China’s ‘Nuclear Option’

Wednesday’s article in the Daily Telegraph titled "China Threatens ‘Nuclear Option’ of Dollar Sales" strikes a raw political and emotional nerve in the U.S. – coming just a day before stock markets around the world dipped – and sets the stage for another demon to accompany terrorism in the minds of many Americans.

The "nuclear option" of dollar sales would be devastating for China to actually implement. And so this option has always been held as a threat, a political flag to ensure a better position when bargaining with U.S. Treasury Secretary Henry Paulson over tariffs, investment regulations, WTO requirements, currency flexibility, and a host of other issues. According to the Telegraph, China has suddenly waved the flag in Paulson’s face.

Paulson is an old China hand who, like many who have spent a while here, finds an absolutist, black-and-white approach to anything quite inappropriate. That approach is wildly successful in Germany and perhaps Japan. But not in China, where many things, especially business, are made into a longer and more convoluted process than otherwise necessary.

The Chinese love Paulson. He apologizes for their step-by-step approach to the RMB issue and criticizes hawks within the U.S. establishment calling for tariffs to force China’s hand. Paulson’s accommodating approach allows Beijing to move at its own pace and provides them with the chance to throw out a threat – global financial collapse, for example. Anyone who has done business in China knows that one needs both the Buddha Palm of soft negotiation and the Iron Hand of hard threats and shoves to get things going. Paulson represents the Palm. Who wields the Hand?

There is constant and sharp debate on both sides of the Pacific concerning China’s huge trade surplus and America’s huge trade deficit. China’s undervalued currency is often described as the most vital link between the two – and therefore a call for an appreciation of the RMB is touted as the solution, if there is a solution at all. America’s fiscal failure may be a moot point.

The current political debate hinges on Apocalypse Now-style proclamations and simultaneous posturing for advantages at the economic table. The reality is that China’s mercantilist, export-oriented economy is in the midst of a progression we have seen before in Asia. Virtually all of the Asian tigers began their economic miracles as kittens suckling at the teat of the American consumer. The more successful of the tigers developed their own industries and global companies and in turn found undeveloped markets of their own to exploit. All of them are sitting on vast stores of dollars. The addition of China has made the issue acute.

Over the past year, in a series of government-sponsored stories in the China Daily, Beijing has pledged to appreciate the RMB steadily over a longer period and eventually create a freely exchangeable currency. At the same time, China’s manufacturing base is moving away from the coast and into the hinterland. The wave of export-based riches moves west and is, in theory, replaced by service-based industries. China hopes to stall the RMB adjustment until it is completely ready.

This development is visible here in Chengdu, capital of Sichuan province. Intel, IBM, Agilent, Motorola, Microsoft, Oracle – all have set up manufacturing and outsourcing operations of some kind, and a slew of smaller manufacturers – metal stamping from Yonkers, electric bikes from Berlin, printing presses from Japan – have set up shop here. Sichuan province is investing billions of RMB in the IT, education, and tourism sectors to help keep the ball rolling. They have a lot to learn here about BPO, eco-tourism, and even new teaching methods. But in Chengdu the powers that be are charging headlong into change.

Determining China’s geopolitical and national goals can help predict whether or not Beijing will cooperate with U.S. Treasury officials and reevaluate its currency, thereby making Chinese exports more expensive and lowering U.S. debt. Almost 200 years ago, China played the same game with the British empire, which resulted in the Opium Wars and the occupation of key Chinese ports. The humiliating defeats led directly to a national leadership crisis and the disintegration of the Chinese nation. A weak China was easy prey for Japan.

With the British, the Chinese too stalled and stalled, building up a large trade surplus through protectionist and mercantilist policies, until the imbalance in silver led to war. The Chinese repeatedly appealed to Britain’s morals but never gave the British what they truly wanted: market access. Will history repeat itself with the American empire? It already has, but the conditions are much different and so is the outcome.

The U.S., too, should have the foresight to avert an economic collapse and adapt to a changing world. But the Bush administration will press for protectionist tariffs and an appreciated RMB before it reconsiders its expensive war-making and addresses America’s true needs. It is in no one’s interest to have the American economy melt down and take half the world with it. China must develop away from mercantilism and cheap exports, and the U.S. must curb its credit-mad consumption culture and expensive adventures abroad. For the sake of world peace, let’s hope they do.