By Matthew Rock.
A common mock debate topic in American high school speech and debate goes as follows: Resolved: The United State should declare a preemptive war on China before China declares war on the U.S. The clever student goes on to produce a series of satirical arguments as to why the U.S. either ought or ought not to declare war on China, the usual point of which are to show the ridiculousness of the original proposition. Indeed, despite the periodic conflicts between China and Japan over the Senkaku-Diaoyu Islands in the Pacific and China’s advances on Vietnam and South Korea’s maritime territories, the idea of a Sino-American war seems bombastic and nonsensical.
And for all intents and purposes, it is.
However, China has begun to make use of a new “soft weapon” to encroach on territory previously under the sole ownership of America and American-backed international institutions: lending to other countries.
The Dragon Does Not Tie Strings
China has lent to Argentina to replenish its dwindling foreign-exchange reserves, to Russia to stave off the decline of the ruble, and to Venezuela to help it avoid a default. It is worth noting all of these countries have challenged the U.S. multiple times. Traditionally at the mercy of the International Monetary Fund, bust countries seem to have a new source of loans to fix their mistakes, one unattached to the liberal scruples of the West.
Furthermore, in the past six months, China has sought a larger role in making loans to developing countries. In about half a year, China has set up or helped to set up the New Development Bank, the Asian Infrastructure Investment Bank, and finally the Silk Road Fund, backed by yet another development bank. Overall, China has pledged $140 billion to these new institutions, which would position it to become a rival of the World Bank in making loans to developing nations.
The great advantage of a Chinese loan versus one from the IMF or World Bank is the lack of conditions attached to it. While the IMF and World Bank require the borrowers to meet cumbersome transparency requirements, among an assortment of other burdens, China seems to need nothing more than the perception that a borrower is important to its strategic interests. As an illustrative example, since 2007, China has lent $50 billion of this strings-free cash to Venezuela, whose CCC+ credit rating makes its debt worth a bit more than junk. China, the world’s top importer of crude oil, takes a key interest in Venezuela, which sits atop the world’s largest oil reserves.
Watch Out for the Fire
Several potential dangers exist for the U.S. and its allies as a result of China’s growing generosity. The clearest threat is that China could lend money to the targets of international sanctions, which would undermine the existing diplomatic order. The money given to Venezuela has let its oppressive government continue to challenge America despite its lack of financial stability, and the loans made to Russia have softened the blow of international sanctions relating to its seizure of the Crimean Peninsula and continuing involvement in the rebellion in Ukraine.
On a subtler but equally important note, China’s increased role as a world reserve bank holds important implications for the world’s currency markets. As of now, the U.S. dollar is the world’s reserve currency of choice, which leads countries to prefer dollar-denominated assets, such as ultra-secure U.S. Treasury notes. Mass purchases of these bonds mean an easy source of funding for the debt-ridden United States government, and high demand for these and other dollar-denominated assets ensures a strong dollar, which makes imports relatively cheap for the U.S.
As China continues to make loans and grow in financial importance, its currency, the yuan, shall too begin to grow in importance. Even now, some of the loans made by China are denominated in yuan rather than dollars, which signals the birth of growing demand for the currency. Granted, the yuan has yet to shed its reputation as an undervalued currency held down by the Chinese central bank, and several years will have to pass before it becomes fully convertible. However, over the next decade, the world will increasingly come to see the yuan and yuan-denominated assets as a budding alternative to the greenback and dollar-denominated assets, and the U.S. will be forced to make tough calls when it sees its stream of bond revenue dwindle down and the strength of the dollar decline.
The Dragon Blows Smoke
For those who suggest China’s financial actions abroad are the making of “soft warfare” against the U.S., the reality is far less sinister. President Xi Jinping wants nothing more than to acquire for China the international influence appropriate for the world’s second largest economy. In fact, the moves made by China have partially been in response to America’s failure to more fully incorporate developing nations into the existing Bretton Woods institutions, the World Bank and the IMF.
Thus, the U.S. and its allies can take a clear course of action to solve the Chinese lending problem: integrate China into the already existing institutions. A world in which the soon-to-be-largest economy offers alternatives to current international organizations smacks of bipolar sectarianism and draws comparison to the Cold War pick-us-or-them mentality. Instead, a world where a rising power comfortably comes into the existing fold demonstrates the maturity and efficacy of the international safeguards the world has set up. Otherwise, those safeguards would become yet one more symbol of division. Clear benefits exist for China, as well, since membership in the IMF and World Bank would give it time-tested guidelines for safe, smart investment in other nations and lend it recognition as a global power. It would be a grave loss for China and its people to continually squander its national savings on pariah states and fiscally irresponsible governments.
As for the value of the U.S. dollar and the U.S.’s position as the world’s de facto reserve bank, it is long overdue for the U.S. to shed some of its global financial clout and pass it on to an up-and-coming player. Right now, when America sneezes, the rest of the world catches a cold, as seen in the 2007 American-led financial disaster. Although the U.S. may be forced to cope with a slower bond purchase rate and a slightly weaker dollar, such is the price it ought to be willing to pay for increased global economic security, for others’ sakes as well as its own. The reduced relative importance of the American economy is inevitable, but the conditions under which this can occur vary drastically. Invite the dragon to the party and have him share a spot at the table. Or have the dragon hold his own party and invite those who, like him, weren’t invited to the first.