As an emboldened China sees, the American dollar is gravely wounded. And the days of US political supremacy are numbered

We have entered one of those rare historical periods that is characterised by a shift in global hegemony from one great power to another. The last such was between 1931 and 1945, and marked the end of Britain’s financial ascendancy and its replacement by that of the United States. It might be argued that the cold war represented a similar period, but that is a fallacy: the cold war was an ideological struggle between two powers that were always hopelessly ill-matched. This new period is marked by the rise of China and the decline of the US. Arguably the process started around a decade ago, but at that stage it was barely noticed, such was the west’s preoccupation with 9/11 and its after-effects. Indeed, the Bush administration was thinking in exactly the opposite terms: that the world was entering a golden age of American global power.

It is more appropriate, however, to date the beginning of the new era from 2008. First, the election of Barack Obama signalled a recognition by the US of the limitations of its own power and the need for it to co-operate with other nations. Second, China has reached a point where it is now clearly prepared, on the basis of the advances of the last three decades, to assume a more active global role. And third, the onset of the global financial crisis provides the context for the decline of American economic power and illustrates the extent to which it has become dependent on China for the continuation of its global financial hegemony.

Such periods of transition are profoundly unstable, deeply uncertain and fraught with danger. The world is fortunate – for the time being, at least – that it has an American president in Obama who is prepared to take a conciliatory and concessive attitude towards America’s decline and that it has a Chinese leadership which has been extremely cautious about expressing an opinion, let alone flexing its muscles.

The picture, however, is changing rapidly; indeed, this year has already witnessed a marked change in Chinese attitudes. Ever since Deng Xiaoping, the Chinese approach has been based on taoguang yanghui – hide one’s capabilities and bide one’s time. But a succession of statements and initiatives suggest that Chinese policy has now entered a new phase. Premier Wen Jiabo expressed a strong confidence at the Boao Forum in Hainan on Saturday that China was successfully weathering the effects of the global economic crisis. During his visit to Europe for the Davos meeting, he made clear that reckless western economic policy, especially by the US, was responsible for the crisis. He also declared that China would not give funds to the IMF unless the latter was subject to major reform.

Later he expressed strong concern about US financial policy and its impact on the dollar, seeking reassurance that the value of China’s US treasury bonds would not be prejudiced. In a carefully staged run-up to the G20 summit, Vice-premier Wang Qishan set out a vision of a new monetary order while, most dramatically of all, the central bank governor, Zhou Xiaochuan, called for a new global currency based on using the IMF’s special drawing rights, an idea immediately rejected by the US. Meanwhile, a meeting of the finance ministers and central bank chiefs from China, India, Russia and Brazil that preceded the G20 summit called for greater voting rights for developing countries in international financial organisations.
This new assertiveness is finding other forms of expression in Chinese society. A new book by five nationalistic authors, Unhappy China, argues that China has no choice but to become a superpower: published in March, it immediately shot to the top of the bestsellers list. There has also been an intense public debate about whether the country should continue purchasing US treasury bonds, especially given their extremely low interest rate.

It is now abundantly clear that China is prepared to take an active and interventionist role in international financial affairs. Given that the global financial crisis is at the top of every agenda and that reform of the existing global financial order is now irresistible, this has far-reaching implications: China will be a central player in whatever new architecture emerges from the present crisis. This represents an extraordinary change even compared with two years ago, let alone five years ago, when China was not even included in discussions on such matters. But it also has a much wider significance.

The rise of China and the decline of the US will, at least during this period, be enacted overwhelmingly on the financial and economic stage. And China has now demonstrated that it intends to be a full-hearted participant in this process. It is not difficult to predict some of the likely consequences: the G20 will in effect replace the G8 and the IMF and the World Bank will be subject to reform, with the developing countries acquiring a greater say.

The most audacious proposal that has so far emanated from Beijing, almost completely unforeseen, is the suggestion for a new global currency which might, in time, replace the role of the dollar as the world’s reserve currency. Whether or not such a proposal would ever see the light of day, or indeed work, given that reserve currencies have always depended on a powerful sovereign state, it nonetheless provides us with an insight into the strategic financial thinking that now informs the Chinese government’s approach. Clearly they recognise that the days of the dollar as the dominant global currency are numbered. This would also, incidentally, signal the end of New York as the global financial centre.

But this is only one side of the picture. On the other side is the growing role of China’s currency, the yuan, which has so far attracted little attention. Although the yuan remains non-convertible, it is evident that the Chinese are seeking to progressively internationalise its role. The Chinese government recently concluded a number of currency swaps with major trading partners, including South Korea, Argentina and Indonesia, thereby widening the use of the renminbi outside its own borders. It is also in the process of taking steps to increase the yuan’s role in Hong Kong. This is significant because of the latter’s international position. In addition, the government has announced its intention of making Shanghai a global financial centre by 2020.

The likely longer-run trends, then, are perhaps not so difficult to decipher; the short term, however, in the context of a highly volatile financial climate, certainly is. The dollar’s strength over the past couple of years remains something of an anomaly, given the catastrophic state of the US financial system. It would be a brave person who bet on the dollar’s strength continuing; it is much more likely, in fact, that at some point its value will plummet. Should that happen, then the dollar’s global position could rapidly be undermined and the need for more fundamental global financial reforms made more urgent. All of this would only serve to accelerate the decline of the US and the rise of China.