China and the dollar

Oct 8, 2015·Alasdair Macleod

With the benefit of hindsight, the two-day devaluation of the yuan in mid-August might have been a masterstroke of strategy.

China executed a financial move that appeared to undermine its own position but instead created trouble for the US; how much is still to be played out. So was the devaluation a well-executed move against the dollar, or are the Chinese authorities as clueless as any other government?

For a clue about how the Chinese might approach these matters, I am indebted to Simon Hunt of Simon Hunt Strategic Services for drawing my attention to a speech by General Qiao Liang, the Peoples Liberation Army's military strategist, delivered about six months ago. The General makes it clear that China's external relationships are pursued through financial, not military means. China pits subtle tai chi against America's brash pugilism. It is therefore quite possible that China's August devaluation was planned and timed to undermine America's financial position.

This possibility is disregarded by nearly all financial commentators, who have been fixated on the bursting of China's credit bubble. This would be a major crisis for a western economy, but it allows China to reallocate economic resources from legacy industries towards the monumental task of developing Asia's infrastructure with the promise of its future markets.

Regarding the August devaluation as designed to enhance the competitiveness of the Chinese currency is too simplistic. The way to look at it is China actually triggered a wide-spread revaluation of the dollar. By undermining US export markets, China has effectively taken control of America's interest rate policy from the Fed. She has shown that China, not America, now sets the pace in the global economy. General Qiao made an interesting point in his speech: China's Alipay alone settled more purchases by value in just one day over China's "Valentine" holiday last November, than all US online and retail outlets over the three-day Thanksgiving holiday.

Exercising control over someone else's currency is not an end in itself. By doing so, China has weakened the negotiating position of her suppliers of raw materials, exposing countries as diverse as Brazil and Saudi Arabia to financial chaos, because of their commitment to the US currency. By whipsawing the dollar, China has exploited the currency disparities between global trade and its financing, and has pressured her suppliers into offering favourable supply agreements. For confirming evidence, see how super-tanker day rates have soared as Saudi Arabia has cut its oil price to China, and how the copper price has held up since mid-August, suggesting there has been accumulation of this vital metal even while emerging markets slump.

This, as the cliché goes, was a win-win for China. Her small devaluation in mid-August triggered a series of events that has allowed her to cash in some of her dollar stockpile at favourable rates to acquire the raw materials she needs for the future. Either she was very lucky, or she had thoroughly analysed global dollar flows before acting. It so happens that dollar flows featured in a large section of General Qiao's speech, which suggests luck was the lesser factor.

The timing, in geostrategic terms, also helps confirm the General's financial war theory. The IMF had decided the week before the devaluation to not include the yuan in the SDR basket before September 2016, when there was every indication it had already qualified (the decision was written up on 4th August and subsequently announced in a press release on 25th August). This removed the immediate prospect of the yuan gaining international marketability through conventional, post-Bretton Woods means, and could have decided China's course of action.

No doubt, the IMF hoped that by delaying the yuan's inclusion by a year, their American masters would be appeased and China would be kept on the SDR hook a little longer. Instead, it appears that China took the view that the existing international order of the IMF and the World Bank set up under American control at Bretton Woods, was just stringing them along.

The realities are stark. China and Russia between them dominate Asia where the majority of the world's population resides. Both super-states are also securing their spheres of interest: Russia in Eastern Europe and the Middle East, and China in South East Asia. After Syria, Russia can be expected to encourage the rest of the Arab world's economic interests to be aligned with Asian markets, while China can rely on her influence to cement economic interests throughout South-East Asia.

China and Russia are the moving forces in the Shanghai Cooperation Agreement. This well-established relationship contrasts with the Trans-Pacific Partnership Agreement, formally signed only this week, which is America's response to China's increasing economic power. President Obama said it himself: "....we can't let countries like China write the rules of the global economy." However, it won't come into effect for some time, and the only mainland Asian nation to sign is Vietnam. All the others, unsurprisingly, have stayed away.

Therefore, despite the TPP Agreement it appears that China already has East Asian trade sewn up. The Chinese alliance has also helped give Putin the power to leave America and her NATO allies flat-footed and strategically outmanoeuvred at the other end of the continent. Putin this week visited Merkel and Hollande in Paris to brief them on Syria and Ukraine, and presumably remind them where their future economic interest lies. Even Britain, one half of the Anglo-American special relationship, was the first outsider to join the new Asian Infrastructure Investment Bank. So at the same time as the US-dominated IMF deferred the yuan's inclusion in the SDR, America's military and financial hegemony was visibly failing.

China's next move could well follow after this weekend, when the IMF and World Bank hold their annual meetings in Lima. It will be the IMF's last chance to take a more constructive approach to China. If the IMF fails to do so, we should expect China to step up her "tai chi" against America and her currency even more, in either of two ways. She could temporarily withdraw entirely from key commodity markets, destroying the US shale-oil industry and inflicting enormous commodity-related losses on the western banking system. That might be too aggressive. Alternatively, China could continue to dispose of the bulk of her remaining dollar reserves, cashing them in for commodities, and giving her embattled suppliers some breathing space. The latter restrained course would be more in keeping with securing her strategic objectives. The sting will be the insistence that, in future, trade deals for raw materials will be conducted more often in yuan, once China's dollar reserves have reduced to more modest levels.

Whether or not China has actually succeeded in controlling external events so much to her advantage must be a debatable topic: a financial war leaves no bodies, only a series of events for historians to unpick. The post-Lima manoeuvres have yet to play out; but with respect to the demise of America's military and currency hegemony, whatever course China decides to follow from hereon, she does appear to be pushing on an open door.

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