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The Dragon's Economic Conquest By: William R. Hawkins
FrontPageMagazine.com | Tuesday, April 14, 2009


The April 2 Leaders Statement issued at the close of the G20 economic summit proclaimed, “We start from the belief that prosperity is indivisible; that growth, to be sustained, has to be shared.” A noble sentiment, but not one many of the participants actually believe. The Chinese certainly do not believe in sharing, as they are working hard to exploit the world-wide economic crisis to their own advantage. Beijing is staking out a position on the global stage as the strongest national economy so as to win entrance into international organizations and councils as a peer competitor to the United States. Its message is that the Western model has failed, and that American “hegemony” is at an end.  

Speaking at the World Economic Forum in Davos, Switzerland in January, Premier Wen Jiabao blamed “inappropriate macroeconomic policies of some economies and their unsustainable model of development” for the current financial collapse. He admitted that the events have had a “rather big impact” on the Chinese economy, saying, “We are facing severe challenges, including notably shrinking external demand, overcapacity in some sectors, difficult business conditions for enterprises, rising unemployment in urban areas and great downward pressure on economic growth.” Yet, Wen nevertheless claimed that China would still be able to meet its 2009 target of 8 percent growth at a time when every other major economy is in recession. The Chinese economy grew 9 percent in 2008 while the U.S. economy declined by 1.1 percent. 

Beijing's bravado impressed World Economic Forum Asian Department Director Frank-Jürgen Richter. He told The People's Daily, the official newspaper of the ruling Chinese Communist Party, “The US economy once had been the engine for world economic development, but now it is faced with predicament and plagued by chaos…. Then, who, after all, can replace the United States? Only China! China's economic situation is very good, not only its domestic situation is favorable, but also more and more overseas investments are turned to China which is hopefully to take the place of the United States in five years to become the main motive force for global economic growth.”

The key to China's perceived clout is its massive $2 trillion hoard of hard currency, mostly held in dollars, which is being added to constantly via its trade surplus. The U.S. has sent over $1.5 trillion to China since 2000 via its trade deficit. Everyone wants the Chinese store of capital and purchasing power to flow their way. By all reports, it was the main subject on Secretary of State Hillary Clinton's agenda when she visited Beijing in February. She was literally begging Chinese leaders to keep investing in U.S. Treasury securities to fund the rapidly expanding Federal budget deficit. She was thus willing to downplay all the geopolitical conflicts between Beijing and Washington.  

Clinton's appeal was not something that had just materialized from the Obama administration. The Bush administration was also begging for Beijing to send back to the U.S. the money American consumers had sent to China to buy imports. In his opening statement to the U.S.-China Strategic Economic Dialogue last June, Treasury Secretary Henry Paulson said, “We will discuss the best way to promote and protect bilateral investment and to counter protectionist pressures.” A major result of the SED was the launch of negotiations for a bilateral investment treaty. Such an agreement could minimize national security reviews and give Beijing a freer hand in the American market. The Joint U.S.-China Fact Sheet released at the end of the SED states that an Investment Forum “will focus on practical investor concerns, such as the process of investment reviews.” It is also stated that “the United States welcomes sovereign wealth fund investment, including from China.” This means the purchase by the Beijing regime itself of American productive assets in the private sector as well as government bonds. 

The American public and Congress have found the specter of greater Chinese penetration of the U.S. economy alarming. When state-owned China National Offshore Oil Company attempted to acquire the Unocal energy firm in 2005, the House of Representatives passed a resolution against the deal, prompting Unocal to accept an offer from another American firm instead. The Unocal deal was one of the cases that led Congress to  enact the Foreign Investment and National Security Act of 2007. This was the first major piece of legislation of the 110th Congress, passed unanimously in the House and by voice vote in the Senate. It placed particular emphasis on investigating deals involving state-owned firms or which involved shifting control of infrastructure to foreign hands. Unfortunately, President George W. Bush confirmed Treasury's dominant role in the process by executive order. His action ignored a warning from the Government Accountability Office that the process “in protecting U.S. national security may be limited because Treasury- as Chair of the Committee on Foreign Investment in the United States- has narrowly defined what constitutes a threat to national security.”  

The first successful test of the improved CFIUS process involved a Chinese firm. Huawei Technologies tried to purchase a stake in 3Com, a U.S. firm that makes computer network security software for the Pentagon. When it became apparent that CFIUS was not going to approve the deal, due in part to objections raised by the Director of National Intelligence (who had been named as an advisor to CFIUS in the 2007 bill), the offer to buy 3Com was withdrawn.   

 But in an alarming turn, Treasury Special Envoy Alan Holmer told a Chinese audience last May, “we often hear concerns from China about the U.S. investment review process and whether the United States truly welcomes Chinese investment. U.S. legal authority in this area is narrowly targeted to address acquisitions that raise genuine national security concerns, not broader economic interests or industrial policy factors.” So the GAO warning remains valid. 

The New York Times reported Feb. 21 that “China is taking advantage of the economic downturn to go on a major shopping spree, investing in energy and other natural resources that could give it an economic advantage it has never had before. Some economic analysts say they believe that China's investments pose a threat to competitors like the United States.” Recent investments include oil production in Brazil, Venezuela and Russia; and mining operations in Australia. With world demand down during the recession, there are bargains to be had for a country with as much cash on hand as China.  

In the United States, Beijing has been buying Treasury debt, which is the less dangerous course from the American perspective. Policy should seek to contain Chinese capital within the public sector where investments do not confer any control. Still, even this is not without risks. Writing in the Spring 2008 issue of the Army War College journal Parameters, business economists Felix K. Chang and Jonathan Goldman argue that China's large block of Treasury securities gives it the power to disrupt U.S. financial markets. “No bombs need fall from the sky. Yet damage can be inflicted on the United States through market manipulation that would be as costly to recover from as any conventional attack,” they warn. 

Yet there is danger is overstating the amount of leverage Beijing can use against Washington. For years, the State Department has argued that the U.S. could not push China on economic issues like the trade deficit, currency manipulation or intellectual property protection because Beijing's help was needed against North Korean weapons programs. North Korea's test of a nuclear device in 2006 and its recent test of a long-range missile indicate that China has been more helpful in protecting the Pyongyang regime from effective countermeasures than it has been in supporting Washington's non-proliferation efforts. Now the argument from Treasury is that the U.S. cannot pressure China on issues like North Korea (or Iran) for fear that Beijing will disrupt American financial markets. 

China tested its clout in the run up to the G20 summit. On March 24, People's Bank of China Gov. Zhou Xiaochuan wrote on the bank's Web site that it was time to step back from the U.S. dollar as the world's reserve currency and consider a global currency controlled by the International Monetary Fund. Russia had actually opened this challenge earlier when Prime Minister Vladimir Putin and President Dmitry Medvedev called for the ruble to become a regional reserve currency, while a new global currency was created.  

Treasury Secretary Timothy Geithner took some heat when he initially said that the Chinese proposal deserved consideration. He clarified his position on March 30 saying, “The policy of the United States is that a strong dollars is in the interests of the United States. I believe the dollar will be the principle reserve currency for a very long time to come.” According to the White House, the issue did not come up when President Barack Obama met with President Hu Jintao on the sidelines of the G20 summit.  

The Russian proposal was a clumsy attempt to create a ruble bloc to link the old Soviet republics to Moscow. Beijing has been trying something similar. China and Argentina recently agreed to exchange 70 billion yuan ($10 billion), of their currencies for use in trade and investment. “Dollars will not be needed for trade,” said The People's Daily, adding, “This measure will play a positive role in improving regional currency stability, preventing financial risk and reducing the spread of the crisis.” What it will actually do is tie the two countries together on a barter basis, confirming Beijing's neocolonial trade pattern of exchanging manufactured goods for Argentine raw materials.  

China is the world's third largest economy, but keeps its financial system isolated. The yuan trades only in China, which allows the central bank to set the exchange rate by fiat to gain a competitive advantage in export markets. The yuan cannot be a world reserve currency, or even be included in a basket of currencies used to stabilize international rates.  

Beijing has fewer options about how to use its dollar hoard than the United States has in regard to how it conducts trades and governs foreign investments. In theory, China could diversify its reserves to hold more euros, pounds, or yen, but China owns too many dollars to sell without driving down their market value. This would bring on the very dollar devaluation they see as the capital loss risk of holding so many dollars.

And this still does not to mention the unmentionable. The United States could cancel (default) on any sovereign debt owed to Chinese entities should the tensions between the rival powers erupt into war.

Beijing has gotten itself into this trap because managing its reserves was not its top priority. It has been happy to hold market safe, low-yield Treasury securities. Its focus has been on boosting employment at home, building production capacity and expanding the trade surplus that supports domestic development. The growth in the real economy is what keeps the Chinese people loyal to the regime. Rising unemployment as exports decline has Beijing worried. Prime Minister Wen Jiabao told a cabinet meeting in January that, “The country's employment situation is extremely grim.” Public security directors from across the country have been summoned to Beijing to learn how to suppress rallies and strikes before they turn into riots. 

Chinese exports in February slid 25.7 percent from a year earlier, leading to the close of thousands of factories and the unemployment of millions. It is estimated that 60-70 million Chinese work in export industries. Of the major nations, China is the most dependent on trade, having engineered its rise on the massive transfer of wealth from overseas gained from trade surpluses, foreign investment, and technology transfers. Beijing is responding to the decline in trade in two ways. First, it is trying to grab a larger share of falling world exports by resorting to even more cutthroat competition against foreign rivals, many of whom in the Association of Southeast Asian Nations (ASEAN) are friends of the United States. Mexico is also a Chinese export rival. The second response has been to launch a massive domestic stimulus package of government infrastructure projects and expanded bank lending.  

President Obama has said on several occasions, including at the G20 summit, that other nations cannot expect to base their economic recoveries on continued deficit spending by reckless American consumers. The United States must reduce its $700 billion global annual trade deficits to rebuild its own strength, and its must stop subsidizing Beijing's rise with $260 billion trade deficits with China. U.S. imports have doubled since 1999, hitting $2.5 trillion in 2008. This number can be brought down by moving high-end production back home, but America will always be the world's largest importer even as accounts are brought towards balance. This gives Washington substantial leverage as it decides who will be granted access to the rich U.S. market. That privilege should go to America's friends and allies, not its rivals.  

In her book Allies, Adversaries and International Trade Princeton political economist Joanne S. Gowa argues that it is a mistake to abandon the traditional practice of having  “trade follow the flag” because interdependence is too risky with any government that cannot be trusted on political grounds. Gowa writes, “power politics is an inexorable element of any agreement to open international markets, because of the security externalities that trade produces....trade enhances the potential military power of any country that engages in it.” Trade with an ally makes both parties stronger, whereas trade with an enemy creates what Gowa calls “a security diseconomy.” Such a security diseconomy exists today with China and should be ended. 

The Beijing dictatorship has based its legitimacy with the Chinese people on economic progress accelerated by exploitive trade policies and on the promise that it can restore China to its rightful place at the center of world politics. The United States still has the power to deny both of these goals to the communist regime, thus not only preserving its own preeminence but hastening true reform in China by discrediting its current model of development.


William Hawkins is a consultant on international economics and national security issues.


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