Mao Tse-tung famously derided the U.S. in the 1950s as a paper tiger — armed with unmatched military might but unable to wield its power effectively. The same could be said about China in recent years, economically and financially. The country’s breakneck industrial development has generated enormous trade surpluses and enabled Beijing to build up an unprecedented pool of foreign exchange reserves. For the most part, however, Chinese authorities have been reluctant to exercise their financial clout. Analysts may speculate about the potentially dire consequences of a Chinese move away from the dollar, but the government has continued to buy massive amounts of U.S. Treasury and agency securities. In its financial policies, Beijing has seemed to be following one of the maxims of former leader Deng Xiaoping: “Keep a cool head and maintain a low profile. Never take the lead, but aim to do something big.”
Lately, however, China appears to be shedding its reticence. In March, People’s Bank of China Governor Zhou Xiaochuan grabbed the attention of global policymakers when he called for a dramatic overhaul of the international financial system that would eliminate the dollar as the global reserve currency and replace it with special drawing rights — a basket of currencies that serves as the accounting unit of the International Monetary Fund — that would include the Chinese yuan. Such a move, he contended, would end U.S. financial hegemony, foster greater currency stability and reduce the frequency and cost of financial crises. Although Beijing hasn’t formally embraced the proposal as official policy, the government has begun allowing a small number of companies to price their exports in yuan, a key step toward making the Chinese currency convertible and moving to an SDR system.
China is also seeking to increase its influence inside the international financial institutions. In June, Beijing announced that it was considering buying $50 billion worth of IMF bonds denominated in SDRs as the country’s contribution to a $500 billion increase in IMF resources that was agreed to at the Group of 20 summit meeting in April. Analysts say that by offering to buy bonds rather than contributing directly, as the U.S. and European countries are doing, China was sending a clear signal that it disapproves of the fund’s governance. China’s voting stake in the IMF — currently just 3.66 percent — is far smaller than the country merits as the world’s third-largest economy, just behind Japan.
Such initiatives indicate a new willingness by China’s top officials to exercise the country’s economic power in the national interest, including safeguarding its giant reserves and securing greater access for Chinese companies to overseas markets. Beijing isn’t angling to supplant the U.S. as the dominant power of the global economy — at least not yet. But officials do want to accelerate a shift from the so-called Washington Consensus, under which the Clinton and Bush administrations set the agenda for global trade and financial liberalization, to a multilateral arrangement in which China and other emerging economic powers have much greater influence.
“I believe it is a historical responsibility for China to have a bigger voice globally,” asserts Li Jiange (see related article, “Interview: China Getting Closer To Making The RMB Convertible, Says Cicc’s Li”). Li, a senior official, helped design the reforms of state-owned enterprises in the 1990s and today serves as chairman of China International Capital Corp., a major Chinese investment bank, and as vice chairman of Central Huijin Investment, an arm of sovereign wealth fund China Investment Corp. that holds controlling stakes in Industrial and Commercial Bank of China, China Construction Bank and the Bank of China.
Li acknowledges that the dollar will remain the primary reserve currency for some years to come but insists that, considering the U.S.’s declining share of the world economy, major governments need to begin preparing for a transition to a new system. “All nations must sit down to talk about a new global currency-reserve system,” he told Institutional Investor recently in an exclusive interview — the first he has given to a foreign publication — at CICC’s offices in the SK Tower in Beijing’s central business district. “As a responsible, large nation, China must bring this topic up. This is a direction we must all move toward.”
China’s might has been growing rapidly since the 1990s. The country owns the world’s biggest currency reserves, which rose by $178 billion in the second quarter to a record $2.13 trillion. It is also the U.S.’s largest creditor, owning an estimated $776 billion of U.S. Treasury bonds and $450 billion to $490 billion worth of Fannie Mae, Freddie Mac and other agency securities, according to analysts at Nomura International. China is on track to overtake Germany this year as the world’s biggest exporter, according to the World Trade Organization, and to supplant Japan by 2010 as the second-largest economy. Thanks to the government’s massive 4 trillion-yuan ($585 billion) stimulus package, China’s growth rate rebounded from a low of 6.1 percent in the first quarter to 7.9 percent in the second — a stark contrast to the weakness seen in the U.S. and Europe.
“The pecking order is changing,” notes Hwa Er-cheng, global chief economist at CCB in Beijing.
The country’s burgeoning economic power was bound to lead to increased assertiveness at some point. After all, China has in recent years chafed at U.S. demands for an appreciation of the yuan. The fact that the economic crisis has diminished the image and reputation of the U.S. while enhancing China’s makes this a golden opportunity for Chinese officials to raise their voices.
“China isn’t going to put up with lecturing from Washington and instead wants to tell Washington what to do,” says Laurence Brahm, a Beijing-based American lawyer who advised Li and former premier Zhu Rongji on state-owned enterprise reform and counsels the ruling State Council on foreign affairs. “For the first time, instead of being on the defensive and being told what it must do with its financial reforms, China has put the U.S. Treasury on the defensive” (see related article, " Unchangeable China”).
China has also spoken bluntly of its concerns about U.S. economic policy, something that would have been unheard of a decade ago. “We have lent a huge amount of money to the United States,” Premier Wen Jiabao said in a March press briefing in Beijing. “I request the U.S. to maintain its good credit, to honor its promises and to guarantee the safety of China’s assets.”
So far the tactic seems to be working. U.S. Treasury Secretary Timothy Geithner, who set alarm bells ringing in Beijing in March when he told Congress that the Obama administration believed China was manipulating its currency, has since adopted a more diplomatic line. On his first official visit to China, in June, Geithner assured officials that the country’s holdings of U.S. Treasuries were secure and that the administration was committed to reducing the deficit. U.S. officials didn’t even raise the currency issue in July, when Geithner, President Barack Obama and Secretary of State Hillary Clinton received Chinese Vice Premier Wang Qishan and State Counselor Dai Bingguo in Washington for the two countries’ Strategic and Economic Dialogue.
“When you own debt of a country, you have a lot of power over them,” points out Paul Schulte, Hong Kong–based Asia equities strategist at Nomura International.
The Obama administration has sent mixed signals on the idea of an SDR reserve currency. Asked about Zhou’s proposal immediately after it was published, Geithner said he was “quite open” to increased use of the SDR. But after his remarks caused a slide of more than 1 percent in the dollar, he quickly reverted to the Treasury’s standard line that a strong dollar was in America’s interest, adding, “I think the dollar remains the world’s dominant reserve currency.”
Some Western analysts would welcome greater use of the SDR, contending that the currency hierarchy is bound to change with the shift in global economic power. “China already is playing an important role in the reform of the global financial system,” notes Columbia University economist Robert Mundell, who won a Nobel prize for his work on currencies. “By simply bringing up various ideas, it is setting up the global agenda and debate.”
China has also used the reserve-currency issue to cement its position at the head of the emerging economic powers. Although the topic wasn’t on the agenda of the Group of Eight meeting in Italy in July, the five guest nations — Brazil, China, India, Mexico and South Africa — jointly called for a “diversified and rational international reserve-currency regime.”
The inclusion of a wider range of countries in global decision making is a paramount goal for China’s leadership, says Li, who holds the title of minister at large. “The G-8 is no longer sufficient to determine the rules of the game,” he tells II. “What is critical is that we have a system or a mechanism that includes the interests of many nations.”
Beijing hasn’t formulated a detailed list of what it seeks, and what it’s willing to offer, as part of a new financial order. This reticence reflects competing interests and conflicting views inside China.
Consider the reserve-currency issue. China, like many other nations, resents the primacy of the dollar in global finance and the freedom it gives the U.S. to conduct its economic policies with little heed to the consequences for others. China’s big Treasury holdings arguably make it a hostage to those policies — since it would suffer from a sharp decline in the dollar — rather than putting it in a position to dictate to Washington.
Shifting to another reserve currency — the SDR proposal or the yuan itself — would greatly reduce China’s vulnerability to dollar weakness. But such a move would require making the yuan freely convertible, and that carries risks of its own. Doing so would expose the country to the danger of large capital inflows and outflows, a major factor in the Asian financial crisis of the late 1990s. Convertibility would also make it much harder for the authorities to control the exchange rate and could lead to a rise in the value of the yuan that would hurt the country’s export competitiveness and growth. In response to U.S. pressure, the authorities did allow the yuan to appreciate gradually, by roughly 21 percent against the dollar between 2005 and 2008, but they reverted to an effective fixed rate in September 2008 in a bid to insulate China from the global economic crisis.
The government remains committed to making the renminbi convertible. (The renminbi is the formal name of the currency, whose unit is the yuan.) Premier Wen told European Union business leaders at a Beijing meeting in 2007 that China would be “gradually enabling capital account convertibility.” Officials are mindful of the economic cost Japan paid when it allowed the yen to rise sharply in the 1980s, however, and they are determined to guard against economic instability by making any changes to the renminbi at a careful pace, officials and analysts say. “The Chinese government is no longer so insecure about capital flight,” notes Li. “I don’t think it will take 20 years for the RMB to be convertible, and it may be not much longer than ten years, but exactly how long I’m not sure.” Once convertible, he adds, the renminbi should be included in the SDR, whose current composition is 44 percent dollars, 34 percent euros and 11 percent each yen and British pounds.
In a significant step toward convertibility, the government in July began allowing a select group of 400 Chinese companies to price their exports in yuan. Such transactions, which previously were done mostly in U.S. dollars, are taking place through accounts established in Hong Kong and five mainland cities. According to estimates by Nomura International, yuan settlement could amount to as much as $70 billion in the first year, or nearly 30 percent of the $240 billion in annual trade that Hong Kong conducts with the five cities: Shanghai, Shenzhen, Guangzhou, Dongguan and Zhuhai.
“If the experiments are successful, it is highly possible that about half of China’s annual $2 trillion worth of global trade will be settled in renminbi in the long term,” asserts Yifan Hu, Hong Kong–based global chief economist for Citic Securities International, the international arm of Beijing-based Citic Securities Co.
China’s demand for a bigger voice inside the IMF and the World Bank will not be met soon. Last year the IMF agreed to modestly increase the voting rights of China, Mexico, South Korea and Turkey. It isn’t due to make another adjustment until 2011, and small European states that currently are overrepresented at the institution are reluctant to cede much ground.
China, whose average representation in the four agencies that compose the World Bank group is about 2 percent, believes it deserves a share closer to Japan’s 7 percent. “We should get a bigger stake that is equivalent to the size of our GDP,” insists CICC’s Li. “We should have more senior Chinese staff at both the World Bank and the IMF.”
In another sign of its growing confidence, the government is beginning to promote yuan settlement through bilateral currency swaps with trading partners. China has signed six swaps totaling 650 billion yuan with Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea since the outbreak of the financial crisis.
China’s new assertiveness extends to trade. China will continue to buy U.S. Treasuries to help America finance its fiscal stimulus, Li says, but in exchange the government will seek more access for Chinese companies to buy shares in U.S. companies.
CIC, the country’s $200 billion sovereign wealth fund, wanted to increase its 9.86 percent stake in Morgan Stanley when the Wall Street bank was shoring up capital last year, but the U.S. government prevented the deal from going through, Li claims without giving more details. Morgan ended up selling a 21 percent stake to Japan’s Mitsubishi UFJ Financial Group for $9 billion, diluting CIC’s stake to 7.86 percent. Spokesmen at Morgan Stanley and the U.S. Treasury declined to comment, but sources with knowledge of the deal say the bank went with Mitsubishi UFJ purely for business reasons. CIC spent $1.2 billion in June to bring its stake back up, to 9.86 percent.
“There are glass ceilings for investments by Chinese companies in the U.S.,” Li says. “I hope people in the U.S. will stop seeing China as a threat. More Chinese investments in the U.S. would be good for the U.S.”
China’s ambitions risk inflaming tensions with its trading partners, though. Australian and U.S. officials have criticized the country for its handling of a dispute with Rio Tinto Group. State-owned Aluminum Corp. of China agreed in February to pay $19.5 billion to double its 9 percent stake in the Australian mining company and help it finance debt, but Rio Tinto rejected the offer after a surge in its stock price enabled it to make a $15.2 billion rights issue. In what many Western executives suspect was retribution, China in July arrested four employees of the Australian company on charges of bribing executives of Chinese steel companies to get sensitive information related to ore-price negotiations. The arrests “are of great concern to U.S. investors and multinational companies from around the world that have projects here,” U.S. Commerce Secretary Gary Locke said during a visit to Beijing in July.
American officials are also prodding Beijing to open up its markets. In March the Chinese Ministry of Commerce rejected Coca-Cola Co.’s $2.4 billion acquisition of privately held China Huiyuan Juice Group, contending that the deal would violate antimonopoly laws and lead to higher beverage prices.
Although China’s leaders are brimming with confidence, the country has its weaknesses. Victor Shih, an assistant professor of political science at Northwestern University in Evanston, Illinois, says China’s stimulus program, which is being channeled through bank lending, could push the country’s percentage of nonperforming loans from about 5 percent currently to as high as 30 percent. “This will involve painful fixes, and China’s international influence will not be as strong as it is at this moment,” he notes.
China may not get exactly what it wants. But the country’s new assertiveness, like its economic power, seems certain to grow. “A nation of 1.3 billion people: We cannot be ignored,” asserts CICC’s Li. “We have been far too quiet for too long.”
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