Politics & Policy

Is China Just Another Failing Bank?

There's more to Beijing's balance sheet than its holdings of U.S. public debt.

Secretary of State Hillary Clinton’s trip to Asia showed that the Obama administration’s policy toward China is unlikely to deviate significantly from that of its predecessor: During its tenure post-9/11, the Bush administration gave great deference to China — on North Korea, Taiwan, and proliferation issues — to ensure Beijing’s general assent, if not cooperation, in the war on terror. After the “economic 9/11” of late 2008, the administration seemed to believe China needed further assuaging on two fronts: 1) as an engine of global prosperity, and 2) as “America’s banker,” given Chinese investment in U.S. public debt.

Unfortunately, the Obama administration seems to be off on the same wrong foot, approaching China with fear-tinged romanticism and a belief that the United States can take no action in Asia without first lining up Beijing. But greater U.S. pragmatism on China is needed. The economic crisis is exposing fault lines in Chinese society, and this seems likely to turn the regime’s attention inward. This calls for U.S. policies that are less dependent upon China’s often capricious Communist leadership and instead built on stable, traditional, and reliable partnerships with Japan, South Korea, and Australia. To take just one example, it may become less defensible over time for Washington to presume that Beijing is willing or even able to exert the leadership needed to contain North Korea’s nuclear ambitions.

That doesn’t seem to be where things are headed. Instead, Mrs. Clinton picked up on the Bush/Paulson theme of “China the banker,” all but pleading for the Chinese government to preserve its store of U.S. Treasury bills, and to continue adding to it. She embraced the conventional wisdom that China, for whatever reason, may shed its holdings of U.S. public debt, which are helping to finance U.S. budget deficits. But the belief that a skittish China might suspend or withdraw capital investment in the U.S. is a fantasy. Where else is China to invest its excess dollars, earned from its massive trade surplus with the U.S.? As long as the dollar is the world’s reserve currency, and the Chinese yuan remains essentially non-convertible, what choice but U.S. Treasuries does China have?

#ad#This was recently affirmed in a burst of candor by Luo Ping, a director general at the China Banking Regulatory Commission (and undoubtedly an official without much of a future in Beijing). Speaking at a gathering of global risk managers covered by the Financial Times, Luo asked: “Except for U.S. Treasuries, what can you hold? . . . Gold? You don’t hold Japanese government bonds or U.K. bonds. U.S. Treasuries are the safe haven. For everyone, including China, it is the only option.”

Mrs. Clinton also assured the world that the U.S. and China are engines of growth that can pull themselves and everyone else out of the recessionary mud. In fact, China may be an engine, but right now it is idling and it could soon be stuck in reverse.

China’s economy is slowing; about that there is little debate. The only question is, How much? The Chinese government and most external analysts still foresee 2009 growth at 5 percent or more, albeit down from the double-digit rates of the recent past. That view is echoed by business leaders in China. Dow Jones reports that Wang Jianlin, chairman of the Dalian Wanda Group, a commercial real-estate company, said in Davos that “the growth of China’s GDP may slow to around 5 percent to 8 percent from around 11 percent, but it is still expanding very quickly. The financial crisis poses little impact on the real economy in China.” But the Obama administration is well advised to hedge against these rosy scenarios. The reality is difficult to ascertain, given the opacity and possible manipulation of official Chinese economic statistics. Even so, several financial economists have concluded that economic growth slowed to about 1 percent in the fourth quarter of 2008. Merrill Lynch’s Ting Lu told the Associated Press recently that growth is unlikely to improve through the first quarter of 2009.

The widely held belief that China will soon surpass Japan to become the second-largest economy in the world ignores the fact that the Chinese economy is a spinning top that can come crashing down if exports slow or if foreign investment dries up. Both are happening now. According to Chinese government data, the number of new companies set up by U.S. investors fell by 32 percent in the first 11 months of 2008. In November 2008, foreign direct investment was down 36 percent, to a mere $5.3 billion, from the previous November.

The export picture is equally gloomy, down nearly 18 percent in January from the previous January, after successive single-digit declines in November and December 2008. As long as the United States and Europe remain mired in economic stagnation and recession, the prospects for export-led growth in China will be dampened.

The economic slowdown will put stress on Chinese society and on the political system. The official view is that 8 percent growth is the minimum needed to ensure social stability. According to a researcher at the Central Party School, as reported in December in the official China Economic Times, every 1-percentage-point drop in economic growth below that level means 8 million lost jobs.

#page#If economic growth came in flat for 2009, job creation would fall by as many as 160 million jobs. This is more than 10 percent of total population and exceeds the entire population of Japan or Russia. This job-creation hole would exacerbate already high unemployment. Official unemployment statistics are unreliable, but in 2003, the Rand Corporation estimated that Chinese unemployment was as high as 190 million (at a time when the economy was believed to be experiencing double-digit growth.)

The effects of China’s economic slowdown are impossible to predict, but the trends are clear. Certainly, the Chinese government will be focused on priorities that include its own survival. Per capita income hovers around that of Swaziland, and there is an aging population supported by too few people in the follow-on generation. There is no serious social safety net, with a public that will soon demand one. Mounting unemployment will create instability. According to a report from the Chinese Academy of Sciences in late 2008, there were more than 80,000 protests, riots, and other “mass incidents” in 2007, up 30 percent from 2006.

As the Obama administration crafts policies in the region, it will be important to remember that China will be distracted for at least the next two years as it adjusts to the effects of lower growth. China’s regional influence will diminish, unless the administration gives Beijing greater credibility than it deserves by failing to recognize its relative weakness. Our friends in the region — including Japan, South Korea, and Taiwan — will seek assurances from us against uncertainty and instability.At the heart of the matter, the U.S. has the daunting challenge of distinguishing fact from aspiration from outright obfuscation about the state of China’s economy. Official optimism, and even arrogance, cannot alter China’s prospects for dramatic economic slowdown accompanied by social instability. Only through sober assessment of China’s true economic situation can the Obama administration develop a more balanced U.S. policy in Asia than exists today.

The worst case would be an extended period of economic stagnation, such as Japan is experiencing. The similarities are worth noting. Hideo Kuman, chief economist for the Dai-Ichi Life Research Institute, recently noted in the New York Times that “at one time, it looked like Japan escaped the brunt of the financial crisis. Now we see Japan’s most damaged because it’s so dependent on trade, which is stalling. This shows how feeble Japan’s economic fundamentals were in the first place.” The same may one day be said of China.

Therese Shaheen was chairman of the American Institute in Taiwan, the State Department’s office of Taiwan policy, from 2002 to 2004. She is a businesswoman and chairs the USAsia Economic Foundation.

Therese Shaheen is a businesswoman and CEO of US Asia International. She was the chairman of the State Department’s American Institute in Taiwan from 2002 to 2004.

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