A different pivot to the East

Chinese historians will recall that until the 20th century, their emperors almost never travelled abroad. But China’s opening up to the West has changed the Middle Kingdom’s perception of its international role. With dynastic decline, China became a rule-taker rather than a rule-maker. After more than three decades of reform and development, China has moved to the stage of rule-shaper – but the geopolitical rule-maker still remains the West.

 

Currency war?

Unfortunately, Europe has become so rules-bound by its own problems that its foreign and monetary policies are now on auto-pilot. So, whether the world enters into a phase of currency war, or more geopolitical conflict, will depend on the US and China and their delicate relationship.

This is not to say that players such as Russia, Japan, India and other countries are not important. Any of them, and even the jihadist group ISIS, can be major disruptors. But whether there will be some semblance of global order, especially in regard to climate change, trade, growth and finance, will depend not on the US and China individually, but the complex interaction between them in many areas.

On the military front, US hawks are now screaming for a fight, fresh from a Vietnam-sized withdrawal from Iraq and Afghanistan. On the trade front, some kind of patch-up deal is being worked out on the US-led Trans-Pacific Partnership, which excluded China.

But high on everyone’s agenda is whether the world will enter into a period of secular stagnation, and whether, finally, the Fed will put the last nail in the coffin of quantitative easing (QE), the idea that monetary policy alone can regenerate growth.

If US interest rates rise (and they inevitably will), the implications for the rest of the world will be profound. This is why equity markets, long-term bonds, currency and real estate markets are already quivering in anticipation.

Prior to 2007 – when the Lehman Brothers failure broke open the US subprime crisis – the international monetary system worked on the hegemony of the US dollar. Addressing global imbalances often depended on US leadership bullying Europe, Japan and others to address crises that were mostly in emerging markets. When the imbalance was in the US itself, the unipolar myth was shattered, and a new multipolar Pandora’s Box was opened.  

Although the reserve currency countries (the US, Europe, the UK and Japan) claim that unconventional monetary policy solved their crises, in reality it was Beijing’s 4-trillion-yuan (Bt22.5 trillion) stimulus package, which kick-started a new engine of growth in the form of China’s imports of commodities and, later, high-value consumer products such as cars.

 

Xi and Obama’s choice

The real choice before Presidents Barack Obama and Xi is whether the yuan will join the US dollar in continuing to sustain global financial stability. Despite comments to the contrary, it was not China that started the currency war, because both the euro and yen devalued more than 20 per cent against the dollar and yuan on the pretext of monetary policy. If China opts to maintain yuan stability against the US, then it will pay the price of tougher real sector adjustment, because it cannot use the export engine as an excuse for reflation.

Obama and the Fed know that if the US dollar is the only major currency to appreciate against all others, the US will run an unsustainable current account deficit, with a possible initial upside followed by another crash. It needs to buy time for its own structural adjustments to take place, including the rejuvenation of its dilapidated infrastructure.

In other words, global financial stability hinges on the US and China reaching agreement on sharing the burden of their global responsibilities, which would mean the US allowing the yuan to join the reserve-currency club.

The Hong Kong dollar peg plays an important role in Sino-US relations. Hong Kong has benefited from its role as a free port and international financial centre, particularly as a window for China to experiment with integration with the global economy. Through its peg to the US dollar, Hong Kong is a full rule-taker. By running a three-currency economy – yuan, Hong Kong dollars and Macau patacas – China has the option of gradual integration with global finance. The US benefits from its large trade and investment positions in China, often via Hong Kong.

This is why financial and social stability are uppermost in everyone’s minds. If Xi returns with a feeling that the US is not committed to a partnership for peace and mutual prosperity, expect more global turbulence.

 

Andrew Sheng is a distinguished fellow of Asia Global Institute, Hong Kong.