Needless to say, other than the fact that military spending is always high, nobody wants any bloodshed. So, despite the possibility of an armed conflict, countries involved strive to avoid this scenario. But China has another capable weapon up its sleeves: capital and debt.
China Moves Up
China’s economic growth has been miraculous.
For three whole decades up until 2015, China’s annual GDP growth rate was 10 percent. Although in 2016, growth slowed down to 6.7 percent, that still beats U.S. GDP growth rate of 1.6.
As you can see from the graph below, no wonder why China is speculated to catch up with the U.S by 2026.
Debt and the Balance of Power
Growth is one thing, but the U.S. government’s US$20 trillion-dollar debt is another matter entirely. That amount is so high that if you use that money to buy a Big Mac for each of the world’s 7 billion people, then you would have over $18 billion in change! It’s that big.
A lot of that debt, US$1 trillion and change, belongs to China. As the graph below shows, China is the second largest holder of U.S. debt, behind Japan.
And this graph shows that since 2001, the amount of U.S. held by China has been growing, and peaked in 2015.
So… Is It a Big Deal? What started it?
Although growth rate was impressive, to ensure goods and services are competitive, China bought U.S. Treasuries by the billions. Not only does that keep U.S. interest rates low, it helped China grow.
But that growth is slackening.
From the graph below, you can see that since 2016, China’s dollar reserves have quickly fallen. To maintain the value of the renminbi, China is getting rid of the dollar.
What’s worth noting is that keeping or getting rid of a lot of debt wouldn’t provide leverage for China over the U.S. However, Chinese generals continued to call for a fire-sale of U.S. securities, since the U.S. decided to sell weapons to Taiwan.
At least China can alter the strength of its currency.
As mentioned, China is going to outpace the U.S. soon, but there is nothing miraculous about it.
This a part of China’s intentional, state-funded scheme to grow its global influence and topple the dollar’s role as the world’s global reserve tender. That also changes the region’s balance of power,
Made in China
From a consumer’s perspective, strong currencies make foreign goods and services more affordable, which is good news. But from a company’s stand point, strong currencies weaken the competitiveness of domestic companies and products in terms in the international market.
The renminbi’s value was low for many decades. That’s a big advantage for Walmart and other U.S. companies, since they could move their factories and production plants to China, thanks to its low-cost labor and resources. So, the cost of production there was significantly lower. As a result, those companies were more profitable, while U.S. shoppers could pay less money on consumer goods.
However, as this graph shows, this caused an imbalance of trade, or trade deficit, between these countries:
Let’s make this clear: trade deficit isn’t bad. Due to the nature of free market, this imbalance is temporary. That is because as currencies rise and fall over time (in other words, international prices for goods become more or less expensive), deficits should correct themselves.
The Free market isn’t everywhere
If a country decides to lower the value of their currencies to take advantage in the international market, then other countries would follow the same route and devaluate as well, so that they can protect domestic firms and their own markets.
As mentioned, lots of American companies take advantage of China’s low labor cost. That means they need to be paid in Yuan – renminbi… in which case the amount of dollars sold will increase to satisfy the rising demand for renminbi. As a result of this zero-sum game, the renminbi becomes stronger while the dollar weakens.
This is a bad news scenario for the Chinese government, because Chinese goods and services would then become relatively less competitive. The government wants international consumers to find Chinese businesses more attractive, so it tries to keep the renminbi low. To undercut international competitors, China prints out a lot more renminbi so that the currency value becomes cheaper.
Actually, that happened from 2001 to 2010. Back then, the People’s Bank of China (the country’s central bank) altered the renminbis’ value, artificially making it cheaper. This helped cause a massive trade imbalance between China and the U.S., and the latter lost nearly 3 million jobs.
The Cost of Selling in China
While China is on the rise, the U.S. isn’t in good shape. The former can maintain the global competitiveness of its goods and services, specifically by using U.S. debt to keep the renminbi’s value low.
But there’s more to that.
China’s booming consumer market is drawing in large foreign companies. However, to enter, there are many strings attached. If tech companies want to gain access and sell to Chinese consumers, they will have to collaborate with local companies, in addition to handing in their technologies and patents.
So, China is using its growing consumer market as a “bait” to lure in large American corporations, demanding them to trade their secrets for low prices. From there, China can start flooding the market with inexpensive goods and services. This is reminiscent to how China drowned the international market with its cheap steel. Through subsidies and cheap loans, this steel was sold at rock bottom prices, and many in the developed world lost their jobs.
Trade Wars in the South China Sea
If verbal conflict in the South China Sea becomes a trade war rather than an actual war, then what will happen? Can President Donald Trump compete in a trade war that has regularly chanted about during his election campaign?
Don’t forget: the U.S. owes over US$1 trillion to China. If the latter suddenly calls in that debt, then U.S.’s interest rate will increase, big time, and the rest of the world will fall into a recession. Even China cannot escape that phenomenon unscathed. If the dollar weakens and interest rate increases, then fewer Americans can afford Chinese products.
The most plausible outcome is “an eye for an eye” against certain sectors, such as Chinese steel. In which case, China can implement tariffs or impose sanctions on American products or even on vital U.S. sectors. As these two try to blockade each other, businesses and consumers all over the South China Sea will definitely suffer… and tensions will rise even higher.
