US economic power is crumbling, but China is not yet ready to take over the reins

The G20 meeting on 2 April will deliver little but, like the first G20 meeting in Washington last November, its symbolism will be enormous. The very fact that it is taking place at all is an admission of the momentous shift in the global balance of economic power from the rich countries to the developing world.

If the western countries plus Japan could have sorted out this crisis through the G8, that would certainly have been their preferred route. The cosiness of eight nations (or preferably seven, excluding Russia) with rather similar interests would have made agreement rather easier and, more importantly, would not have implied that in future power would have to be shared with countries possessed of very different interests and histories.

We have come a long way in a very short space of time. In 2001, the United States was the world’s sole superpower, believing that it did not have to share power with even its historical allies, let alone the developing world. Just eight years later, the theme of the new president of the United States is rather more humble: that the US can exercise power only by co-operating with others. More striking still, there is the acceptance that it is no longer possible for the US to sort out the world’s problems in the time-honoured fashion – namely by means of a cabal with the other western countries plus Japan.

We are still struggling to understand the significance of the New Depression – its causes, its duration, its consequences and its possible solutions. Nonetheless, it is becoming steadily more evident that this crisis marks a fundamental shift in the balance of global power. Of course, this has been happening over a long period, certainly since China’s meteoric economic growth commenced three decades ago. The fact is that the rich countries now account for about only half of global GDP, a huge shift compared to 1970.

However, it requires a major crisis of some kind to bring longer-term trends into a new kind of focus and to define their meaning. The global crisis that began in summer 2007 with the onset of the credit crunch and the unravelling of the western financial system signals the decline of the west and the end of US power as we have known it since 1945. The financial crisis began in the United States. It has served to expose the deep flaws and falsities of US economic growth since the early 1990s. And it marks the collapse of the neoliberal ideology that has dominated western thinking since the 1970s. In other words, it constitutes the most profound financial, economic, political and ideological crisis of the west since the 1930s.

The shift in global economic power – above all, the one between the US and China – must be seen as one of the fundamental causes of the crisis. China’s economic dynamism enabled it to run a huge current account surplus with the United States, with which it bought US treasury bonds and thereby enabled American consumers to live on the never-never courtesy of the abstinence of the Chinese consumer. It has been commonplace for western commentators to criticise not only the United States for its deficits and profligacy, but also China for its surpluses. This misses a crucial point. US deficits and Chinese surpluses are a manifestation, as well as a symbol, of the shift in economic power between the two countries. The United States could only sustain the kind of living standards it has enjoyed by borrowing enormous sums from China.

This was always a fundamentally unsustainable arrangement, an interregnum rather than anything more permanent. It has served, moreover, as a dramatic illustration of the weakening of the US economic position and China’s growing economic power.

Not only are we in the midst of the biggest world economic recession since the 1930s, but we are also entering an entirely new global era. It marks the end of the Bretton Woods order and the US-made inter national economic and financial order. The US is no longer economically strong enough to sustain it. The basic cause of the financial crisis has been this weakening of the US, its growing dependence on China, and the asset bubbles that this enabled. But if the American order is in its death throes, what might replace it? Herein lies the dilemma which threatens any imminent resolution to the global economic crisis, and could well signal that it will prove as protracted as the Depression of the 1930s.

The obvious successor state is China, but China is not yet in a position to assume such a role. It still has the colossal problems of a developing country and the inward-looking mentality that these necessarily engender. It remains, at one and the same time, a developed and a developing country, with the emphasis firmly on the latter; nor is China yet economically strong enough to assume such a role. That the US is no longer able and China not yet ready is a recipe for ongoing global instability and impasse. There will be many players at the G20 and many sideshows – including the dif ferences between the US and Germany – but the relationship that lies at its heart will be the one between Washington and Beijing. This will determine not just the success of the G20 but, more substantively, the course and duration of the global crisis. In effect, we are once again living in a bipolar world, though of a very different kind from the bipolar world of the Cold War.

The parallel between this global crisis and that of the 1930s is uncanny. After the First World War Britain remained the backbone of the international gold standard system, but it became increasingly evident during the 1920s that it was no longer economically strong enough to do so. Although it fought desperately to cling on to its role, the 1931 crisis finally forced Britain to abandon the gold standard and signalled the end of its international financial dominance. The obvious successor nation, the US, was not yet in a position to take over this role, nor did it have the desire. In consequence, the world fragmented into different trading and currency groups. In the event, it was not until the end of the Second World War that the US finally assumed the role of the dominant financial power.

The dilemma posed by the decline of the architect (and prime beneficiary) of the present system and the rise of a new hegemonic power will be manifest at the G20. The US has proposed a tripling of the resources available to the International Monetary Fund – that it should receive an extra $500bn, which could be lent to countries in acute financial difficulties. The money would be raised by borrowing from richer nations and, to this end, the US has offered $100bn and Japan something similar. But to raise that kind of sum requires China to dip into its pocket. However, the Chinese premier, Wen Jiabao, has made clear that Beijing will not lend to the IMF until the institution is subject to fundamental reform.
The Chinese position is understandable – and perfectly reasonable. At present, China has less than 4 per cent of the votes in the fund, only slightly more than Switzerland, and less than Benelux. Why should it commit its hard-earned resources to an institution in which it enjoys virtually no power? The only situation in which China might do this would be if it enjoyed real authority within the IMF. Yet increasing China’s power (and that of India and Brazil) within the IMF requires that the influence of the likes of Italy, Britain, France, Canada and the Netherlands be drastically reduced. These nations will desperately try to resist such a move, as they have made clear, just as they have resisted expanding the G8 into something more meaningful. In the era we are now entering, we will witness a profound diminution in the power and status of many western countries, but they will fiercely resist this process. Without such reforms, however, the IMF is likely to find itself far short of the resources that it needs.

In this context, it is worth reminding ourselves of the IMF’s significance and role. Together with the World Bank, it remains one of the two main institutions of the US financial order, with the power to lend to countries in difficulty and thereby act as an instrument of US policy. In fact, the resources at its command have been steadily declining and now amount to less than 14 per cent of China’s foreign exchange reserves. Or, to put it another way, the instruments of US international economic power are in steep decline and are unlikely to be restored without a revolution in their complexion and composition.

But this is only one aspect of the crumbling of US global economic power. Over the past year or so, the value of the US dollar has risen steadily, as it has been seen, perhaps perversely, as a safe haven in a profoundly unstable and uncertain global economy. This can only be temporary. The weakening of the US economy prefigures the decline of the dollar as the world’s reserve currency. If the Chinese government started to invest its huge reserves in a more diversified fashion, rather than overwhelmingly in US treasury bonds, the value of the dollar would plummet.

In other words, the value of the US dollar, and therefore its future as a reserve currency, depends on China. Yet China faces its own dilemma in this respect: if it stopped buying US treasury bonds in such vast quantities, the value of its existing treasury bonds would decline. This does not mean, however, that the present state of affairs will continue indefinitely. The Chinese government recently warned that it was concerned about the value of its holdings and called on Washington to protect the dollar.

In reality it seems highly likely that the value of the dollar will indeed fall considerably at some point in the not-too-distant future, thereby intensifying China’s predicament. On 24 March the governor of China’s central bank, Zhou Xiaochuan, called for a new global reserve currency, to be run by the IMF, and which would inevitably, if it transpired, considerably diminish the role of the dollar. The global crisis will almost certainly herald the end of the US dollar as the world’s reserve currency of choice – and the beginning of the end for New York as the world’s financial capital.

As the leaders of the G20 gather in London on 2 April, the world will be watching. However, the relationship that will predominate over all others, recognised or unrecognised, seen or not seen, will be the one between Presidents Hu Jintao and Barack Obama. The relationship between China and the United States holds the key to the next decade and the fortunes of the world.