When China Rules the World

One of the more fundamental economic effects of the rise of China will be to transform and reshape the international financial system. By 2007, for the first time since 1918, when the dollar began to replace the pound as the world’s leading currency, it found itself with a new rival in the form of the euro. After 2002 the value of the dollar was steadily undermined by the effects of the United States ’ twin deficits (namely the balance-of-payments deficit and the government’s own deficit) combined with the slow long-term decline of the American economy discussed in Chapter 1. The decline in the dollar’s external value was precipitous: against the euro, by the end of 2007 it had depreciated by 40 per cent since its peak at the end of January 2002. [1273] It recovered significantly in late 2008, but this is likely to be a temporary respite. The financial crisis triggered in September 2008 suggests that the US is no longer economically strong enough to underwrite the present international economic system and sustain the dollar as the world’s premier reserve currency. The significance of the dollar’s decline, moreover, is not confined to the financial world but has much larger ramifications for Washington ’s place on the international stage. Flynt Leverett, a former senior National Security Council official under President George W. Bush, has argued that: ‘What has been said about the fall of the dollar is almost all couched in economic terms. But currency politics is very, very powerful and is part of what has made the US a hegemon for so long, like Britain before it.’ [1274] Similarly Kenneth Rogoff, former chief economist at the International Monetary Fund, wrote: ‘Americans will find global hegemony a lot more expensive if the dollar falls off its perch.’ [1275] The consequences of a falling dollar could be manifold: nations will prefer to hold a growing proportion of their reserves in currencies other than the dollar; countries that previously pegged their currency to the dollar, including China, will choose no longer to do so; the US will find that economic sanctions against countries like Iran and North Korea no longer carry the same threat because access to dollar financing has less significance for them; countries will no longer be so willing to hold their trade surpluses in US Treasury bonds; US military bases overseas will become markedly more expensive to finance; and the American public may be less prepared to accept the costs of expensive overseas military commitments. To put it another way, the US will find it more difficult and more expensive to be the global hegemon. The same kind of processes accompanied the decline of the pound, and Britain ’s position as an imperial power, between 1918 and 1967.

The decline of the dollar, meanwhile, will coincide with the rise of the renminbi. As yet, the role of the renminbi is fundamentally constrained by the absence of convertibility. But over the next five to ten years that will begin to change, and by 2020 the renminbi is likely to be fully convertible, enabling it to be bought and sold like the dollar. By then, if not earlier, most, if not all, of East Asia, perhaps including Japan, will be part of a renminbi currency system. Given that China is likely to be the main trading partner of every East Asian nation, it will be natural for trade to be conducted in the renminbi, for the value of their currencies to be fixed against it rather than the dollar, which is largely the case now, and for the renminbi to be used as the reserve currency of choice. As the dollar continues to weaken with the relative decline of the US economy and the emergence of developing countries like China and India, it will steadily lose its global pre-eminence, to be replaced by a basket of currencies, with power initially being shared by the dollar and the euro, and perhaps the yen. [1276] When the renminbi is made fully convertible, it is likely to become one of the three major reserve currencies, along with the dollar and the euro, and in time will replace the dollar as the world’s major currency. This is a likely scenario within the next fifty years, more probably twenty to thirty years, perhaps even less. [1277]

As I discussed in the last chapter, the present international financial institutions could well, in time, be superseded by new ones. Of course, it is possible that the IMF and the World Bank will be transformed into something very different, with, for example, China and India eventually usurping the role of the US, but a new institutional architecture may be more likely, operating alongside a progressively marginalized IMF and World Bank in which US influence remains predominant. Both the IMF and the World Bank enjoy rather less power and influence than was the case even a decade ago, and this process may well continue. [1278]

CHINA’S BEHAVIOUR AS A GREAT POWER