The past 60-70 years the U.S. has had decisive say in setting rules for global financial systems, and it’s unlikely that changes to American dominance of institutions like the International Monetary Fund (IMF) and World Bank will happen overnight. But America’s huge national debt and a rapidly growing China (pictured above: economic center of Beijing) are a threat to this order.
China is adept at playing the long game, and it’s slowly putting the pieces in place to assume a larger role and more control in this realm. Meanwhile, Congress struggles mightily just to put a budget together, with no real plan to begin reducing the national debt.
One example of China’s growing independence and clout is its formation of the Asian Infrastructure Investment Bank (AIIB), as a rival to the U.S.-led World Bank, and the Japanese-led Asian Development Bank (ADB). The U.S. opposed the Chinese bank and urged its allies to do the same, but much to our chagrin, many of them (Germany, France, U.K., and others) joined and became founding members of AIIB.
China decided to fund this new multilateral bank rather than contribute more funds to the existing ones because of the very slow pace of change in governance of the World Bank and ADB. China had grown frustrated by resistance in allowing them more say in these institutions, especially in relationship to its large and growing economic power. China will no doubt use the AIIB to increase its influence in Asia, and do so at the expense of the U.S. and Japan.
Another sign of China’s growing strength is the probability of its currency – the renminbi, also known as the yuan – becoming an official reserve currency. The IMF currently recognizes the U.S. dollar, euro, Japanese yen, and England’s pound sterling as reserve currencies. Just this past week, a team from the IMF visited China to assess this prospect. A final decision is expected at the end of this year.
Although America currently has the most sway in the IMF, many economists believe this cannot continue as the U.S. has become such a large debtor. No one knows how long it may take for other IMF members to urge changes such as recognizing the renminbi and less American control. However, it may become more likely as these members continue to benefit further from trade and favorable deals with China. It is not beyond the realm of possibility that U.S. control of the IMF could diminish as China’s rises.
To help facilitate such moves by the IMF, China has also implemented a deposit insurance system within the past year, and is allowing greater access to foreign investors who want to buy its securities. It’s anticipated that soon it will be much easier for Chinese citizens and companies to buy stocks, bonds, and real estate in foreign markets. A recent report from the People’s Bank of China states that it will soon realize its goal of capital-account liberalization, and have free cross-border flows of funds for financial transactions.
If the renminbi is declared a reserve currency by the IMF, demand for it will increase over time among the world’s central banks, and allow other institutional financiers to invest in China’s bond market. Such a move would elevate China’s position in the global economy, and allow it to exercise even more influence.
Some economists believe that the renminbi could eventually replace the U.S. dollar as the dominate world currency. This could be troublesome for America, as many believe its ability to sell bonds (our debt) is based upon the dollar remaining the primary reserve currency. It’s also common for the country with the dominate currency to have the most power in governance of global financial institutions.
Coupled with the fact that China’s GDP will exceed America’s GDP by about 2021, and is forecasted to be twice the size of U.S. GDP around 2030, it’s not far-fetched to see China being in a strong position to replace the U.S. as the nation most able to control the world’s financial systems.
If this happens, we could be in a pickle. Because of its size and enormous trade, we can’t stop China from becoming the world’s largest economy. But we don’t have to be subservient to them – if we act. We still possess some strong competitive advantages that give us time to make necessary adjustments and get our financial house in order.
First, is the U.S. Constitution – our greatest asset. Domestic and foreign financiers alike know that the U.S. has many financial challenges, but America’s financial system still retains the most confidence and trust in the world. In the event of a global economic crisis, with world finances teetering in the balance, where will people believe their money is safest – in China, or the U.S.? Thanks to our rule of law, it’s currently a no-brainer.
Second, is our political system. While it has been largely dysfunctional the past few years, America is still a democracy, and China isn’t. Fortunately for us, it may take China several years to establish a functioning democracy, and to gain the high-level of trust and confidence enjoyed by the U.S. financial system.
We also have advantages in technology, education, and weaponry that will help us buy time. But we must address our colossal and growing national debt. Because China is a large creditor and the largest holder of U.S debt, it puts Beijing in a superior position in many regards. At a minimum, this situation allows China to largely ignore America’s attempts to corral Beijing’s increasingly assertive actions.
There’s still time to protect our interests, but we shouldn’t dilly-dally. Some economists believe that Chinese economic dominance is more imminent and broad based than is currently acknowledged. They think that U.S. policymakers are too sanguine in recognizing this threat. They also believe that we have just a few years (five to fifteen), not decades to re-position ourselves.
We still have the ability to control our future, but we must act to make the adjustments necessary to eliminate deficits, and begin to reduce the national debt – as a percentage of GDP – over time. But we need Congress and the administration to stop fighting and begin resolving these serious issues soon. The longer we wait, the less we will be able to maneuver. The less we can maneuver, the more arduous the task becomes.
This is the third of a series of blogs that I plan to write about the economy and U.S. fiscal policy. I’m asking my readers to follow along as I first describe the current situation, and then begin to lay out what I think could be an effective bi-partisan comprehensive plan.
Links to related blogs:
China and U.S. national debt: http://www.commonsensecentrist.com/china-why-deficits-and-the-u-s-national-debt-matter/
Budget concerns: http://www.commonsensecentrist.com/the-federal-budget-were-getting-boxed-in/
Economic growth: http://www.commonsensecentrist.com/growing-the-economy-the-road-ahead/
Fiscal policy: http://www.commonsensecentrist.com/leadership-not-misleadership/
Deficit reduction: http://www.commonsensecentrist.com/passing-the-buck-really-big-bucks-2/