Remarks to China Renaissance Capital Investors
Many years ago, surveying an apparently collapsing China, Mao Zedong coolly observed that there was “great disorder under the Heavens and the situation is excellent.” By this, he meant that the disappearance of the old order offered the opportunity to build a new one. In many ways, our world’s political economy now seems to be in the midst of the sort of disorderly decay that precedes eventual regeneration. Some new approaches to managing world affairs are clearly needed. But few today are inclined to call the situation excellent.
For sixteen days last month, the United States government was partially shut down because it had too little revenue to keep itself in business on a “pay-as-you-go” basis and hadn’t been able to pass a budget for the new fiscal year. A year or so earlier, after teetering on the edge of a similar “fiscal cliff,” the U.S. Congress decided it wouldn’t even try to set spending priorities. Instead, the United States began disinvesting in both its present and future through mindless across-the-board spending cuts.
In part to offset the deflationary effects of this default on this most basic of all legislative responsibilities, the U.S. central bank began to buy large quantities of U.S. government debt, printing massive amounts of money to boost consumption and exports. When it appeared that the “Fed” might begin to phase down this practice, there was mild panic in capital and currency markets, not just in America but around the world. The “Fed” pulled back from its proposed “taper.”
Two weeks ago, the world looked on in horror-filled fascination as its cornerstone economy – the United States – prepared to halt payments of both interest and principal on the huge amounts of money it had borrowed to keep itself in business in the past. Short-term interest rates on U.S. government debt spiked as the perceived risk of default grew. At the last minute, the U.S. Congress reopened the government and adopted a three-month suspension of its threat to implement a still undefined form of national bankruptcy. The global financial system shuddered. It did not, after all, shut down. But there is ample reason to fear that in January the world may once again be held hostage by American politicians engaged in blackmailing each other at the expense of the full faith and credit of the United States. This is the sort of folly that accelerates history.
There is little chance that the American republic will soon return to orderly government. A substantial bloc of American legislators now sees playing “Republican roulette” with U.S. fiscal policy as a fun game with no personal consequences. They think that wrestling on the edge of fiscal or monetary cliffs is a safe sport in which they can rack up points with their constituents. They believe that, however risky their behavior may seem, the foreigners who buy U.S. debt, hold the dollar as their reserve currency, and settle their trade in dollars do so because they have no alternative. Whatever doubts these legislators’ statements and actions raise about the competence of the U.S. government and its willingness to meet its obligations to its many creditors, they insist the dollar is for many reasons inherently stronger than all other currencies and that T-bills will always dominate global debt markets. They are sure that there is no safe haven comparable to the dollar.
For now, they are right. But those who live outside the United States may be forgiven for the conclusion that they had better now find or create alternatives to the dollar and to reliance on U.S. debt. In time, of course, they will. It’s notable, in the meantime, that both Americans and foreigners currently frame the issue in terms of an unstated presupposition that American hegemony can only be succeeded by that of another hegemon.
Who might replace America?, they ask. The answer, despite a lot of ill-founded speculation about China doing so, is that no one can. America dominates global finance in ways no one has since Spain in the 16th century. In the case of America today, like Spain then, no one wants to imagine the end of such hegemony or what might follow it. But we can no longer afford not to think about the consequences of America’s eventual displacement from its seven-decade-old monetary dominion. This could happen in any one of three ways: suddenly, following congressionally-induced fiscal thrombosis; gradually, in response to global hedging against future American irresponsibility; or slowly as others prudently expand their role in global monetary affairs and that of the dollar naturally retreats. But, one way or another, it’s going to happen.
The United States now accounts for only about 20 percent of global GDP, down from about two-thirds after World War II and one-third as this century began. U.S. trade is about 10 percent of the current world total, slightly smaller than China’s. Yet about 60 percent of the world’s monetary reserves are still in U.S. dollars. About the same percentage of American currency is in the hands of non-Americans, with only 40 percent of dollars circulating domestically. About ninety countries peg their currency to the dollar, which is present in almost 90 percent of currency exchange transactions. Somewhat over half of cross-border loans and deposits are in dollars. Almost half of the world’s private debt is dollar-denominated. About 36 percent of world trade is invoiced in dollars, while about 38 percent is in euros. These ratios don’t match up.
The world is as grossly over-dependent on the U.S. dollar as the dollar is overextended. However one measures change, the global financial restructuring that American political recklessness has just thoughtlessly kickstarted threatens tectonic shifts in the world’s financial system, not just an earthquake or two. Delaying restructuring just exacerbates the underlying problems in the U.S. and global economies. It’s hard to overestimate the potential for economic disruption as uncontrolled change proceeds.
The staggering irresponsibility of the U.S. Congress in recent years has forced thoughtful people to contemplate the previously unthinkable: a world in which America no longer reigns financially supreme. In such a world, the United States will no longer issue debt able to collateralize most banking transactions. The U.S. dollar will no longer be the measure of all currencies and accepted as the universal medium for monetary reserves and trade settlement. Washington will no longer enjoy the “exorbitant privilege” of global “seigniorage,” the ability to pay for imports by printing money rather than exporting goods and services. But, contrary to widespread presupposition, no single currency, country, or bloc of countries is likely to succeed the dollar or the United States in any of these roles. The renminbi yuan will not replace the dollar. Nor will the euro. The dollar will still be a reserve currency and means of trade settlement. But the U.S. currency will not retain its hegemony.
Instead, we will have a period of financial anarchy and depression, confusion and recession, or gradual adjustment – depending on the extent to which the U.S. trades its credibility for “deadbeat "status, otherwise diminishes its credit by generating financial risk, or yields gracefully to the inevitable. Then a new, multipolar monetary order is likely to arise. It seems certain that the euro, which has stubbornly refused to die, will play an important role in such an order. In time, so will the Chinese yuan – the internationalization of which Beijing has just accelerated, with London farsightedly making a play to become a global trading hub for the renminbi. So, very likely, will other currencies willing to risk a significantly greater place in global reserves, including some still-to-be crafted plurilateral currency linkages within the various regional trading blocs that are emerging from the disintegration of global efforts at trade liberalization.
Whether the transition to a new world financial order that has been set in motion is catastrophic or manageable depends in large measure on how the United States handles it. Some elements of change can be managed without reference to Washington. Some will likely prove unmanageable by anyone. Currency markets will be volatile.
The period before us is likely to be defined in part by a broadening international effort to find work-arounds and substitutes for reliance on the dollar and dependence on the United States. A recent example is the proliferation of Chinese currency swap arrangements, including the unprecedentedly large swap contract that was just made between China and the European Union. Another is the ongoing international effort to forestall the extraterritorial application to trade with Iran of U.S. policies and laws by avoiding dollar settlement or the New York-based U.S. banking system. Trade settlement in currencies other than the U.S. dollar is growing, with use of the yuan rising especially rapidly. China’s emergence as the world’s biggest oil importer has boosted its efforts to buy oil in its own currency rather than dollars. The euro’s difficulties temporarily scared off those trying to stitch together new, plurilateral currency arrangements. Now these efforts are resuming among groupings as diverse as ASEAN, the Gulf Cooperation Council, the Union of South American Nations, the West African Monetary Zone, or the so-called “BRICS.” Given widening fears of overdependence on the dollar, there will be others yet undeclared who begin to explore doing the same.
Demands to set aside American dominance in the key institutions of global financial governance are certain to become steadily louder and more insistent. In the normal course of events, China and other countries whose share of the global economy is increasing would have expected their part in global governance to grow apace with their expanding roles in global trade and investment. After the latest irresponsible behavior by the U.S. Congress, their efforts to seize control of global financial institutions or develop alternatives to U.S. financial hegemony are bound to accelerate. The Xinhua News Agency’s editorial calling for a “de-Americanized” world is a portent of this.
The United States is unlikely gracefully to yield the positions of privilege it has long occupied at the apex of the international financial order. Widespread dissatisfaction with American politicians’ casual indifference to the international effects of their quarrels over domestic issues guarantees the outbreak of struggles over governance in the IMF, IBRD, and other economic and financial institutions. If these global bodies cannot be made more transparent and “democratic" through deals to share power between America and newly rich economies, plurilateral arrangements will supplant them.
This has already happened in negotiations over trade and investment issues since the Doha Round went into a coma. For the past seven years, liberalization of economic intercourse between the world’s nations has proceeded almost entirely through regional and bilateral talks rather than at the global, multilateral level. The same trend away from American-dominated multilateralism now promises to appear in the monetary sector.
Unwelcome as this devolution of authority and accountability may be, it parallels developments in other spheres. After all, the transformation of the U.S. image and the ebbing of American global political leadership over the past two decades have also had the effect of distributing power to the world’s regions. Increasingly, in the Middle East, Europe, Latin America, Africa, and Asia, regional affairs are driven mainly by regional actors, not external powers. U.S. military prowess remains without peer at the global level, but most problems are not amenable to military solutions. All political decisions are local. Few abroad still defer to American interests or policies.
In part this is because, when the world now looks at the United States, it is no longer reminded of the “decent respect for the opinions of mankind” with which the country began. Nor does America evoke thoughts of “freedom,” “hope,” constitutional “democracy,” or the “rule of law.” Instead, the world sees aggressive electronic invasions of privacy even in American allies, an inordinate fear of terrorism, government shutdowns, Guantánamo, and drone warfare. The sky once seemed the limit for an idealistic, affluent, and purposive America. Now references to Washington bring up images of a lowering debt ceiling and profligate monetary policies that flirt with “tapering” but shrink from it. America appears to be in the midst of a national nervous breakdown. The United States has never seemed less capable, less wise, or less inspiring than it does now.
In addition to declining prestige abroad, America suffers from an accumulation of serious domestic problems and impairments. These include decaying physical infrastructure and school systems that no longer produce workers with the competence needed to compete with their peers in nations like Germany, Japan, Singapore, Finland, or even China without significant remedial training. The U.S. tax system badly misallocates investment, exacerbates the maldistribution of income, and impedes social mobility. The country now ranks well below other industrial democracies in terms of equality of opportunity. It has acquired a permanent proletariat in its cities. By most metrics, standards of public health in America are now among the lowest in the developed world.
Post-crisis financial regulations and banking practices are choking off the flow of capital to small and medium-sized enterprises. Participation in the labor force has dropped to historically low levels. Innovation, once a remarkably robust feature of the American economy, is beginning to slip. The United States continues to live beyond its means, pampering its military by pyramiding debt while disinvesting in its civilian economy and running persistent global trade and balance of payments deficits.
Most Americans imagine that the United States continues to be the world’s best in each of the categories I have mentioned. There is a strong belief in American exceptionalism that fuels complacent denial about the country’s condition. It is therefore unrealistic to expect that the United States will confront and correct its problems in the short term. But it would be a huge mistake to count America out in the longer run. The United States may now be badly off its game but it’s still gifted with greater strengths than any other nation of comparable size. The causes of both its distress and the world’s dissatisfaction with it are self-inflicted political paralysis and parochialism. If forced by circumstances to awake from denial and to address what ails it, America has the talent and resources to rebound and to do so with uncommon vigor.
Let me illustrate the potential for American recovery by using the example of China, which many put forward as a plausible candidate to succeed the United States as global hegemon. (It’s indeed hard to think of another.) But, if global dominance were the aspiration of China’s leaders (which I don’t think it is), they would give anything to have the United States rather than their own country to work with.
The United States is flanked by wide oceans and bordered by Canada and Mexico, two of the least menacing and most congenial neighbors one could hope to have. In its 237-year-long existence, the United States has been raided three times – in 1812, 1941, and 2001 – but never invaded and occupied. In contrast, across a narrow sea from China lies Japan. Within the memory of the oldest living Chinese, Japan invaded China and killed perhaps 35 million of their relatives and friends. China shares land borders with fourteen nations, among which are numbered some of the toughest customers anywhere – Afghans, Indians, Koreans, Mongols, Pakistanis, Russians, and Vietnamese. For four of the last ten centuries, China was ruled by foreign occupiers. U.S. intervention in the Taiwan Strait divided China sixty-three years ago. To this day, Taiwan’s military confrontation with the China mainland is backed by the United States. China is pinned down by the realities of geopolitics in ways that Americans cannot begin to imagine.
There are also great disparities when it comes to natural resources. The United States uses 12.5 percent of the world’s arable land and about 10 percent of its water to feed and clothe a mere 4.5 percent of its people before exporting a huge food surplus. China must sustain 19.5 percent of the world’s people on about 7.5 percent of its arable land, with less than 7 percent of its water. It is the world’s largest importer of oil seeds and other food crops. America has never had to be concerned about starvation. It has a vast, if notably inefficient, system of public health to protect it against disease. China, where many pandemics originate, cannot help but worry constantly about the possibility of mass disorder or death from famine and pestilence.
The United States has been the global leader in science and technology for over half a century. Its language is the lingua franca of international commerce, engineering, and the internet. It commands a network of alliances that enable it to aggregate the capabilities of most of the world’s great powers to its own when the need arises. It has comprehensive military capabilities that no other country aspires to match. China is just beginning to regain a significant role in science and technology and to spread knowledge of its national language. It has no allies, though it has clients that it must be prepared to protect. China's military is only now developing a credible capability to defend its territory and the approaches to it in its near seas.
Until recently, at least, U.S. civil liberties and social mobility have been the envy of the world. Enormous numbers of foreigners have aspired to transform themselves and their families into Americans. There are many ethnic groups in the United States but none seeks independence or is in a state of rebellion. The last serious effort to dismember America occurred a century and a half ago, in the war between the states. By contrast, China has no political allure for foreigners. It attracts no foreign immigrants. Several of its ethnic minorities and regions seek to separate themselves from it, sometimes through violent means. As recently as the 1960s and 1970s, it experienced a state of anarchy.
The difficulties that are now making China and other countries impatient to end U.S. financial hegemony originate neither in American weakness nor lack of potential. They stem almost entirely from the growth of political incivility, gridlock, and indecisiveness as well as bad financial practices in the United States. America’s financiers continue to be too clever by half. They contrived a financial collapse into recession and lower long-term growth rates not just for the United States but for the developed world. They remain unrepentant, unreformed, and unconscionably willing to risk other people’s money and well-being in the service of their own unconstrained greed. There is nothing wrong with America and the world that greater realism, revitalized leadership, and more farsighted policies cannot cure. If the United States adopts these, it can reinvent itself and bounce back. I believe it will. But that will take a while.
In the meantime, China is doing very well despite having far fewer natural advantages than the United States. Assets denominated in renminbi yuan are likely to be more secure than most. But China has too many domestic and foreign policy distractions to wish to replace America as the manager and mainstay of the global political economy or to be able to do so. China will react defensively, as it must, to the problems posed by the collapse of the American-led world order but it will not take the lead in resolving them. Nor will other rising powers, none of which is up to the task of replacing America in the roles it has played in global governance over the past seventy years.
We are entering an era in which there is no alternative to global power-sharing. The world will have to get used to crafting collective solutions to problems rather than looking to American presidents to imagine, invent, announce, and impose them. This is true in foreign policy, where it is now universally recognized that there is no made-in-America solution to the problems of the Middle East, the territorial disputes in East Asia, and many other issues. It is also true for much-needed changes in the global monetary and financial systems.
There is indeed great disorder under the Heavens. We must be prepared for the shocks and uncertainties of transition. But the defiant optimism of Mao Zedong should inspire us. Rather than bemoaning the crumbling of the old order, we should be looking to build a replacement for it that is less vulnerable to unilateral abuse, equally responsive to the requirements of increased flows of trade and capital between nations, and at least as stable and predictable. That will not be easy but, if we focus on the opportunities for innovation inherent in inevitable change rather than on the difficulties of adjustment it presents, we will find those opportunities.