Can China afford to downgrade the U.S.?

By Joseph S. Nye, Jr.
August 8, 2011

By Joseph S. Nye, Jr.
The opinions expressed are his own.

After the rating agency Standard & Poor’s downgraded America’s long-term debt, China said that Washington needed to “cure its addiction to debts” and “live within its means.” It must have been a delicious moment in Beijing, accustomed over the years to lectures from Washington about its management of the yuan.

But actions speak louder than words. The real test will be whether China moves away from the dollar in any significant manner. While it makes modest adjustments to its reserve holdings, there are few good alternatives to the dollar. And while it calls for an international basket of currencies to replace the dollar, there are few takers. Of course, China might move toward opening its currency and credit markets in an effort to make the yuan a reserve currency, but the authoritarian political system is unwilling and unprepared to move to that degree of economic freedom.

Many commentators see the downgrading of American debt as a great shift in the global balance of power between the U.S. and China. Some wags have warned the American navy not to sail too close to China, because if the Chinese captured our ships, we would no longer have enough money to ransom them. But such jokes misunderstand the nature of power. Analysts point to China’s seemingly unstoppable growth and its holdings of United States dollars. But as I show in my latest book, The Future of Power, they fail to take into account the role of symmetry in interdependence in creating and limiting economic power. If I depend on you more than you depend on me, you have power. But if we both depend equally upon each other, there is little power in the relationship.

Some observers claim that China could bring the United States to its knees by threatening to sell its dollars. But in doing so, China would not only reduce the value of its reserves as the price of the dollar fell, but it would also jeopardize U.S. willingness to continue to import cheap Chinese goods, which would mean job loss and instability in China. If it dumped its dollars, China would bring the United States to its knees, but might also bring itself to its ankles. The situation, analogous to the Cold War’s balance of terror, where the price of aggression was the inevitable destruction of both sides, has both sides eager to maintain the balance of interdependence even as they continue to jockey to shape the structure and institutional framework of their market relationship. In 2010, when the United States angered China by selling arms to Taiwan, some People’s Liberation Army generals suggested that China punish the U.S. by dumping its dollars. The Chinese leadership wisely rejected their advice.

On American power relative to China, much will depend on the often underestimated uncertainties of future political change in China. China’s size and high rate of economic growth will almost certainly increase its relative strength vis-a-vis the U.S. This growth will bring it closer to the U.S. in power resources, but doesn’t necessarily mean that it will surpass the U.S. as the most powerful country. Even if China suffers no major domestic political setback, many current projections are based simply on GDP growth. They ignore U.S. military and soft-power advantages, as well as China’s geopolitical disadvantages. As Japan, India and others try to balance Chinese power, they welcome an American presence.

The United States faces serious problems regarding debt, secondary education, and political gridlock, but one should remember that they are only part of the picture. In principle, and over a longer term, there are solutions to current American problems. Given the challenges they face, both China and the United States have much to gain by working together. As the largest and second largest economies in the world, the two countries have a responsibility to provide such international public goods as financial stability and less carbon intensive growth. But hubris and nationalism among some Chinese, as well as unnecessary fear of decline among some Americans, make it difficult to assure this future. Extrapolating the wrong long-term projections from short-term cyclical events like the recent financial crisis or the S & P downgrade can lead to costly policy miscalculations.

21 comments

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1. the Chinese people are accustomed to living at a much lower living standard than the US citizen.

2. India is rising. 1.3 billion people in a developing market that dwarft the Americans mere 330 million people.

3. American decline is unavoidable. The US currently uses more than 40% of all global energies within only a fraction of the global population. The developing markets of China and India will force America out of oil supplies.

4. USA imports in excess of 65% of their daily energy consumption. They are not self sufficient. National defense dependent on oil. Diminishing purchasing power coupled with #3 above spells certain economic doom for the USA.

Posted by stambo2001 | Report as abusive

I would not be that complacent for the US. In addition to the concerns raised in stambo2001′s comments, a kind of assets that China could park its dollar reserves to is the human capital trained in the states – China could lure the unemployed/underemployed engineers in the states by offering to pay them with US dollars at competitive wages.

Posted by theorem | Report as abusive

Confucius would have said that bringing down an adversary by sacrificing cold reserves would be less expensive than a hot war.

Posted by SanPa | Report as abusive

Agree – Chinese and Indians have seen the rainy days, have savings and are the best survivors at the moment.

But for the longer term, conditions are favorable to US as follows -

1. Manufacturing base outside of US means related pollution and subsequent environmental calamity confined mostly to these offshore bases. Worse, depletion of fresh-water base over time in these countries that lack replenishing schemes and pollution controls.

2. Around 2050, with global population at around 10 billion+, these countries will get most populous with minimal resources to survive on. With the trend of village population migrating to cities, the balance of 10% city vs. 90% rural that is needed to sustain these economies, will fail as the proportion changes to more like 35+% urban occupation, that will prompt overcrowding issues of traffic, air-pollution, resource contention, water-born and other diseases over time.

3. Alternatively, US population will only grow to around 440 million by 2050 and can ward-off effectively, any encroachment on resources. Energy issues will be resolved by 2025 where, the alternatives will play their 30-year cycle replacement of the conventional energy sources as primary means. US will still have the technology superiority.

4. The current leadership-vacuum rooted in wrong idiology of – unregulated free-trade that depleted jobs, tax-handouts to the unworthy and letting illegal immigrants drain the system, is currently reaching a threshold for transformation in this self-correcting system and will bring the needed correction.

There are a few more technical factors but the above are enough at the moment for this discussion.

Posted by Mott | Report as abusive

the world does not consist of just two countries, Chinese goods can ship somewhere else like Europe because labor cost in Europe is extremely high too. The main root cause though for the US is that there is lacking the driving engine to propel the economical growth, labor cost is too high, technology has been caught up by many emerging countries, financial system is flawed, US citizens are so used to living with debts (in a nice term “leveraged”). I also agree with theorem.

Posted by foto | Report as abusive

Why there are so many people especially the American “thinkers” so addicted to POWER and talk about it endlessly to be the sole superpower.

Posted by Ben_s214 | Report as abusive

There is a large distinction between the financial habits of the bulk of the American people and the financial habits of the American Government. Most of the waste has been on the part of the Government, and most of that has been related to military and foreign political spending. Oddly, the American Empire costs a great deal of money rather than generating money. It is, thus, the most wasteful, unproductive, and self-indulgent part of the USA.

If the dollar drops to its correct level, the bulk of America’s trade problems will be over.

Posted by txgadfly | Report as abusive

Here, Dr Nye seems to imply that power is defined as “the ability to force another party to bend to your will.” This may indeed be an appropriate definition for power, but in a world with so many competing, implicit, complicated and contradictory wills it seems that it might be hard to ever really know who is forcing who to do what.

Instead, we might just observe that getting what we want is a good thing, and that forcing people to do things is obnoxious.

Power matters, but it possible to be “the most powerful” and sill not get what you want.

Posted by effoff | Report as abusive

Listen to Peter Schiff: If yuan appreciates and dollar depreciates, it will be easier for the Chinese to afford goods that was unavailable so far so that the domestic spending in China will increaase. It will also be aesier for China to get new technologies and machinery. At the same time rising cost of goods (e.g. food and oil) denominated in dollars will hurt Americans. Chinese might not want to dump on the dollar, but they might stop be willing to buy the American treasuries. And if that happenns, it doesn´t matter what kind of debt ceiling is approved or dissapproved. The american government will run out of money. The only solution will be to print more dollars which means more inflation and more depreciation of dollar.

Posted by Petr_CZ | Report as abusive

In truth, there is a big brain drain coming from all over the world and that still remains to be the case. Only about 25% of the people came from BRIC (Brazil, Russia, India, and China) return home once they finish the post secondary degree in the USA. That said, the fiscal disaster course that US is taking is absolutely absurd and large portion of our budgets are spend over the defense expenditure of many foreign government and many should be able to spend the money on their own (Germany, Korea, Japan). British had scaled back and we should be too..Ask them to contribute more to their own defense should not be unreasonable.

Posted by Azthairub | Report as abusive

China need to get spending money. They can’t hord it and expect people to keep paying.

Posted by BDIH | Report as abusive

The level of dialogue in this comments section is so low.

1. The US is not going to run out of oil, or even be priced out of the energy market. The US has a much higher energy efficiency than China or India (China, in fact, uses MORE energy than the US to produce LESS output). Not to mention, the US’s oil reserves – when one accounts for the rapidly developing shale market – are larger than Saudi Arabia and Russia combined.

2. Many act as if Chinese have “savings for a rainy day,” but this is not how things work. China runs an account surplus because it exports massive amounts of capital through purchases of assets like UST bonds; it is not investing in these assets because it has tons of “free” money lying around, but because it runs a trade policy that takes money AWAY from households in order to keep interest and exchange rates down, so as to keep export prices artificially competitive.

3. If China dumped the USD or UST, that’s good! That means a lower trade deficit for the US and more jobs in the export industry. It also means a more balanced US economy, with more manufacturing and investment to go along with consumption. The USD as global reserve currency is a burden, as it lets surplus countries exploit the US market to an absurd degree, and it screws up US finances by making borrowing too easy.

4. Sure, China can invest its savings in gold. That will work out smoothly, seeing as how the combined value of all the gold ever mined ($6 trillion) is less than the value of the US bond market, or even the Japanese bond market. Gold, like other commodities, is also prone to wild fluctuations in value.

5. Peter Schiff is clueless as usual. An appreciation of the yuan means that unemployment rises as the export industry dries up. It also means that China would have to confront its investment-driven growth model, which has squandered resources for decades. The over-promotion of investment (HSR, buildings and other construction) is a major reason that the Chinese state is rich while its people are poor, and a good explanation for why consumption in China (like consumption in post-1990 Japan) is so anemic relative to its GDP.

Posted by ZombieMother | Report as abusive

so whos really winning this economic war?

Posted by RDH | Report as abusive

This thinker is spot on:

China and the USA are inextricably linked for the next 30-50 years. For years China has manipulated the yen at the expense of the dollar; the short term advantage being to create a massive market share for Chinese made goods. Unfortunately, Chinese imports to the USA and Europe are coming to a not so soft landing halt. Many Taiwanese and American manufacturers have already shifted production away from China and to other less expensive countries.

China will soon have its own problem of tremendous lay-offs as exports dwindle, the dollar cheapens, and Chinese goods become too expensive as they face pay cost increases, more demands from workers, and soaring raw materials costs.

The US has some alternatives, including re-energizing its own manufacturing base at home as the dollar weakens, shifting purchasing away from China towards India and other developing nations.

China has made its own bed, as has the U. S., but dollar devaluation may be just the thing needed to level the playing field and increase employment at home for an export market.

Posted by deemerk | Report as abusive

Just sour grapes!

Posted by Wederson | Report as abusive

Peak oil will change the world before 2020. Globalized trade will nearly cease, as the cost of crude oil goes to the Moon. America and Mexico will become major manufacturing countries again. The majority of imports will consist of things the USA just doesn’t have much of, like oil, chromium, and platinum.
China will soon be the fastest aging country on Earth. Indian and US warships now routinely visit Vietnam. Rich Australia is planning to construct huge, modern military bases along their Northern Coast. They aren’t to keep out a few migrant fishing boats.

Posted by Discovery451 | Report as abusive

The world seems to be moving more to a multilateral mesh, with regional economically significant countries like China, India, Brazil, Turkey, and some regional integration.
Americans seem to think in Cold War, two camps, terms. “With us, or agin us” – so they got (past tense) to lead a big gang.
Most of what is said about China and economic relations could be said about the Asian region in general, of which China makes up about 40% in population and GDP. And Japan and South Koreans have already taken the export oriented, high technology, development path. To the cost of uncompetitive American manufacturing, 30 years ago.
Maybe Americans should ask why they have been left behind by Germany, rather than obsess about lower wage competitiveness.

Posted by Neurochuck | Report as abusive

What a bunch of hypocrites, the Chinese should be careful what they wish for. All that junk the U.S. buys from them is financed by the debt they criticize.

Furthermore, who’s their biggest FOOD source? The U.S. In an economic war of dumped T-Bills versus canceled wheat contracts who’s going to win?

Posted by PapaDisco | Report as abusive

While the Chinese are having their moment of schadenfreude over USA’s mishaps it is pretty obvious that they do not want to see it implode. With trillions invested in the US they cannot afford to. The question for the Chinese is, was it a tactical error to invest so much in the US? Did they not remember the adage about debt? If you owe $100 the bank owns you but if you owe billions then you own the bank.
The US has not acquitted itself well in its place in the world with the antics of their politicians especially the ideologues. Now the credit downgrade is a blow to the American psyche as they’re no longer apart of the premier AAA creditors. Not that S & P’s record is beyond approach, with their questionable advice leading up to the collapse of Lehmanns.

Posted by dsurte66 | Report as abusive

[...] Joe Nye, the Soft Power guy (not to be confused with Bill Nye, the Science Guy) argues that China’s “demand the United States address its structural debt problems and ensure the safety of China’s dollar assets” is really just talk. The real test will be whether China moves away from the dollar in any significant manner. While it makes modest adjustments to its reserve holdings, there are few good alternatives to the dollar. And while it calls for an international basket of currencies to replace the dollar, there are few takers. Of course, China might move toward opening its currency and credit markets in an effort to make the yuan a reserve currency, but the authoritarian political system is unwilling and unprepared to move to that degree of economic freedom. [...]

Don’t listen to these comments. It is a bunch of ‘Wu-Mao’. In case your not familiar, Wu-Maos are Chinese netizens that are paid 5 Mao (hence the name in Chinese pinyin – Wu Mao) to write pro-Party propaganda on foreign news outlets websites, commentary sections, etc. Since 5 mao is just a few cents, you will notice how many of their comments are boiler-plate responses that often have little to do with the actual article being commented on. It is most obvious when you see comments fashioned with numerical point-by-point argumentative outlines. This way the author…err…Wu-Mao…can cut-paste and tinker to add quantity and therefore get paid more.

Don’t get me wrong. This is not intended to be negative in anyway, as I have lived in China for years, and I greatly admire the people and culture. The nationalism that is stoked by the Party, and the use of nationalism as a political mandate is just not right and it creates friction, ugliness, and it really does nothing to address the fact that we are all in this together and that world is only getting smaller.

Posted by bailong80 | Report as abusive

I think the argument follows the common complacency and linear thinking of most western scholars. China could use its reserves to bring down the US, yes, the problem is that the author is thinking not like the Chinese but like a westerner with lots to protect. If things go sour what’s left for the Chinese, hold our worthless dollars?
I think a bit of dialects might help; and history. Technological supremacy is no longer in the hands of a few rich countries that by the way became that way through colonialism and the benefits of being the only country standing with a built up economy after WWII.
Things are changing and while the author makes very good points, they only make sense if one puts visors on and only sees what is only in front of one’s eyes. He seems to ignore the great damage that Americans themselves have been making to their own country.

Posted by ofilha | Report as abusive

[...] 路透社:中国能承受得了美国 债降级吗?——认为中国威 卖出美国国债就可令美国屈服 的人,只看到了问题的一个方 [...]

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