China and the US must anchor their relationship on sound economics to drive 21st-century globalisation
Andy Xie says the world needs China and the US to base their relationship on a shared economic vision
The US Federal Reserve, citing concerns over a slowing Chinese economy, decided not to raise interest rates last week. It came as a shock to the financial markets. Investors and economic experts in the West didn't think China would have that much of an impact.
China has essentially pegged its currency to the dollar for two decades. As both economies are quite open, they have inevitably become entangled. One underappreciated point is how important China has been to the profitability of multinational companies. For many tangible products, China has become the largest market in the world. Moreover, as China encourages production through cheap capital, free land and low taxes, foreign companies have been able to charge a premium on anything that China couldn't make.
How the 21st century pans out depends on how China and the US relate to each other. If they form an effective partnership, the globalisation that began after the cold war will continue, and the resulting income gains would enable the world to deal with poverty, global warming, ageing, pandemics and other looming global crises.
If the two become adversaries and engage in a new cold war, the world may suffer stagnation for decades to come.
President Xi Jinping is visiting the US this week. There are many thorny issues on the table, including cybersecurity, the South China Sea and the extradition of people wanted by the Chinese government. But far more important is for both countries to anchor their relationship on sound economics. It is virtually impossible to resolve all their differences now. But, if the economics works, other issues will resolve themselves over time.
The US has been the ultimate source of demand for almost every economy since the second world war. With exceptionally high national indebtedness and a low savings rate, however, it can't do the same in the future. Still, the US remains the source of new technologies that drive productivity gains; that is, corporate America has the capability to reap high profitability in the global economy.
China, with its vast population and high savings rates, is clearly the source of demand in the future. That has been the case in commodities over the past 15 years, but not in consumer products. If the global economy is to have another boom, it has to realise this potential in China's economy. China has gained huge market share in the global economy, and has distributed its income gains disproportionately in fixed asset investments. That has led to insufficient demand and excess supply in the global economy. The current difficulties largely reflect this imbalance.
The US, by contrast, has relied excessively on financial capitalism - to the detriment of others. Its extended period of zero interest rates has sparked financial speculation that has damaged emerging economies most. To remain the leading economic force in the world, the US must abandon financial capitalism.
During Xi's visit, the most useful agenda should be how the global economy, especially with respect to the top two, should be managed. The recurring crises demonstrate that the existing way of managing things - everyone for himself - is not working. The Fed's prolonged zero interest rates laid the seed for today's market turmoil, while Japan's strategy of yen devaluation has undermined China's renminbi peg to the dollar, which could push the world into a global currency war.
China and the US have been counting on signing a bilateral investment treaty to further the economic relationship. It would be a step forward. However, as the sentiment towards China in Washington deteriorates, this doesn't look likely. This is a pity. We need something to reverse the downward spiral in the bilateral relationship. Without the treaty, there is nothing else to reverse the trend.
The two governments must do something extraordinary to anchor their relationship in the 21st century. They should pursue a free trade agreement based on restricting what each can do in their domestic economy.
China has become the world's second-largest economy. What it does at home is of global concern. Its government power in mobilising resources for investment has become a major factor in causing insufficient demand globally. It has kept inflation too low, which has prompted major central banks to keep interest rates exceptionally low, sparking massive speculation across the globe. For any international agreement to be meaningful, China's government power in the economy must be defined and limited.
As for the US, since the dollar is the reserve currency for the global economy, its monetary and fiscal policies are of global concern too. Without due consideration for others, US policies would undermine their interests. In an interconnected world, this could come back to harm the US itself. The Fed, for example, shouldn't move interest rates up or down rapidly; that would only increase speculative activity and threaten further globalisation. It should shift to fiscal policy for economic management.
The bilateral relationship is drifting dangerously. What's keeping the situation from spiralling out of control is the unimaginable cost of a rupture. This economic equivalent of the military strategy of "mutually assured destruction" is currently holding the two countries and, by extension, the global economy together. Nonetheless, as each side takes defensive action, the strategy will lose its power over time.
If China and the US don't take bold action to anchor the bilateral relationship, a rupture is inevitable. When that happens, it will bring to an end this phase of globalisation. The world would certainly be worse off.
Andy Xie is an independent economist