Chinese warn US debt, dollar hegemony may lead to another ‘Nixon shock’ with global implications

‘Nixon shock’ occurred a half-century ago when economic policy shifts by US President Richard Nixon upended the international monetary system
US ‘doomed to bring a second shock to the world’, globalisation expert says, pointing to record inflation levels and mounting debt

US-China relations

Frank Tangin Beijing

Published: 7:30am, 26 Jan 2022

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The current state of US economic policy, with its decades-high inflation levels and a mountain of federal debt, is a worrying reminder for China of the conditions that prompted US President Richard Nixon to end the gold-to-US dollar convertibility and eventually switch to a floating exchange-rate regime a half-century ago.

Fresh concerns over another “Nixon shock” causing turbulence in the international monetary system have also prompted Beijing’s policy advisers to say that the two largest economies must work together on policy coordination to manage short-term risks, while the US dollar’s hegemony should be weakened in the interest of long-term financial security.

“The 2008 global financial crisis and the unprecedented pandemic have built up the debt level, and the Fed’s balance sheet is snowballing … There’s a potential crisis that the US dollar’s hegemony will go bust,” Liu Junhong, who heads globalisation research at the China Institute of Contemporary International Relations, said last month.

His comments came during a closed-door symposium reflecting on the 50th anniversary of the “Nixon shock”, which occurred in August 1971. Other government think tanks in attendance included the China Association of Policy Science and the Chinese Academy of Macroeconomic Research affiliated with China’s economic planner, the National Development and Reform Commission.

The US shows no intention of cooperating with other countries … to deal with a crisis that it is unable to handle alone

Liu Junhong, China Institute of Contemporary International Relations

Back in the summer of 2020, when the Trump administration imposed financial sanctions on some Chinese officials after the introduction of Hong Kong’s national security law, there were concerns among Chinese academia and policy advisers that China could be denied access to the US dollar and the US-led international payment system.

Last month’s symposium, held four months after the 50th anniversary, reflects Beijing’s worries over America’s economic situation, particularly with respect to its abrupt monetary policy turnaround.

“The US shows no intention of cooperating with other countries, especially developing countries, to deal with a crisis that it is unable to handle alone. It is doomed to bring a second [Nixon] shock to the world,” Liu warned.

US inflation reached a 40-year high of 7 per cent in December, forcing the Federal Reserve to consider accelerating tapering or raising interest rates earlier and more aggressively.

“If we see inflation persisting at high levels, longer than expected, if we have to raise interest rates more over time, then we will,” Fed chair Jerome Powell said at a Senate Banking Committee hearing earlier this month.

The market has been largely convinced that more aggressive rate hikes by the Fed could start from March. The Federal Open Market Committee was due to convene a bimonthly meeting on Tuesday, and that was expected to provide more clues over the road map.

Beijing has tried to shore up domestic confidence by saying that it has plenty of policy tools and is well prepared for US rate hikes. Authorities also assured the market that the 2015-17 turbulence – massive capital outflow, rapid yuan depreciation and a stock market rout – won’t happen this time, but they raised their call for international policy coordination.

Speaking at the annual gathering of the International Finance Forum last month, Lu Lei, deputy head of the State Administration of Foreign Exchange, warned about the spillover of Fed rate hikes and called for “more effective” monetary coordination with developed countries to ensure a “fairer” international environment.

And two weeks ago, Xiao Yuanqi, deputy chairman of the Chinese Banking and Insurance Regulatory Commission, called the Fed’s stimulus withdrawal “a big question”.

“The timing, sequence, method and steps of the exit are crucial. How can the world’s major economies strengthen cooperation, and to what extent can they help reduce the shocks? Everyone should sit together now to discuss and find solutions and road maps,” he said at the Asian Financial Forum.

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Since the late-October virtual meeting between Chinese Vice-Premier Liu He and US Treasury Secretary Janet Yellen, when the importance of bilateral macroeconomic policy communications was highlighted, no concrete measures or further contacts have been made public.

While China’s central bank remains on high alert to US inflation and upcoming monetary tightening, the Fed also flagged the potential risks of the Evergrande debt crisis in its November financial stability report.

Bilateral economic relations were further complicated as US President Joe Biden refused last week to lift punitive tariffs on Chinese goods, pointing to China’s failure to meet the purchasing terms laid out in the recently expired phase-one trade deal.

In his 20-minute address last week to The Davos Agenda, organised by the World Economic Forum, President Xi Jinping called on world leaders to make their policies transparent and coordinated, to prevent a double-dip of the global economy.

China should base its monetary policies on its domestic economic conditions and serve its own development strategy

Zhou Xuezhi, Institute of World Economics and Politics

“Major developed countries need to make responsible economic policies and well manage their spillover to prevent having a severe impact on developing countries,” Xi said. “International economic and financial institutions should play a constructive role in forming an international consensus, enhancing policy coordination and preventing systemic risks.”

Turbulence in international financial markets has already been seen this year, with sharp declines in the Nasdaq Composite Index and the Dow Jones Industrial Average. The benchmark Shanghai Composite Index has also declined this month, and the CSI 300 Index that includes major A-share companies has fallen.

Zhou Xuezhi, a fellow with the Institute of World Economics and Politics under the Chinese Academy of Social Sciences, said he doesn’t expect the US dollar’s dominance to change in the short term, and he recommends that Beijing and Washington discuss how to best manage their respective policies.

“China should base its monetary policies on its domestic economic conditions and serve its own development strategy,” he said.

The world’s second-largest economy, which withdrew its stimulus from May 2020, is under heavy pressure to stabilise growth, and this has marked a divergent approach from Western countries.

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The People’s Bank of China last week cut two policy rates – the one-year medium-term lending facility and the seven-day reverse repurchase rate – by 10 basis points, respectively.

Zhou said authorities should also consider a more flexible yuan exchange rate to help absorb external shocks.

Those shocks have been at the forefront of the minds of China’s geopolitical researchers and strategists since relations with the US started deteriorating about three years ago. They worry that the Biden administration will take forceful measures to strengthen the US dollar’s hegemony.

“The US, which has turned more unilateral and irresponsible than it was 50 years ago, could give the world another ‘surprise’ if similar situations occur again,” Liu Yufen, a researcher with the China Institute of Contemporary International Relations, said at the December symposium.

While the euro or the yuan could rise to challenge the US dollar’s dominance, a supranational currency – backed by a basket of reserve currencies – may be reconsidered with the introduction of digital currency, according to a transcript of Liu’s speech.

“Such an adjustment won’t come overnight,” Liu said. “But the international community should push for a consensus as soon as possible, and make more preparations.”

China kicked off its yuan internationalisation plan in 2009, starting with trade settlements and eventually extending to yuan-denominated crude futures and investment in belt and road countries.

Meanwhile, China has improved a yuan-settlement channel known as the Cross-Border Interbank Payment System, has fast-tracked its cross-border digital yuan trials, and has set up a domestic joint venture with the SWIFT financial messaging service to strengthen global financial connections.

Overall, the overseas use of China’s currency is making progress, but it remains far behind the US dollar in terms of international payments, reserve currency and forex transactions.

The euro, however, is catching up, as SWIFT data showed that it accounted for 36.7 per cent of global payments in December, compared with 31.7 per cent two years earlier. The share of the US dollar fell to 40.5 per cent from 42.2 per cent in the same period.