China Flexes Its Muscles

If there was any doubt that China is a global competitor, then those thoughts should be put to rest with recent news. After a couple of revisions, China's growth rate for 2004 was 10.1%; 2003, 10%. In fact China came very close to a ten percent per year growth rate from 1993 to 2004. The latest figures make China the fourth largest economy in the world. The U.S, Japan, and Germany are one through three.

The growth rate of China (and India) are Leaving G7 Nations in the Slow Lane. China's growth, and huge export surplus, are impacting G7 economies - particularly the U.S.. The combination of debt (a significant amount of which is held by China), and import dependence has put inflationary pressures on the U.S. economy. This situation has resulted in increasing short term interests where they are threatening to exceed long term rates. This threatened "inversion" has historically lead to a recession in the U.S.

Given this situation, it is not a surprize that China is working to "reduce its dollar exposure". China now holds about $800 billion in foreign exchange reserves in U.S. dollars. About $600 billion of that is in U.S. bonds which translates into U.S. debt. China's diversification of their holdings of U.S. dollars could further drive down the value of the dollar. This makes debt repayment more expensive, as well as imports which the U.S. depends upon. Goodman notes in the NY Times article:

"China now boasts the world's second-largest cache of foreign exchange -- behind only Japan -- and is on pace to see its reserves climb past $1 trillion later this year. Even a slight diminishing of the dollar as a percentage of those holdings could exert significant pressure on the U.S. currency, many economists assert.

In recent years, the value of the dollar has been buoyed by major purchases of U.S. Treasury bills by Japan, China and oil-exporting countries -- a flow of capital that has kept interests rates relatively low in the United States and allowed Americans to keep spending even as debts mount. Some economists have long warned that if foreigners lose their appetite for American debt, the dollar would fall, interest rates would rise and the housing boom could burst, sending real estate prices lower."

China has long made clear that it is in a head on competition with the U.S. for oil and gas. It is rapidly expanding it access by buying up a 45% stake in a Nigerian oil field. They have also made a cooperative exploration agreement with North Korea, and they aced out India in a 30 year agreement with Myanmar for natural gas. Other energy agreements link China to Russia, Iran, Venezuela, and initial discussions have begun with Bolivia.

The energy competition overlaps with the currency issue in the transitioning to the Euro. Since the end of World War II and the initial signing of GATT (General Agreement on Tariffs and Trade), oil has been traded in U.S. dollars. That has given the U.S. significant economic power globally. A movement away from dollar-based oil is a significant threat. A threat large enough to prompt the preemptive attack on another nation. One of the reasons for the pre-emptive invasion of Iraq, was Hussein's decision to start selling Iraqi oil in Euros rather than dollars (Sharma et al). This might also be the tipping point for the invasion of Iran.

While China certainly does not want to sink the U.S. - yet - it can well afford the cost of weakening it. This may be just another sign of the latest empire in its inevitable decline.