is this find of fear that Beijing is counting on to deter American action.
America should not live in fear. As Peter Morici, economics professor at the University of Maryland”s Robert H. Smith School of Business, has argued, “If the Peoples Bank of China were to sell enough Treasury securities to disrupt financial markets and cast the U.S. economy into recession, where would China’s factories sell all their stuff? Where would all those Chinese living in cities work if their stuff does not move? What would they do with their time if they were laid off? Oust their government? Riot in the streets? The Chinese Communist Party can make effective threats to disrupt the U.S. economy only if Americans are stupid enough to panic.”
China holds dollar assets mainly in U.S. government bonds. If it were to start dumping these bonds, it would have no immediate effect on Washington finances, as the bonds would be sold in the secondary market. If Beijing wanted to overload the market to drive up interest rates on future debt issuance to a level where they would slow the U.S. economy, it would have to discount its bond prices, taking a lose. It might be willing to do that, but that would also offer the U.S. the chance to buy up its debt on the open market for less than it owed. The Federal Reserve could simply print the money needed to make these purchases. That’s the strategic value of having the dollar as the world’s reserve currency. The Fed would be reluctant to print money on such a scale because of inflation concerns, but then, debtors have often used inflation to lessen the real costs of their obligations.
In the end, Beijing would be left with a basket of less valuable dollars. It would then need to find a place to invest the money (again) if it wanted a return.
The economic threat China poses to the United States is not in financial markets, but in the markets for real goods. It is China’s trade surplus ($233 billion with the U.S. last year) that has put $1.3 trillion in hard currency in Beijing’s hands, a tremendous reserve of purchasing power that can be used to further expand China control of the world’s productive capacity or resource base, the real wealth of nations that Adam Smith noted over two centuries ago.
China's government took the first official step June 27 to inject $200 billion into a new sovereign company that will buy equity assets abroad. Beijing had announced plans in March, calling it an effort to make more profitable use of its currency reserves. As its agents scout the world for lucrative investments, it will be acting to draw private enterprises into government control. It will be entering the market to subvert the market.
Beijing’s foreign direct investment has focused so far on energy and raw materials to support its expanding industries. China would prefer to import from itself, owning its overseas supplies to assure security and avoid market fluctuations. Importing at the internal cost of production, rather than a price set by rising global demand, will give Chinese industry another edge in world competition. And holding real assets instead of paper assets will reduce its exposure to financial risks if there is a geopolitical confrontation with the U.S. in any of the many global hot spots where Beijing and Washington are on opposite sides.
The attempt by China National Overseas Oil Company (CNOOC) to buy the American energy producer Unocal in 2005 set off alarm bells in Washington. Unocal then accepted a rival bid from Chevron. To avoid another such confrontation, the new Chinese fund initially may limit itself to minority stakes administered by front companies like the Blackstone Group, into which it has poured $3 billion.
In the longer run, a state-run agency with such enormous reserves will likely try to use those funds to advance broader national objectives than merely a few extra percentage points of return on capital. Fortunately, on July 26, President George W. Bush signed the Foreign Investment and National Security Act of 2007 (H.R. 556). The legislation strengthens the Committee on Foreign Investment in the United States (CFIUS). This multi-agency committee was created in 1988 to analyze foreign acquisitions of privately-owned entities to determine their affect on national security. CFIUS can modify or block any foreign acquisition or merger that is deemed dangerous. Having made the mistake of putting so much money into foreign hands, it would be even more foolish to allow them to spend it any way they wished.
The new law widens the scope of CFIUS jurisdiction to include “infrastructure” as well manufacturing related to high-tech and the defense industry. CFIUS derives its authority from the 1950 Defense Production Act (DPA).
The findings upon which the DPA is based include, “the domestic defense industrial base is a component part of the core industrial capacity of the Nation; much of the industrial capacity which is relied upon by the Federal Government for military production and other defense-related purposes is deeply and directly influenced by-- the overall competitiveness of the United States industrial economy; and the ability of United States industry, in general, to produce internationally competitive products and operate profitably while maintaining adequate research and development to preserve that competitive edge in the future, with respect to military and civilian production.” Thus the clear concern was to stay ahead of foreign rivals, not fall behind or accept a dependence on imports of either goods or capital.
The new CFIUS legislation came out of the Congressional banking committees. The Senate Banking Committee has also passed one of the major bills seeking to pressure Beijing to end the currency manipulation it uses to gain a competitive advantage in trade. The Currency Reform and Financial Markets Act of 2007 (S. 1677) was approved by the committee on a bipartisan 17-4 vote on August 1. Only a few days earlier, the Senate Finance Committee voted out the Currency Exchange Rate Oversight Reform Act of 2007 (S. 1607) by an even more impressive 20-1 vote, indicating that patience with Beijing has worn thin on both sides of the aisle. In was in response to these Senate actions that Beijing rattled its financial saber.
But rather than deter the full Congress from enacting legislation to sanction Beijing for its unfair trade practices, the recent incident should encourage even stronger action, for it is clear that China is not a trade “partner.” Beijing is a rival. Its predatory policies around the world are providing China with technology, resources, and strategic production capacity, as well as hard currency, to support its geopolitical ambitions– ambitions which are at odds with American economic and security interests.
The views of Senior Colonels Qiao and Wang are not as new as they may think. Some 350 years ago, Jean-Baptist Colbert, finance minister to Louis XIV of France, proclaimed “Trade is the source of finance, and finance is the vital nerve of war.” It is time that the United States sought to deny China both trade and finance, to head off its emerging capabilities for war.