Why China's New Colonialism Should Precipitate a Crisis

The United States and China will hold a Strategic Economic Dialogue during the last week of July. The talks were an initiative of former Treasury Secretary Hank Paulson, but have continued under President Barack Obama and Treasury Secretary Tim Geithner.

However, China, with the help of the media and many observers have wrested control of the agenda in the court of public opinion, if not the actual substantive part of the dialogue. Previously, at nearly every international economic forum, U.S. officials harangued China to allow its currency to become flexible so it could appreciate.

The renminbi’s appreciation was demanded by U.S. lawmakers, who have repeatedly tried to pass legislation that threatened greater sanctions if China refused. The appreciation of the renminbi was desired not for its own sake, but to help ensure that China’s emergence on the economic world stage is less disruptive. The artificially under-valued currency was exacerbating global imbalances, provided China with an unfair advantage, and fanned the flames of protectionism.

That was Then, This is Now

Since the end of the first quarter, China, tired of being on the defensive, went on the offensive. It began using international forums to press for reform of the monetary order which gives the dollar a privileged role. The head of China’s central bank proposed expanding the role of Special Drawing Rights, a weighted-basket of dollars, euros, sterling, and yen. The IMF has used SDR, for official transactions over the last few decades, but only in a very limited fashion.

Even though other Chinese officials, including the ambassador to the United States, played down the seriousness of the proposal and European and Japanese officials were nonplussed, the feint by China worked. The media and many analysts have taken the bit and are running with it.

As the next round of SED talks are at hand, pundits are discussing the demise of the dollar and the U.S. role in the world economy. This topic gets lumped together with the diversification of reserves, which, according to the most authoritative data from the IMF, is not really taking place. The dollar today accounts for roughly two-thirds of the world’s reserves, largely unchanged from the early 1990s, before the run-up to EMU.

Remember EMU? The European Economic and Monetary Union and creation of the euro were embraced by many as the first real alternative to the U.S. dollar. Prior to EMU, the ECU, a weighted basket of European currencies, the German mark and French franc accounted for about a quarter of the world’s reserves. The euro, accounting for the same amount today, has not challenged the role of the dollar as the numeraire. It is simply the sum of its parts.

Nor has the Chinese talk been sparked by a dollar crisis. Indeed, over the past four quarters, the euro has fallen 11% against the dollar, sterling is off 17%, and the Australian dollar has depreciated 16%. The Norwegian krone, which some analysts claimed could be a safe haven, has lost more than a fifth of its value.

There is only one G10 currency that has gained against the greenback over this time, Japanese yen. Ironically, to the extent that IMF reserve data shows a shift in the currency allocation of reserves, it is away from the Japanese yen and toward the British pound.

Europe is engaged in the great experiment of our time. Can economic and monetary union be sustained without political union? A decade is too short of a time period for judgment. Yet the talk about a new international reserve asset to supplant the dollar begs similar questions. Taken to its logical conclusion, China’s proposal would have Europe’s experiment imposed on the rest of the world. Who would determine the amount of reserve assets to make available and set its interest rate? What would take the function of the U.S. Treasury market, in which most reserves are kept?

An Embarrassment of Riches

Contrary to what passes as conventional wisdom, China is a poor country. Its economy is far too small to support such a large population. Using an assessment of fair value for the Chinese renminbi (purchasing power parity), the IMF estimates that last year, China’s per capita GDP ranked 100th at about $5,963. That same per capita figure ranked China 89th, by the World Bank’s calculation. The CIA rounded the per capita GDP to $6,000 and ranked China 106th on its tally.

It has over $2 trillion in reserves. In the days before the SED, China’s Premier, Wen Jiabao, appeared to announce a new initiative. Reserves would not be used to improve the lot of the Chinese people through things like education, social security, unemployment compensation, health car, or improved living conditions.

Instead, Premier Wen announced reserves would be to support and accelerate the overseas expansion and acquisitions by Chinese companies. Chinese companies have reportedly gone on quite a shopping spree in recent months (see Business Week’s July 27th cover story), but this was the first time a senior Chinese official linked the “going out” strategy with the vast reserves.

Ironically, the day before Wen announced the initiative, the Financial Times ran a story, based on a report by Deutsche Bank that sovereign wealth funds, set up by central banks to better manage their reserve holdings, have taken substantial losses during the financial crisis. Deutsche Bank estimates that sovereign wealth funds lost around $600 billion since the end of 2007, or 20% of the estimated $3 trillion they held. The losses were attributed to sharp declines in equities and real estate values. These losses prompted Deutsche Bank to cut the expected growth in sovereign wealth funds to $7 trillion in 2019 from its forecast of just two years ago of $10 trillion by 2016.

It turns out that asset managers at central banks do not perform better than large private sector fund managers. Indeed, China’s investments do not appear to have fared much better. Nor have its purchases always been linked to strategic importance, like the stake it took in Diageo (DEO), the distiller. Moreover, as Chinalco’s failed attempt to take a bigger stake in the Anglo-Australian Rio Tinto (RTP) demonstrated, there are limits to how much countries will tolerate an expansion of businesses owned by foreign states in their economies.

While some observers have tried to cast Wen’s initiative as another effort to diversify reserves away from the dollar, like the IMF’s SDR bond offering, the scale is off by an enormous magnitude. China’s outward bound foreign direct investment was just shy of $41 billion last year. China’s reserves have grown in value by more than $330 billion since the middle of 2008.

Imperialism of the eighteenth and nineteenth century consisted of Britain, France, Holland, Spain, other European powers, and Japan entering Africa, South America, and parts of Asia, for the main purpose of extracting minerals. This extraction occasionally required some modest infrastructure improvement, like a railroad or a deeper port. China is arguably engaged in a 21st century version of the same thing.

Even if only part of its current reserves are earmarked for foreign acquisitions, as if Wen was going to really operationalize his proposal, China could buy all the shares listed on Brazil’s Bovespa, Australia’s ASX 200, or Switzerland’s Market Index. Alternatively, China could buy the entire market cap of Mexico, Chile, South Africa, and Russia combined.

China’s thirst for raw materials and commodities may provide developing countries with some needed funds and without the conditions often imposed by multilateral lenders or other investors. However, this does not lead to development anymore than 18th and 19th century imperialism did. It prevents the economic diversification away from low value-added commodity extraction. It often doesn’t lead to employment opportunities as China often exports workers to operate projects. Considering China’s purchase of farm land in Africa, some estimate by the end of next year there will be over a million Chinese farm workers in Africa.

Conclusion

In March, China announced that beginning in May only provincial authority was needed to approve outgoing foreign direct investment in excess of $100 million. Starting in August, Chinese companies will be allowed to purchase currencies to fund foreign acquisitions. Chinese outbound investment will no doubt increase. Yet, it will not be sufficient to address China’s embarrassment of riches and its humongous reserve accumulation.

The more the media and analysts accept at face value China’s urging for reform of the international monetary order and desire for a dollar replacement, the less time and energy will be spent on examining the real issues, like re-pegging the renminbi to the dollar, the fact that domestic demand accounts for a smaller percentage of the Chinese economy now than a few years ago, or that its foreign direct investment policies look a lot like old fashioned imperialism.

Wherever capitalism grows the fastest, there will be crisis. China’s rapid growth is indeed impressive, but it has not repealed the laws of economic development. It is producing excesses and this will lead to a crisis. Its currency is not convertible and is in no position to rival the dollar, or the euro for that matter in any kind of time horizon that makes sense for private investors.

Comments

[Observer45:]

This is a poor attempt at misinformation and spin. The author obviously believes that the greater fool theory extends to this end of the literary world. I notice that readers of this site are more critical and generally better informed than to swallow this load of rubbish. Comments and conclusions are not supprted by solid facts, data are outdated and pulled from the air. Better try next time!

Jul 26 04:33 AM

[lisaberlin:]

It is hard to determine whether this is just a poor attempt at misinformation and spin or simple ignorance. Whatever the case, it is the clear the writer of this article is part of the Wall Street Crowd who brought us the current economic circumstances. And guess what, he is still working there.

Jul 26 10:46 AM

[Alphameister:]

"Wherever capitalism grows the fastest, there will be crisis. China’s rapid growth is indeed impressive, but it has not repealed the laws of economic development. It is producing excesses and this will lead to a crisis."

Give me the periodic crises of the fastest-growing capitalist economy in the world as opposed to the almost unending crisis I see for the U.S. during the decade ahead. Not a persuasive article.

Jul 26 12:49 PM

[Hillsfar:]

Rapidly booming prosperity in the late 1800s led to America flexing its wings and engaging in our own brand of imperialism: Puerto Rico, the Philippines, etc. We did the earlier in the early 1800s with Westward expansion and the idea of Manifest Destiny. And we certainly did it on an economic and political level during the Post-WWII economic boom that coincided with the Cold War. There are many countries in Latin America, the Middle East, and Asia whose histories and people still bear our economic and political hegemony. Well guess what? China has burgeoning economic muscle and it's flexing its power more and more now.

Jul 26 01:52 PM

[Alan Young:]

"a poor country" ... with "over $2 Trillion in reserves." If only the US were that "poor."

The comparison with 19th-century imperialism (and the even worse headline) is really over-the-top. When has China sent any military force overseas, or even beyond its borders, to take control of resources, or even to protect its investment? What they are doing is perfectly normal capitalist competition, no different than Shell vs. Exxon competing for oil reserves.

Jul 26 05:15 PM

[The Recusant:]

Hillsfar: Touché! What the author suggests is that they are not "ready" for global economic domination. I can't think of a country MORE ready and the similarities to Post-WWII US expansion is remarkable.

"Contrary to what passes as conventional wisdom, China is a poor country," attempts to link population to overall economic wealth. Compare this to "...China could buy all the shares listed on Brazil’s Bovespa, Australia’s ASX 200, or Switzerland’s Market Index. Alternatively, China could buy the entire market cap of Mexico, Chile, South Africa, and Russia combined." Regardless of their population, which is declining by the way, they still have the economic power to establish themselves as the most dynamic player in the world.

Jul 26 05:41 PM

[jt:]

" Its currency is not convertible and is in no position to rival the dollar"

That is as one-sided a pro-dollar, pro-administration, pro-bigbankster piece of WashingtonianWallSt. economic propagandist crap as I've read recently.

That's not to say China doesn't have its problems. But the dollar is the deadliest piece of the entire fiat fraud with which the WallSt Banksters and their Intl Bankster Cartel Family have defrauded and robbed not only the working class of this country, but of the world. To call it "strong" or especially to imply that it is "stronger" than any other fiat currency is simply to restate the lie that has made that Criminal Clan wealthy beyond all human imaginings at our expense.

In fact, the dollar's only strength now is the strength of the lies that surround it...their ability to deceive "the peoples" that there is ANYthing backing it but the promises of superwealthy and superpowerful conscience-less criminal scumbags who don't care one drop of sweat about them NOR have ANY plans whatsoever to repay the absolutely ungodly debt they own them nor make good on or take responsiblity for the financial fraud that backs the dollar (as in $600-700 Trillion or more of derivative debt / bad bets) that they have perpetrated on them for the purpose of putting pretty lipstick on the green paper piggy that they can create for their own use with absolutely NO oversight from the American people, nor even by their elected representatives!!

But that time is coming to an end soon, when the peoples will continue to listen to and believe the lies. And then authors like this one and the rest of his ilk can pen all the "strong-dollar" "weak ROW" spin they want. But the ROW...the Rest Of the World...by then will all know the lie, and in fact, will reveal the fact that they've known it was a lie for a long time. Hope y'all have your wealth in something other than (Nothing)Federal(About... (Absolutely-NOTHING-in)Reserve(Backing-It) Note(Paper)...it's nothing but a lie. jt

Jul 26 07:17 PM

[NaomiY:]

There's one vital difference between China's BUYING foreign physical asset and the colonization by the western world. China paid market price while the west just invade and took what they want.

Also, I don't see any reason for the Chinese govt to spend the foreign reverse locally, they can pay for stimulus and any other new program by increasing the money supply.

Jul 26 07:20 PM

[Locked Out:]

This author is correct on all accounts. In China we are dealing with a dictatorship which has used capitalism to build vast amounts of wealth without sharing it with its vast populous. 0.4% of the population holds 70% of the wealth and they are all connected to the CCP. An article recently out entitled "Rich China, Poor Peasants" illustrates this noxious wealth gap quite well.
online.wsj.com/article...

And I would highly recommend this article posted by another user which illustrates the route a USD takes in and out of China as it makes it's way through that country's ENFORCED saving and currency manipulation mechanism:
www.theatlantic.com/do...

Summed up:
"Unpegging from the dollar would further destroy China's already plunging exports. So they can't afford to do that. China will keep up the insecent rhetoric on the "new reserve currency" for political gain at home and abroad, but in reality, it is China's currency control that caused the imbalance in the world economy. Natural market forces would have driven up the value of the yuan and made American exports cheaper, thereby acting to help balance trade."

Jul 27 12:07 AM

[ngwun:]

" "a poor country" ... with "over $2 Trillion in reserves." If only the US were that "poor." "
Take your hand out of your pants, grab a calculator, & divide it by the real population. [Chairman Mao said in the Little Red Book that it was hard to govern 600M people... a few more now] Yes, a poor country, with all the hobbles of "multiculturalism" as well. Lucky they are nazis.


"Well guess what? China has burgeoning economic muscle and it's flexing its power more and more now."
Well, someone bigger than me is knocking on my door. I guess i had better move out the back door & let them have the house, & maybe the family. And the history.

You Yanks seem to have taken such a guilt trip from your hegemonic excesses that you now want to sell your collective ass to whomever wants a piece of you. It was not all bad, & most of the people who hate you want to become you.

I reckon the article is well written & relevent, according to my ignorant bias, but we don't need the U.S. to cringe & decay any more than we need you

Jul 27 05:45 AM

[coreopsis:]

I would write that this is a shockingly ignorant and propagandistic article, but so much that is politico-economic in nature has been hijacked in the media by the Chandlers of the world (another example: Israel), that nothing about the US media could be termed shocking except the ongoing harm that it does to the status of America beyond its borders.

Jul 27 09:25 AM

[Nick B D:]

Another gold bug with his panties in a bunch.


On Jul 26 07:17 PM jt wrote:

> " Its currency is not convertible and is in no position to rival
> the dollar"
>
> That is as one-sided a pro-dollar, pro-administration, pro-bigbankster
> piece of WashingtonianWallSt. economic propagandist crap as I've
> read recently.
>
> That's not to say China doesn't have its problems. But the dollar
> is the deadliest piece of the entire fiat fraud with which the WallSt
> Banksters and their Intl Bankster Cartel Family have defrauded and
> robbed not only the working class of this country, but of the world.
> To call it "strong" or especially to imply that it is "stronger"
> than any other fiat currency is simply to restate the lie that has
> made that Criminal Clan wealthy beyond all human imaginings at our
> expense.
>
> In fact, the dollar's only strength now is the strength of the lies
> that surround it...their ability to deceive "the peoples" that there
> is ANYthing backing it but the promises of superwealthy and superpowerful
> conscience-less criminal scumbags who don't care one drop of sweat
> about them NOR have ANY plans whatsoever to repay the absolutely
> ungodly debt they own them nor make good on or take responsiblity
> for the financial fraud that backs the dollar (as in $600-700 Trillion
> or more of derivative debt / bad bets) that they have perpetrated
> on them for the purpose of putting pretty lipstick on the green paper
> piggy that they can create for their own use with absolutely NO oversight
> from the American people, nor even by their elected representatives!!
>
>
> But that time is coming to an end soon, when the peoples will continue
> to listen to and believe the lies. And then authors like this one
> and the rest of his ilk can pen all the "strong-dollar" "weak ROW"
> spin they want. But the ROW...the Rest Of the World...by then will
> all know the lie, and in fact, will reveal the fact that they've
> known it was a lie for a long time. Hope y'all have your wealth
> in something other than (Nothing)Federal(About... (Absolutely-NOTHING-in...
> Note(Paper)...it's nothing but a lie. jt

Jul 27 01:26 PM

[ngwun:]

I apologise for the (lack of) end to my comment. I don't recall how the sentence was meant to finish, but it was not meant to be so rude.

Jul 27 07:42 PM

[Marc Chandler:]

I don't get it. I present a rational argument that:
1. China got the better of the US in the propaganda battle. It changed the agenda to int'l currency reform and took attention away from it.
3. China's reserves are an embarrassment of riches given how poor the country is.
4. China's policies in LDC is a grab for resources. It will not lead to development of these countries.
5. First the US in decline camp said the euro would replace the dollar. Now it is the yuan. Neither case is true.

I would add, I see no sign that the US is seeking a weaker dollar. Some European finance ministers have expressed concern about the euro's aprpeciation (though it is down year-over-year). The Swiss, with their current account surplus, have intervened to knock its currency down. Canada and the UK have also expressed concern that their currencies' strength could derail the recoveries.

I would also add that as closer readers of Adam Smith could attest, the origins of the wealth of nations does not lie in reserve accumulation but the division of labor and the productivity gains that follow.

I do not understand many of these comments which attack my integrity instead of the arguments. To simply assetr that this is spin and misinformation is not enough. There is a difference between assertions and arguments. I presented an argument that said essentially China is not eating the US lunch. I give numerous reasons. I could learn and others might as well if there was a alternative argument rather than name calling.

Jul 27 08:15 PM

[Marc Chandler:]

In the first 2 qrtrs of 2008, as the USD was going Down the Tube, says Freya: These are the facts: the euro fell 0.09% in H1 09, the Swiss franc fell 2.23% and the yen fell 5.8%. The dollar did sell off against the 4 currencies that were the hardest hit in H2 08, Australian dollar, New Zealand dollar, British pound and the Scandi-bloc.

An appreciation of the CNY iis not tantamount to a dollar devaluation because CNY appreciation says nothing about the euro-dollar exchange rate or the dollar-sterling or the dollar-yen rate.

That said, I tend to believe that the currency is not the key way China competes in the world economy, but rather by cheap labor. Asian Development Bank estimates that Chinese mfg wages are 1/33 of US. CNY doubles and their wages are 1/16 of America's.

It looks to me like the US is one of the few countries that as a declaratory policy says that a strong currency is in its interests. The Swiss don't say that. They intervene to sell their currency. The British, Canadians, Europeans do not say they want a strong currency. Geithner and Bernanke have recently repeated the US mantra. They do not say they want a strengthening dollar, simply a strong dollar. No straw man here please.

Jul 28 02:09 PM

[Nick B D:]

Mr. Chandler,
I found your article informed, insightful and objective. I think it's likely the people responding emotionally and dismissively to your words are heavily invested in an asset (probably gold) that doesn't benefit from the scenario you suggest. Hyper-inflation, the devaluation of the dollar, perhaps even further economic crisis in the U.S. is what some of them may be hoping for. Some seem attached to an ideology or world view. In any case, they seem threatened by your ideas and that says a lot about their bias and their rationality.

Jul 31 10:56 AM