MCLC: High cost of soft power

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High cost of soft power
From: Timothy J.T. Pi <timothy.pi at gmail.com>
Source: Foreign Policy (8/11/15)
Currency Devaluation Shows the High Cost of China’s Soft Power
Beijing has been spending hundreds of billions of dollars to buy friends and influence its neighbors. Weakening the value of the yuan shows that the bill is coming due -- and China may not be able to pay it.
By David Francis
China’s sharp devaluation of its currency Tuesday caused panic on global financial markets, set off feverish speculation about what had motivated Beijing to take a step it had avoided for more than two decades, and led U.S. lawmakers from both parties to accuse China of manipulating its currency to make its exports more attractive. Donald Trump, the 2016 Republican presidential frontrunner, accused Beijing of trying to destroy the U.S. economy.
Setting aside the overheated rhetoric, China’s admission of fiscal weakness comes at an inopportune time for a country trying to project economic soft power in the region and counter what it sees as American overreach in its own zone of influence. Washington is laboring to secure the Trans-Pacific Partnership, a massive Asian trade deal covering 40 percent of the world economy that excludes China. At the same time, the Pentagon is scrambling to advance its flagging “pivot” to Asia to counter China and to build military and financial might there. At Arizona State University on April 6, Defense Secretary Ash Carter said the TPP could be as important to checking Beijing as an aircraft carrier.
Beijing has also been trying to flex its muscles at the potential expense of the United States through the creation of the Asian Infrastructure Investment Bank. It’s meant to rival the International Monetary Fund, the World Bank, and the Asian Development Bank, institutions where the United States has a strong influence because of the size of its financial contributions to them. But the devaluation, combined with China’s economic woes, hardly inspire confidence in a development institution championed by Beijing.
The world will know soon enough whether China will continue to allow outside forces to control the value of its money. In the meantime, officials from around the globe — and investors from major economies throughout the world — are trying to discern what prompted Beijing to devalue the country’s currency, the renminbi, by nearly two percent, the largest cut since 1994.
One school of thought holds that China is using the cut as a crutch to bolster its languishing economy in the short term by making exports cheaper and more attractive to foreign buyers able to spend stronger currencies.
A second school of thought argues that the devaluation could be part of a longer-term effort to allow world markets to determine the value of the renminbi, giving it the same weight as established currencies like the dollar and British pound. That’s a step that both the IMF and Barack Obama’s administration have long called for.
There’s a third option, according to Scott Kennedy, a China expert at the Center for Strategic and International Studies in Washington: “They’re trying to do a little bit of both.”
“They think this is an opportune time to provide a modest boost to Chinese exporters, who have suffered a lot,” Kennedy told Foreign Policy Tuesday. “This also addresses a critical step in the internationalization of the renminbi into the global market.”
In a statement Tuesday, the Treasury Department said it’s too early to tell what China’s strategy is. The global economy’s reaction Tuesday seemed to favor the first option: This is a cynical move by China to save a sinking ship.
This point of view is understandable, as fiscal news out of the world’s second-largest economy has been discouraging recently. Chinese stocks fell more than 30 percent over a three week stretch that ended in July; Beijing intervened to stop the freefall by cutting interest rates, suspending initial public offerings, and putting limits on short selling. It could miss its seven percent growth target for 2015. It is spending on infrastructure, including on a $128 billion high-speed rail system, but that’s done little to spur economic activity. Data released last weekend show exports tanked 8.3 percent year-over-year in July.
The announcement, made early Tuesday China time, hammered world markets when they opened hours later. The Dow closed down 1.2 percent. In Germany, Europe’s biggest exporter to China, the DAX dropped nearly three percent. The carnage continued in the oil markets, which closed at six-year lows on the news of the devaluation.
There was also pain in Asia, where China’s neighbors rely on Beijing to import their goods. The South Korean currency, the won, dropped 2 percent, while the Japanese yen sold off 0.3 percent. Australia, which needs China to buy up its commodities, also took a hit; its dollar was down 1.75 percent Tuesday.
Michael Klein, the former chief economist for the office of international affairs at the Treasury Department, said China’s move could also impact the U.S. Federal Reserve’s decision about  whether to raise interest rates, which haven’t gone up since 2006, prior to the start of the Great Recession. Fed officials have long been reluctant to increase them, fearing outside threats like the economic turmoil in China and Greece could undermine the American recovery.
Fed chief Janet Yellen has hinted a rise could come before the end of the year, but Tuesday’s currency devaluation could cause a rethink. Continued weakness in China is a “negative economic headwind” said Klein, who served as chief economist at Treasury from 2010 to 2011. “You’re concerned about the fragility of the recovery.”
Concerns about a slowdown in Europe are especially acute because of the ongoing political wrangling over the terms of a bailout package for Greece. Its prime minister, Alexis Tsipras, finally reached a rescue deal with his European Union creditors to free up an 86 billion euro, or $94.76 billion, bailout over the next three years. But the package still has to be approved by other eurozone governments.
The devaluation could complicate this calculus. Germany — Europe’s economic engine — exports 6.6 percent of its goods to China, which is Berlin’s fourth-largest trading partner. A weaker renminbi makes it harder for Chinese consumers to buy German goods, which, in turn, could hurt German companies. As proof, BMW was down 4 percent Tuesday.
“Germany accounts for close to 50 percent of European exports,” Andrew Small, an Asia expert at the German Marshall Fund, told Foreign Policy. “It’s disproportionate, so any drop in exports will be noticed.”
The challenge to Germany comes at a critical time during bailout talks. In Berlin, anger over the deal among members of German Chancellor Angela Merkel’s own conservative government is growing louder. If the German stock market continued to fall this week in the wake of China’s move, threats to her own economy could further undermine efforts to prop up Greece. Berlin is the largest provider of Greek bailout funds.
An EU spokesperson called the devaluation a “positive development” and said Chinese currency should be tied to international markets.
Whether this pain will continue might depend on whether the People’s Bank of China continues to “float” their money, or allow foreign-exchange markets to determine the value of it through supply and demand, Wednesday, and in the weeks and months to come. This is something U.S. Treasury Secretary Jack Lew and the IMF both want because it would subject the Chinese currency to the same market forces as pounds and dollars.
There are clear incentives to do this. China wants its currency to be part of the IMF’s Special Drawing Rights (SDR), an international reserve fund meant to back up national coffers. The SDR basket is currently made up of the euro, the Japanese yen, the UK’s pound sterling, and the U.S. dollar — all currencies that float on international exchanges. The IMF has made clear to Beijing that it must allow international markets to determine the value of the renminbi if it wants to join that exclusive club, according to Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics.
Lardy said Chinese officials were “accelerating a lot of reforms ahead of the fall IMF annual meeting” that is scheduled to start Oct. 9. He said he expects the Chinese currency experiment to continue “to take away one of the potential obstacles when the board meets in the fall.”
Another advantage to having a floating currency is that it would attract more foreign investors, according to CSIS’s Kennedy. Right now, investors can make bets only on the long-term value of the renminbi. If investors can make short-term hedge bets — or investments to balance other positions — in Chinese currency, hedge funds seeking a quick return could flood back into the Chinese currency market, he said.
The argument that China’s actions are part of a broader global integration strategy isn’t playing with some U.S. lawmakers. Republican Sen. Rob Portman of Ohio, a former U.S. trade representative, railed against currency manipulators during this summer’s fights over the trade authority President Barack Obama ultimately won. On Tuesday, he blasted the devaluation, which he said would give Chinese workers “an unfair advantage over Ohio workers.” He was joined by Sen. Bob Casey (D-Pa.), who said “China can’t be trusted on currency policy in the global economy.”
Klein, the former chief economist at the Treasury who now teaches at the Fletcher School of Law and Diplomacy at Tufts University, dismissed such concerns.
“That’s a conspiracy theorist’s view of the world,” he said. “It’s basic international macroeconomics. You would expect currency to move in this way in a weakened economy.”
by denton.2 at osu.edu on August 17, 2015
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