A currency functions as a global reserve not only because of the relative weight of the country that issues it – although that may be an influencing factor – but because of the confidence it inspires.
China has the second-largest economy in the world. Apart from the United States, it is the only country projected as a superpower. However, the Chinese Yuan is used for 4% of all global transactions; the American dollar – more than 80%. China tries to maintain a strong currency, a guarantee of internal purchasing power, without reducing enormous imbalances due to inadequate investment and over-indebtedness. It relies on exports and induces artificial competitiveness through exchange rate manipulation that allows it to control the flow of capital. It locks up local savings and investments, thus devaluing the currency to “create” competitiveness. Therefore, it disguises imbalances.
Chinese capital controls do not prevent capital flight driven by its exchange rate manipulation and make it impossible to strengthen the financial balance. They have total gold reserves of less than a quarter of 1% of their money supply, and their ratio of foreign exchange reserves to the money supply is less than 12%. The crisis of 1997 broke out when the rate fell below 25% in some Asian economies.
China’s technological and industrial competitiveness still depends on seizing foreign research and development in exchange for restricted access to limited shares of its protected domestic market or spying to steal intellectual property from international corporations in favor of local private companies close to the Party. Its large private exporters – and those oriented to the domestic market – depend on artificially cheap credit, a large internal market protected from all foreign competition, and subsidized external competitiveness with exchange manipulation and capital control.
The Trump administration, whether we like it or not, is rightly outing China as a currency manipulator. In large developed economies, all governments create excess money supply and artificially cheapen credit to some degree. However, China is the only one among these large economies to undertake capital controls and political fixing of the exchange rate.
We saw the devaluation of the yuan under seven to the USD. In 2008, two units of debt-financed one unit of Chinese GDP. Today, one unit of GDP requires seven units of debt. There is control of capital and still there is capital flight. Even the savings locked inside the domestic economy are displaced to gold or bitcoin as Chinese are forbidden from converting savings to foreign exchange.
More than economic wars between governments, these are wars of a governments against their citizens by pillaging wages, savings, and productive investments to finance inefficient and over-indebted privileged people. When victims salvage their savings, they show the advantage of the reserve currency issuer, their first option is to protect themselves from the devaluation of any other.
In the short term, Washington achieves the same – or more – at a lower cost, devaluing less because capital flees to the dollar in the face of any devaluation of strong and convertible currencies such as the euro and the British pound. None to the inconvertible Yuan. The dollar cannot be displaced as a reserve currency?copying the errors of the United States -and further committing errors that the United States has never committed – because a less stable currency will not replace a more reliable one, and the yuan does not even offer free convertibility.
What does Beijing play? Not because what every uninformed anti-Yankee believes about the “financial atomic bomb” of U.S. debt in Chinese hands. This year China reduced U.S. bond positions by 100 billion USD, and the U.S. bond strengthened without repurchases from the Federal Reserve. In the meantime China – with capital control – suffered the flight of more than 40 billion USD in the first half of the year.
But Xi Jinping heads a totalitarian communist state that adopted limited and controlled “capitalism” to avoid a Soviet collapse, not a free market. We are talking about private companies that are politically loyal and always dependent on the government: mercantilism, privileges, and controls. It was enough to lift millions out of misery by creating an economy capable of supporting a globally projected superpower without ceding a millimeter of political power and increasing social control with new subtle and efficient technological tools.
Beijing has no difficulty forcing its voiceless population to bear enormous costs when they assume that a much smaller impact on the American voter would seriously affect the Trump administration. China understands that they face not a bipartisan consensus, but the position of an administration subject to public opinion, legislative opposition, and regular elections. If they are wrong, China’s internal political cost would usually be non-existent, except when some atypical error triggers an open struggle for power within the Politburo.
A gift from heaven to Beijing would be if the European Union were to imitate it, setting aside its recent warnings of Beijing’s protectionism for a populist anti-Yankee wave. Particularly since in the United States, those who ask to intervene politically the value of the dollar – fifth column against its position as a reserve currency – do more damage from within than any external threat.
The totalitarians are confident of their permanence and easily bet on the long term. However, Beijing is not considering that regardless of what happens in the United States, China – despite its weight in international trade – will not be able to issue a credible reserve currency without eliminating capital controls and renouncing the manipulation of the exchange rate. The currency war will strengthen the reserve and tear apart those who bet on devaluation as a way to grow. The sacrifice would be too much for the uncertainty of compromising Trump’s re-election to some democrat who might even maintain the same pressure on China. But Xi possibly can’t find a way to give in now – whereby giving in the short term would strengthen China in the medium and long term – without compromising his position on totalitarianism of which, unlike Mao or Deng, he is not yet the undisputed leader.