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Chapter Three: Economic Realities
Detailing the economic relationship between the United States and China in an effort to reveal the vulnerabilities of both countries should they exist, requires a systematic approach based on Kirshner’s tools for economic coercion: Trade, Finance, and Monetary Power. This chapters more holistic approach provides a more comprehensive view of the complex economic relationship between China and the United States. By separating the three areas and creating a systematic analysis this research minimizes the tendency to declare one area or tool of economic statecraft as paramount to the others. The findings of the chapter are therefore mixed and show a more nuanced view of the economic realities between China and the United States that
complicates more simplistic narratives that one country holds absolute economic coercive power.
The findings are thus that China holds relative strength in monetary power. The United States has greater leverage in trade. And, finally, China and the United States have reached parity in terms of finance.
The structure of this section follows the tools as outlined by Kirshner starting first with monetary power, following with financial power, and ending with trade. By analyzing the current economic realities existing between the two countries this research finds that economic coercive potential is split between the two parties. This is true in so far as: China has economic coercive leverage in monetary power and the United States has economic coercive leverage in trade, but neither country has substantial leverage in financial power.
3.1 Monetary Power
It is prudent to start with monetary power, because it is the economic coercive tool with the least prerequisites to its use and of the greatest efficiency as posited by Kirshner who says,
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“given a reasonably integrated international market economy, monetary power, in theory, should be the most potent instrument of economic coercion available to states in a position to exercise it” (Kirshner, 1995, p. 31). Monetary Power has the lowest threshold to its use according to Kirshner’s measurements of efficiency: publicity of the coercive action, ability to target specific countries and government, and sufficient agent-government control. This is because, assuming there is a global economy and a relatively free flow of currencies, as is the case today, then there are few other constrains to its use. Monetary power can be undertaken with or without alerting either the public of the agent country or the government of the target country. This has two results both to the benefit of the agent country. First, the public, having little knowledge of the action taken, cannot protest its use or any adverse effects that might come from its use.
Secondly, the target country will have little means to respond if the destabilization of their currency has uncertain origins. For the first two prerequisites outlined by Kirshner – the
domination of domestic politics and the publicity – both are largely a function of how transparent the agent country wishes to be providing great freedom to their use of monetary power. The last requirement – focus of action – also has a low barrier for clearance because monetary power is can be focused through the dumping of the target currency or through the selling of their treasury bonds (Kirshner, 1995). This chapter operates under these assumptions; however, the case study in chapter four complicates this notion as it moves beyond theory and into reality.
Where does a countries monetary power come from? Monetary coercive power refers to the manipulation of actions that value, use, and stabilize the national currencies issued by states, in order to influence the preference or behavior of other states (Kirshner, 1995, p. 3). Therefore, any attempt of a country to change the valuation, uses, or to destabilize a currency is the
utilization of monetary power. The main definitive way of understanding a countries monetary
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31 power capabilities is the measurement of their reserves. Knorr tells us that as agent countries take monetary coercive action to put a target currency under pressure “a weak reserve position will curtail a government’s capacity to engage in warfare at home or abroad” (Knorr, 1973, p.
88) as it pertains to hard power capabilities, so does it also apply to the ability of the target country to stabilize its own trade positions or engage in development projects at home. The vulnerabilities and capacity to use monetary power are intertwined. Theoretically, those with high foreign debts and low foreign currency reserves are vulnerable to monetary coercive action;
whereas, countries with low to no foreign debt as well as high foreign currency holdings are in a greater position of power to utilize monetary power.
The United States national debt is nearing twenty trillion dollars (US Debt Clock, 2017), furthermore the U.S. reserve assets total just over 110,000 million dollars (Treasury, 2016b).
This positions the United States assets and debts at definitive polar opposites of each other.
Furthermore, the United States national debt represents 105 percent of GDP meaning that the United States owes more than it can produce in a given year. This creates a distinct
vulnerability, in traditional terms of monetary power. China also seems to be in quite the
position to exploit it. Although no clear tracking or official data on Chinese debt are reported by the Chinese government, there are estimates between three trillion and six trillion dollars
(National Debt of China, 2015). This represents a relatively low percentage of GDP at 66
percent. Both of these figures are dwarfed by the estimates of Chinese foreign currency reserves, which sits at just over 3 trillion dollars (BloombergMarkets, 2016).
Even the great disparity, as is evident between the difference in debt and reserves of the countries, doesn’t provide the full picture of United States exposure. China also holds a vast amount of U.S. debt as Figure 1 shows China owns just shy of 1.2 trillion dollars of US. Debt.
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32 For our analysis this is a definitive demarcation of Chinese theoretical capacity for monetary power.
According to Setser, “never before has a country as poor as china lent so much money to a country as rich as the United States. And never before has the United States relied so heavily on another country’s government for financing” (Setser, 2008, p. 17). By this traditional measurement, China has significant leverage over the United States in terms of monetary coercive power. Therefore, in the first case of economic coercion action which tracks monetary policy it would be prudent to test and see when China would choose to utilize their leverage, and to what extent China was successful in their attempt. By utilizing a case study, chapter four does exactly this.
Figure 3.1 Chinese Holdings of U.S. Debt. Illustrated in millions of dollars. (Treasury, 2016a)
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33 These are the facts that many today point to when claiming that China has the capacity to influence the United States and guide policy make; however, it is noteworthy that looking at the gross accumulation of foreign debt is most useful when looking at smaller economies with more local, or less globalized, currencies. The United States is neither of these things. Although,
many news reports, politicians, to do so, comparing Chinese debt holdings to the United States GDP can show the reliance relative to the United States annual output.
The Chinese debt holdings looked at in this light tell a more telling story of the economic co-dependence of the two countries. The percentage of China holds of United States treasuries in terms of United States GDP is actually quite low comparative to 2007-2012. This is true for a number of reasons. First, United States treasuries is only one way in which China can buy United States debt. Therefore, Although Chinese treasury holdings usual argument for Chinese supremacy of the United States in monetary policy as a tool of economic coercion, it is not the Figure 3.2 China’s Debt Holdings as a percent of GDP. (World Bank, 2016)
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34 only measure that should be taken into account. Purchasing power parity can also play a factor as well as private debt and private debt holdings. Brad Setser has explored some of these other options providing a more nuanced view of China’s debt holdings and their relative leverage.
Second, China also has significant exposure since their United States treasuries holdings
represent a comparatively higher percentage of their annual economic output making it a double edge sword as likely to hurt them. Indeed, as figure 3.2 shows there is a convergence of the two lines, indicative of an interdependent relationship. From this it is reasonable to assume that China’s ability to utilize their debt holdings will be constrained by the economic pressure that will create on their economic growth.
With this is mind, it is prudent to assess China’s goals in using their debt holdings to influence United States policy. According to Kirshner, there are three ways in which monetary power can be utilized: currency manipulation, monetary dependence, and systemic disruption.
In choosing the case study for testing the projection that China has relative strength in the exercise of monetary power it is prudent to choose a realistic manifestation of their power.
Monetary dependence is not an option in this case because it requires the setup of a special currency zone or a system in which the target currency is directly tied to the agent currency. No such arrangement between the United States and China exists. Secondly, systemic disruption is an unlikely case since China still benefits greatly from the liberal trade order as it has been set up by the United States, and any disruption to that system would be uncontrollable and detrimental to the global economic recovery which China relies on for strong demand for their exports. It is realistic however that China will seek first to uncouple itself from this system or create and lead a parallel economic system. Therefore, systemic disruption or the unseating of the United States as the center for the global trade financial systems can be seen as a far off objective, but not as an
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35 observable phenomenon that can be put to the test. The remaining option is the possibility of currency manipulation which is a perfect test. Kirshner tells us that:
Currency manipulation is the simplest instrument of monetary power, and has the widest number of applications. Currency manipulation can be used either for short-term
coercive power, that is, to change a target state’s preferences or action over a specific issue, or to provide general long-term support for an ally. This instrument has a great degree of flexibility: it can be used with varying degrees of intensity, ranging from mild signaling to the destabilization of national regimes. (Kirshner, 1995, p. 8)
United States politicians have long made claims of Chinese currency manipulation all over the campaign trail; however, for the selection of a case study to test the objectives and the utility of Chinese monetary power it is more prudent to select a specific time and purpose for which China exercised its leverage. This fits with the understanding of economic statecraft that action is taken to have a relatively negative impact on another country to obtain definable objectives. Just as China is likely to choose a limited and achievable goal in utilizing their leverage in monetary power, this research should also aim to select a case in which China can reasonably affect the U.S. dollar as small an impact as possible on U.S. debt holdings. As many have commented, China cannot dump large quantities of U.S. Treasuries without destroying the value of their remaining holdings. In other terms, in flooding the market with the asset they could destroy the dollar, but such an action would also dilute the effectiveness of the remaining holdings to have any effect on devaluing the dollar or in stabilizing their own currency (Dyer, 2009).
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36 Because China’s utilization of its leverage necessities calculations that take into account their considerably large U.S. debt holdings their relationship remains one of co-dependence.
However, this is a noticeably volatile codependence as China sees its their debt holdings working against them they may move away from United States treasuries as a means of stable investment, shaking violently the United States growth model dependent on cheap international financing (Roach, 2014).
Likewise picking a specific time period is necessary for any tracking of a currency overtime. As Figure 1 has shown buying of U.S. Treasuries increased significantly since 2000 – even in the midst of the 2008 financial crises; however, it is most prudent to look at the time after the 2008 financial crises when the buying has more or less leveled off and even dropped. This is because, for the same reason that the United States’ politicians have continually made claims of currency manipulation but come up short to take action, it is exceedingly difficult to prove currency manipulation over an extended time. Instead, tracking the Renminbi and Chinese sales of U.S. Treasuries in the months after China’s shock devaluation in August 2015 and ahead of the promotion of the Renminbi to World Currency Reserve status in November of the same year provides the best option to test Chinese leverage in monetary power. This is because it is a shorter time frame in which great fluctuations in the Renminbi were met with decisive action was taken to sell U.S. treasury assets for a definitive purpose: to gain entry into the elite group of world currencies.
Given these figures and findings, this research can proceed on current reality that China has high theoretical leverage in utilizing monetary policy as a tool for economic coercion.
However, given some of the difficulties provided in this subsection and in the previous chapter
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37 showing the inherent difficulties that remain stubbornly present in the use of monetary power we can derive and test two hypothesis:
Hypothesis One: China can use monetary power to stabilize domestic market, meeting a limited but crucial aim of the Chinese government.
Hypothesis Two: The renminbi’s ties with the dollar make long term currency manipulation difficult, limiting monetary power’s utility.
These hypothesizes acknowledge China’s theoretical advantage, but also take into account the unruly nature of using economic coercion as a means to influence a foreign power as well as the vast inter-dependencies characteristic of the Chinese-United States relationship. as introduces the case study that will test their validity. This sub-section also proposes following the 2015
monetary policy changes and the time surrounding as a means to test the validity of the hypothesizes. The conclusion of this chapter further expounds on the importance of this time period and its usefulness in delineating between real and theoretical economic coercive power.