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On: 25 February 2014, At: 18:28
Publisher: Routledge
Informa Ltd Registered in England and Wales Registered Number: 1072954 Registered
office: Mortimer House, 37-41 Mortimer Street, London W1T 3JH, UK
To cite this article: Aaron L. Friedberg (2010) Implications of the Financial Crisis for the USChina
Rivalry, Survival: Global Politics and Strategy, 52:4, 31-54, DOI: 10.1080/00396338.2010.506817
To link to this article: http://dx.doi.org/10.1080/00396338.2010.506817
Aaron L. Friedberg
DOI 10.1080/00396338.2010.506817
32 | Aaron L. Friedberg
their future roles in the international system. Dividing the problem into
three separate pieces helps to make it more tractable analytically, albeit at
the cost of some oversimplification.
Internal effects
In broad outline, the United States and China passed through similar experiences following the start of the global financial meltdown nearly two years
ago. Both experienced sharp drops in aggregate demand and a decline in
growth rates (in the US case triggered by a contraction of credit and the
collapse of consumer spending, in China as the result of a sharp fall-off in
exports) and both initiated large-scale stimulus programmes designed to
boost demand and restore growth. In the US case the slowdown was sufficient to tip the economy into a protracted recession; in China expansion
slowed briefly and then resumed at near pre-crisis rates. The difference in
the two countries performance has caused some observers to conclude that
China must be the winner in the current crisis.
From a geopolitical perspective what matters most are relative rather
than absolute gains; not how fast each economy is growing (or contracting),
but how wide the differential is between their respective growth rates. Since
the end of the Cold War the US economy has been expanding at an average
of about 3% per year while China has enjoyed annual growth rates closer to
10%. It is this persistent seven-point gap that has caused many economists
to predict that, by the middle of this century, at the latest, China will have
overtaken the United States in terms of total output. If both countries return
quickly to their pre-crisis growth trajectories the date of expected conver-
gence will not change. If, on the other hand, one recovers more rapidly or
more completely than the other, that moment could either be moved up, or
pushed even further into the future.
While there are some optimistic outliers, the emerging consensus among
forecasters is that the United States will not bounce back immediately to its
pre-crisis performance. Instead of averaging 33.5% per year (to say nothing
of the 4% some had predicted at the turn of the century, before the dot.com
bubble burst) growth is expected to remain at about 22.5% for much of this
decade and perhaps beyond.3 As for China, after rising to a peak of 13% in
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2007, its annual growth was cut almost in half (to around 7% on a year-onyear basis), during the initial stages of the global crisis.4 Thanks to a very
aggressive response by the central authorities, growth climbed back to just
under 9% in 2009. Some estimates show it hovering between 9 and 10% for
at least the next few years, while others are even more bullish, at least in the
near term.5 If China can return to something near its pre-crisis, double-digit
growth rates while the United States continues to limp along at roughly
0.51% less than its earlier performance, the gap between the two countries
will obviously close even more rapidly than it was before.
Whether or not China can sustain its initial recovery remains to be seen.
At least in the near term, Beijing responded to the crisis by doubling down on
a development model that was already approaching the limits of its utility.
Rather than taking aggressive steps to boost consumer spending as a share
of GDP, a course that both outside experts and many Chinese officials have
identified as essential to sustaining long-term growth, the regime chose initially to pump even more money into infrastructure projects and to provide
both direct and indirect support for a variety of export industries.6 While
this approach may have been effective in preventing an even steeper shortterm drop in output, it threatens to create massive excess capacity, fuelling
asset bubbles, weighing down banks with more non-performing loans and
setting the stage for another slowdown that will be even deeper and more
difficult to manage. As economist Stephen Roach points out, Beijing appears
to have acted on the assumption that, as in previous recessions, foreign (and
especially US) demand would soon recover, leading to a rise in exports and
a resumption of rapid growth. If this turns out not to be the case, however,
34 | Aaron L. Friedberg
Roach concludes that China runs the real risk of facing a more pronounced
shortfall in economic growth.7 In sum, short-term expedients may end up
hastening the day of reckoning for Chinas investment-heavy, export-led
development strategy. While the regime has recently taken steps to encourage domestic demand, permitting workers wages to rise and the renminbi
to appreciate, the changes to date have been small and tentative.8
Despite its magnitude, Beijings stimulus programme was insufficient to
forestall a sizeable spike in unemployment. The regime acknowledges that
upwards of 20 million migrant workers lost their jobs in the first year of
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Beijings
stimulus was
insufficient
36 | Aaron L. Friedberg
grow, and the federal governments efforts to contain the banking crisis and
stimulate the economy have produced even bigger imbalances. In the span
of only a year the deficit quadrupled in size from $459 billion (or 3.2% of
GDP) to $1.85 trillion (13.1% of GDP).16 This would be the most rapid deterioration on record, far worse than any previous recession.17
More important than the speed with which this gap has opened is its
sheer size: the deficit is now larger in relation to the economy as a whole
than at any time since the end of the Second World War.18 In order to cover
the difference between revenues and expenditures, Washington has had to
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borrow at an unprecedented rate, with the result that the federal debt has
ballooned from 41% of GDP to 60%.19 For the moment, low interest rates
have helped hold down the cost of servicing this massive increase in debt.
As interest rates rise from their current low levels, so too will the size of the
federal governments payments to its creditors. Within the next decade, for
the first time on record, annual payments on the federal debt will exceed
outlays for national defence.20
This transition is symbolic; higher debt payments do not necessarily
have to mean downward pressure on defence spending. For a variety of
reasons, however, this is likely to be the case. The combination of rising
interest costs, slower growth and the long-awaited explosion in entitlement
programmes due to population aging will tend to squeeze all forms of discretionary spending.21 Of these, the defence budget is the biggest and, in
political terms, it may turn out to be the most vulnerable. As the United
States disentangles itself from Iraq and Afghanistan, there will be calls to
pocket the resulting peace dividend and to direct more resources to urgent
domestic needs. Instead of being freed to spend more on systems relevant
to a possible long-term competition with China, the Defense Department is
likely over the coming decade to face the necessity of making cuts in R&D
and procurement.22
Barring some galvanising event, the United States may lack not only the
resources to conduct a sustained rivalry with China but the inclination to do
so. Recent opinion polls show a sharp increase in the number of Americans
who believe their country should mind its own business and let others get
along on their own. Indeed, nearly half of those questioned in 2009 agreed
with this proposition, the largest fraction on record, bigger even than at
the end of the Vietnam War. These sentiments no doubt reflect the nations
unhappy experiences over the last eight years with terrorism and insurgency, but they are also clearly a product of the recent economic downturn.
Since the start of the crisis the number of Americans who see their country
as the worlds leading economic power has fallen sharply (from 41% in
February 2008 to 27% in November 2009), even as those who see China in
this role have grown more numerous (from 30% to 44%). While ordinary
citizens remain wary of China, they show little sign of wanting to compete
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with it for influence. To the contrary, the American people at present seem
far more inclined to want to tend to their own problems than to go out into
the world looking for trouble.23 What remains to be seen is whether and if so
how China will try to exploit an interval of American introspection.
Bilateral relations
From the Nixon administrations first feelers to Beijing until the Tiananmen
Square incident and the end of the Cold War, the United States and China
were drawn together mainly by their shared opposition to the Soviet Union.
For the last 20 years, by contrast, the two powers have been united primarily
by trade. The benefits from increasingly close commercial ties have helped
to at least partially offset underlying ideological and geopolitical impulses
toward mutual mistrust and strategic rivalry. To be sure, economic issues
were, at times, a source of contention. Still, recurrent disputes over intellectual property rights, subsidies and currency values were never serious
enough to threaten bilateral flows of trade and investment, still less to poison
the larger political relationship between the United States and China.
The current crisis may mark the end of a period in which trade served to
stabilise Sino-American relations and the beginning of one in which it will
become a source of increasing friction and conflict. Recent events may also
lead to at least a partial decoupling of the two nations economies, a development that could have significant implications for their dealings with each
other, and with the rest of the world.
For the better part of two decades the United States has been importing more from China than it exports and paying for the difference with
38 | Aaron L. Friedberg
Treasury bills and other dollar-denominated assets. Despite the fact that
it was heavily lopsided, this arrangement had clear benefits for both sides.
American consumers enjoyed inexpensive goods and lower interest rates
than would otherwise have been possible. For their part, Chinese manufacturers (or, more precisely, manufacturers with final production facilities in
China, some of which were actually owned by American and other foreign
companies) gained access to the vast US market. The Chinese government
helped boost exports by holding down the value of the renminbi (by using it
to buy dollars) and invested the resulting surplus in Treasury securities and
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favoured local rivals, and make money in the Chinese market means that
the advocates of continued openness are less united and less powerful than
they once were.25 Serious measures to restrict imports from China would
endanger that countrys recovery and long-term growth and would likely
trigger an escalatory response and a downward spiral in trade and political
relations. Despite the obvious dangers, the odds of this happening over the
next several years are probably greater than at any time since Tiananmen
and perhaps since the era of reform and opening up began in the late
1970s. Indeed, the possibility of a USChina trade war has been identified
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by some market analysts as the biggest risk to global stability over the next
few years.26
For the moment, trade tensions have been channelled into the continuing
dispute over currency values. Here, although they have thus far behaved
cautiously, Beijing and Washington are playing what amounts to a game of
chicken. Rather than proceed immediately with a formal
accusation of currency manipulation, as future Treasury
Secretary Timothy Geithner hinted that it might during
the 2008 presidential campaign, in its first year in office the
Barack Obama administration allowed congressional pressure to build, while at the same time hinting that it might not
be able to hold back popular demands for action.27 Public
statements by top US officials seemed designed to convey
the message that, whatever sound economic reasoning
Beijing and
Washington
are playing
a game of
chicken
40 | Aaron L. Friedberg
Clinton
downplayed
disputes
over human
rights
time exhorting Beijing and more time reassuring it.33 This is a change that
many in China clearly welcome and, indeed, have come to expect. As one
high-ranking banking official put it in an interview with journalist James
Fallows: your economy is built on the support, the gratuitous support,
of a lot of countries. So why dont you come over and ... I wont say kowtow
[with a laugh], but at least be nice to the countries that lend you money.34
Even those who are sceptical that Beijing can use financial leverage to
compel the United States to change its behaviour on specific issues agree
that it is now in a much better position to deter overt American influence
attempts. In a careful analysis of this issue Daniel Drezner notes, for example,
that by spring 2009, US government officials had decided that their financial position made it too dangerous to risk a showdown with China over
exchange rates. Drezner concludes that although China could not compel
the United States, it could deter Washington from trying to apply its own
foreign policy pressure.35
The assumption that deep financial interdependence will lead to stable,
mutual deterrence is more comforting than it ought to be. It may well be
true that economic warfare, like nuclear war, would do terrible damage to
all involved but, as with nuclear weapons, this does not mean that such a
conflict is impossible. Leaders may miscalculate the extent of the damage
they would suffer, conclude that the stakes in a given confrontation are so
high that they justify running extraordinary risks, or feel compelled to act
in potentially self-destructive ways by domestic political pressure. As risky
as a confrontation between two nuclear-armed nations might be, there are
also special dangers of unintended escalation in the financial arena where
42 | Aaron L. Friedberg
panics are always possible and relevant decisions are made not merely by
a handful of national command authorities, but by large numbers of independent investors.
Chinas accumulation of dollars is a reflection of its trade surplus
with the United States and that, in turn, is a manifestation of the symbiotic imbalances between savings and consumption in the two countries.
Broadly speaking, the United States has been saving little, consuming much
and making up the difference by borrowing from others, especially China.
The US has
been saving
little and
consuming
much
44 | Aaron L. Friedberg
said to herald the demise of the dollar as the worlds reserve currency. The
Washington Consensus would soon be displaced by a Beijing Consensus
blending market economics with authoritarian politics, and the dollar would
eventually be replaced by the renminbi.
If they were to occur, these shifts in beliefs and policies would have profound strategic consequences. As the American model fell out of favour in
Asia, Africa and elsewhere, US soft power would diminish. With it would go
Washingtons ability to get its way on specific issues and, more broadly, its
capacity to reshape the world according to its own values and preferences.
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Assuming that China came to be seen increasingly as the worlds most successful and dynamic society, Washingtons loss would be Beijings gain.
The decline of the dollar as the worlds reserve currency would have
more concrete effects. If foreigners lose their appetite for dollars, future
US governments will no longer enjoy what has been termed the exorbitant privilege of being able to finance their expenditures at relatively low
cost (and with no exchange-rate risk) simply by issuing more debt. The
ability of the United States to sustain an assertive foreign policy and, in particular, a costly global competition with China would be correspondingly
diminished.41
With the advantage of some perspective it seems clear that announcements of the evaporation of American soft power and the collapse of the
dollar are, at best, premature. There are several long leaps of logic from a
harsh critique of the US governments deregulation of parts of the financial
industry to a more fundamental judgement that the current crisis (like the
Great Depression before it) proves the necessity of a permanently enlarged
role for government in the economy; to the conclusion that much of the
world requires an entirely new approach to economic development; to the
claim that China presently provides such a model. The first step is one that
many Americans, as well as most foreign observers, would be willing to
take; the last would likely be rejected by most informed commentators in
China, to say nothing of the rest of the world.
In East Asia on the eve of the current crisis, the United States continued to hold an advantage in soft power. A survey completed in spring 2008
found that, albeit by narrow margins, respondents in Japan, South Korea
46 | Aaron L. Friedberg
and Vietnam still saw the United States as a more important economic
partner than China (the two were tied in Indonesia). However, attempts to
measure the various dimensions of soft power (including cultural appeal
and diplomacy, as well as economic influence) found that, in each country,
the United States ranked either first or second (to Japan), while China came
in third across the board. When asked to look ahead, most of those surveyed
expressed the view that China will be the leader of Asia. But this was a
prospect that many regarded with considerable discomfort.42
Recent events have probably strengthened each element in this complex
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so heavily in an asset whose value Beijing cannot control. This was hardly
something of which Chinese planners were unaware. The problem for the
moment is that there is nowhere else for them to go. As one official told an
American audience in February 2009, except for U.S. Treasuries, what can
you hold? U.S. Treasuries are the safe haven. For everyone, including
China, it is the only option We hate you guys. Once you start issuing
$1$2 trillion we know the dollar is going to depreciate, so we hate you
guys but there is nothing much we can do.44
This is true, at least in the short run. In the somewhat longer term,
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however, what China can do is to move gradually away from the dollar
while encouraging others to make greater use of its own currency. The
primary obstacle here has long been Beijings refusal to allow the renminbi
to trade freely on global markets. Because this step would mean surrendering control over capital flows in and out of the country, it is one the regime
has thus far been reluctant to take. Nonetheless, by making plain that the
status quo also has its risks, the recent crisis may have tipped the balance
in internal debate towards those who favour a somewhat more rapid transition. Assuming that China continues on its present upward trajectory
the renminbi will eventually join the dollar as a medium for international
exchange. For the time being, however, the United States will continue to
enjoy its exorbitantly privileged position.45
*
The full effects of the financial crisis have yet to be felt because, in many
respects, the crisis is not yet over. We do not yet know if the mix of policies
presently in place in the United States, China and elsewhere will be sufficient
over the next several years to restore steady global economic growth and
head off further resort to protectionism. Nor is it clear how Washington and
Beijing will address the structural imbalances in trade and finance brought
so plainly into view by the current crisis. With that said, let us close with
some speculative thoughts on the three sets of issues analysed above: the
impact of the crisis on the capacities of the two Pacific powers, their bilateral
relations and their dealings with the rest of the world.
48 | Aaron L. Friedberg
At least for the next several years, and possibly for much of the coming
decade, the 200809 crisis will make it more difficult for the United States
to generate the financial resources necessary to wage an escalating arms
competition with China. On the other hand, Chinas seemingly rapid recovery from the recent downturn may be illusory and could prove fleeting.
Unless they are supplemented by more effective measures aimed at increasing domestic consumption, the policies used to revive aggregate demand
could end up hastening a deeper and more wide-ranging systemic crisis.
Finally, it is possible that concern over the consequences of a protracted
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been made more plausible by the events of the past two years. The belief
that Chinas rise is inevitable and may be accelerating is generating respect,
but also anxiety, and this is likely to intensify impulses toward balancing
that are already present across Asia. The inclination of others to bet on the
United States and to follow its lead will be determined, at least in part, by
perceptions of its willingness and ability to meet the economic challenges it
now confronts.
Acknowledgements
An earlier version of this paper was prepared for a seminar sponsored by the Long-Term
Strategy Group. The author wishes to thank Jonathan Kirshner and Jacqueline Newmyer
for their helpful comments.
Notes
1
cfm?fa=view&id=22851; Matthew
J. Burrows and Jennifer Harris,
Revisiting the Future: Geopolitical
Effects of the Financial Crisis,
Washington Quarterly, vol. 32, no.
2, April 2009, pp. 2738; Robert
D. Blackwill, The Geopolitical
Consequences of the World
Economic Recession A Caution,
OP-275-RC (Santa Monica, CA: RAND
Corporation, 2009).
3 David J. Lynch, U.S. May Face Years
of Sluggish Growth, USA Today, 8
May 2009, http://www.usatoday.com/
money/economy/2009-05-07-slowus-economic-growth_N.htm. For a
relatively optimistic prediction of 2.6%
for the period 201020 see Martin S.
Feldstein, U.S. Growth in the Decade
Ahead, National Bureau of Economic
Research, Working Paper 15685,
January 2010.
4 Pieter Bottelier, China and the
International Financial Crisis, in
Ashley J. Tellis, Andrew Marble and
50 | Aaron L. Friedberg
10
11
12
13
14
15
16
17
18
www.reuters.com/article/
idUSTRE5050F520090106.
See Malcolm Moore, China Summons
Police Chiefs to Crisis Meeting Over
Unrest, Telegraph, 27 February 2009,
http://www.telegraph.co.uk/news/
worldnews/asia/china/4862517/
China-summons-police-chiefs-tocrisis-meeting-over-unrest.html;
China to Train Judges on Social
Unrest, AFP, 2 September 2009, http://
www.google.com/hostednews/afp/
article/ALeqM5h4mr3DSeqS9CV
vd8bGFxH1TYNOuw.
Minxin Pei, Will the Chinese
Communist Party Survive the
Crisis?, Foreign Affairs, March
2009, http://www.foreignaffairs.
com/articles/64862/minxin-pei/
will-the-chinese-communist-partysurvive-the-crisis.
Military spending could be a substitute for yet more investment in
civilian infrastructure. This possibility
is mentioned in passing (with reference to both China and India) in an
article by two members of the staff
of the National Intelligence Council
but, so far as I am aware, it has not
been explored in any detail. Matthew
J. Burrows and Jennifer Harris,
Revisiting the Future: Geopolitical
Effects of the Financial Crisis,
Washington Quarterly, vol. 32, no. 2,
April 2009, p. 37.
Seeing Red, Economist, 13 June 2009,
p. 33.
Center for Geoeconomic Studies,
Quarterly Update: The Recession in
Historical Context, 5 June 2009, available at www.cfr.org/cgs.
Congressional Budget Office,
The Long Term Budget Outlook,
19
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52 | Aaron L. Friedberg
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