The G-2: Are America and China Headed for Divorce?
Niall Ferguson is a professor of history at Harvard University and a professor of business administration at Harvard Business School. His most recent book is The Ascent of Money: A Financial History of the World. He recently spoke with NPQ editor Nathan Gardels about the “strategic dialogue” between the US and China—the “G-2.”
NPQ | Despite all the other issues on his plate, President Barack Obama’s overarching challenge over the course of his administration is correcting the imbalance with China. More than anything else, as you have noted, it has been China’s strategy of dollar-reserve accumulation that financed America’s debt habit. Chinese savings were a key reason United States’ long-term interest rates stayed low and the borrowing binge kept going. Now that the age of leverage is over, what is the key to maintaining the partnership between the big saver and the big spender?
Niall Ferguson | My friend Moritz Schularick and I came up with the idea of “Chimerica” back at the end of 2006. We were trying to explain the global financial boom, with its correlated upward movement of virtually every asset class.
We decided the answer was that China and America had effectively fused to become a single economy: Chimerica. The Chinese did the saving, the Americans the spending. The Chinese did the exporting, the Americans the importing. The Chinese did the lending, the Americans the borrowing.
As the Chinese strategy was based on export-led growth, they had no desire to see their currency appreciate against the dollar. So they intervened consistently in currency markets, and as a result have now got international reserves totaling $2.1 trillion. Around 70 percent of these are in dollar-denominated securities, and a large proportion of these are in US government bonds.
The unintended effect of this was to help finance the US current account deficit at very low interest rates. Without that, it’s hard to believe that US financial markets would have bubbled the way they did in the period 2002-07.
The big question is now whether or not Chimerica is a marriage on the rocks. The financial crisis has brought the age of leverage to an end in the sense that America’s highly indebted consumers really cannot borrow anymore. The US savings rate is soaring upward, and US imports from China have declined significantly. The Chinese trade figures tell the same story: Exports have fallen.
Of course, that doesn’t mean the Chinese are going to stop buying dollars. They daren’t allow their currency to appreciate when so many jobs in the export sector are under threat. But it does mean that they are questioning the “Chimerica” strategy.
I would say this is a bit like one of those marriages between a saver and a spender. It can work for a certain period of time, but then the saver gets disillusioned with the spendthrift spouse. Every time the Chinese complain about American profligacy, it reminds me of one of those domestic tiffs in which the saver says to the spender: “You maxed out on the credit cards, but now I am going to cut them up.” Except that it’s a threat the Chinese aren’t quite ready to carry out.
NPQ | The Obama administration is seeking to borrow billions from the Chinese to finance its stimulus and bailout packages to get the economy going again. What if the Chinese don’t buy those Treasuries? Why wouldn’t they?
Ferguson | Let’s look at the numbers. China’s holdings of US Treasuries rose to $801.5 billion in May, an increase of 5 percent from $763.5 billion in April. Call it $40 billion a month. And let’s just imagine the Chinese do that every month through this fiscal year. That would be a credit line to the US government of $480 billion. Considering the total deficit is forecast to be around $2 trillion, that means the Chinese could conceivably finance less than a quarter of total federal government borrowing (whereas a few years ago they were financing virtually the whole deficit).
The trouble is that the Chinese clearly feel they have enough US government bonds. Their great anxiety is that the Obama administration’s very lax fiscal policy plus the Federal Reserve’s policy of quantitative easing (in layman’s terms, printing money) are going to cause one or both of two things to happen: The price of US bonds could fall and/or the purchasing power of the dollar could fall.
Either way the Chinese lose. Their current strategy is to shift their purchases to the short end of the yield curve, buying Treasury bills instead of 10-year bonds. But that doesn’t address the currency risk.
NPQ | What is China’s alternative if it seeks a divorce from Chimerica?
Ferguson | I’d call it the empire or superpower option. Instead of continuing in this unhappy marriage, the Chinese can go it alone, counting on their growing economic might (their gross domestic product could equal that of the US by 2030) to buy them global power in their own right.
In some ways they’ve already begun doing this. Their naval strategy implies a challenge to US hegemony in the Asia-Pacific region. Their investments in African minerals and infrastructure look distinctly imperial to me. And now the official line from (Prime Minister) Wen Jiabao is “hasten the implementation of our ‘going out’ strategy and combine the utilization of foreign exchange reserves with the ‘going out’ of our enterprises.”
That sounds like the start of a Chinese campaign to buy a lot of foreign assets. But at the same time, crucially, they need to have their own domestic consumers step up to take the place of over-leveraged Americans. China’s economy is above all a manufacturing concern. If no one is going to the shopping malls, their companies are just building their inventories. So a post-Chimerican China needs to be not only an empire but also a consumer society. That means getting ordinary Chinese households to save less and spend more.
NPQ | China seems to have embraced the Special Drawing Rights idea of a basket of currencies to replace the dollar as the reserve currency. Isn’t this like “serving papers”—it shows China’s intention of breaking up Chimerica over the longer term? Or, are they just hedging their bets?
Ferguson | Yes, I think they are “serving papers,” or at least threatening to do so. I don’t myself believe that it’s practical to turn International Monetary Fund Special Drawing Rights into a new world currency. They’re purely an accounting device, not proper money. But I do see the euro and the yen playing a bigger role in Chinese reserves.
I also see a day within the next five to 10 years when the Chinese will feel ready to remove their capital controls and allow their own currency, the renminbi, to develop as an international currency. At that point the Chimerican marriage really will be over. And, after all, that’s what Moritz Schularick and I always said would happen. We called it “Chimerica” because we thought that such an unbalanced relationship would eventually prove to be a chimera.
NPQ | What are the global strategic implications of such a divorce?
Ferguson | Imagine a new Cold War but one in which the two superpowers are economically the same size, which was never true in the old Cold War because the USSR was always a lot poorer than the USA.
Or, if you prefer an older analogy, imagine a rerun of the Anglo-German antagonism of the early 1900s, with America in the role of Britain and China in the role of imperial Germany. This is a better analogy because it captures the fact that a high level of economic integration does not necessarily prevent the growth of strategic rivalry and ultimately conflict.
We are a long way from outright warfare, of course. These things build quite slowly. But the geopolitical tectonic plates are moving and moving fast. The end of Chimerica is causing India and the US to become more closely aligned. It’s creating an opportunity for Moscow to forge closer links to Beijing.