Escaping the Dollar’s Shadow

Like it or not, the next US president must accept that his great country and its mighty dollar are no longer unchallenged masters of a world economy slowing alarmingly. According to the International Labor Organization (ILO), there will be 20 million more people unemployed worldwide by the end of 2009 than in 2007. The
summit of both industrialized and emerging nations, the G20 on  November 15,  did  not challenge a market system that has patently failed. Change will be slow because China, America’s main banker, has a vested interest in maintaining the status quo – for the moment at least

The US government decision to bail out the mortgage giants Fannie Mae and Freddie Mac in September came – according to rumor – after a phone call in which the Chinese president, Hu Jintao, threatened President George Bush that if they were not rescued, China would stop buying US Treasury bills. The US government denies the story. The Chinese point to the facts: Fannie and Freddie were saved and the Chinese loans, $595.9bn, were guaranteed. The story is emblematic of the current changes in the geopolitics of capital.

Once upon a time the US determined the world’s financial affairs alone, but at the 63rd session of the UN General Assembly, on  September 24, Bush had to endure the reproaches of heads of state. “There was a certain satisfaction among some of the attendees that the Bush administration, which had long lectured other nations about the benefits of unfettered markets, was now rejecting its own medicine by proposing a major bailout of financial firms” (1).

China ‘vindicated’

On  September 27, Chinese economists and politicians reminded the World Economic Forum in Tianjin that they had been justified in resisting pressures for the total liberalization of China’s financial system. Liu Mingkang, chairman of the China banking regulatory commission, said: “When US regulators were reducing the down payment to zero, or they created so-called reverse mortgages, we thought that was ridiculous” (2).

In recent years Liu has tried to bring order to this chaotic sector and to ensure that the markets are controlled by the state, rather than by their own invisible hand: “A lot of the time, we learned that what we had learned from our teacher the day before was wrong.” This irony did not escape the bankers present who, in a move without precedent in the financial world, admitted responsibility. Stephen Roach, Morgan Stanley’s Asian head, acknowledged that huge mistakes in monetary policy had been made and accused the US central bank, the Federal Reserve, of forcing the US into an orgy of consumption.

Only a few Americans were invited to the orgy. Although 1 per cent of Americans own 20 per cent of national income, a historical record, overall median earnings rose by only 0.1 per cent a year between 2000 and 2007. For most people the problem was less that consumption rose too high than that wages fell too far, forcing people to borrow for housing, education and healthcare (health insurance premiums have rocketed). Wealthy people and leading companies chose to invest abroad at the expense of domestic industrial development, forcing the US to import more and export less, driving up the deficit.

The US rich got richer by refusing to pay decent wages, driving the poor into the arms of lenders. The developing world paid the ultimate price. Until the mid 1980s, capital flowed from the developed to the developing world; this flow has reversed. Emerging economies made US deficits good by buying Treasury securities, debts issued by the US government and 80-90 per cent taken up abroad. Although Japan is still their major purchaser at $1,197bn (3), China, in second place with $922bn, is now the US’s banker as well as the workshop of the world. Including other major holders of US bonds (Hong Kong, South Korea, Singapore), Asia incorporates more than half of all foreign US public debt. The oil-exporting countries are major suppliers of capital funds (although only half as much as China), along with emerging nations such as Mexico and Brazil. Russia, so disparaged by Bush, is among the top 20 global lenders, thus demonstrating that you can trade insults and do business simultaneously.

But he who pays the piper calls the tune, or hopes to. It would be catastrophic for Wall Street if China reduced its financing or stopped buying Treasury securities – not that it is contemplating such a move. “We should join hands,” China’s prime minister Wen Jiabao told Newsweek magazine. “And particularly at such difficult times, China has reached out to the US. And we believe such a helping hand will help stabilise the entire global economy and finance and prevent major chaos from occurring. I believe now that cooperation is everything”.

Some commentators have seen this as proof of an ideological alliance between supporters of capitalism. But China is simply trying to defend its interests. As the prime minister continued: “If anything goes wrong in the US financial sector, we would be anxious about the security of Chinese capital” (4). This is true externally, since the crash has not spared China’s foreign holdings, as well as internally.

Treasury bills have allowed the US to finance its deficit and borrow the money to buy cheap Chinese goods; but China is sitting on the world’s largest dollar reserves, almost $2trn (5), more than two-thirds of its total annual production. If the present tsunami swept away the US financial system and undermined the dollar, China’s nest-egg would be destroyed, another reason why China won’t spoil the party, ignore the next round of Treasury securities or significantly reduce its dollar reserves. Any fall in the value of the dollar would bring about a rise in the value of the yuan and devalue China’s dollar reserves, as if China had spent decades stacking up toytown money. Nobody is going to do anything rash.

Japan, Russia also in play

The US can no more do without Chinese finance than China can be indifferent to the fate of the US. This mutual dependence also includes Japan, which holds the world’s second largest dollar reserves, and for Russia, which holds the third largest. This is the legacy of the special role that the dollar has played in world trade since 1945.

The US emerged from the second world war as the richest power. Britain was weakened by debt; France was exhausted; the Soviet Union had been bled dry. US dominance was formalized by the Bretton Woods accords, named after the New Hampshire town where the new financial rules were laid down in July 1944. These affirmed the pivotal role of the dollar (in place of sterling) and created the two institutions that became Washington’s wings: the International Bank for Reconstruction and Development (IBRD, subsequently part of the World Bank) and the International Monetary Fund (IMF). The Marshall Plan for Europe was funded in dollars to consolidate the strength of the dollar and guarantee opportunities for US producers.

One of the most famous participants at Bretton Woods, John Maynard Keynes, fought hard against the dollar’s stranglehold and proposed a monetary system based upon a unit of account, a genuinely international currency called the “bancor” (6). But the balance of power was against him. The dollar won, and with it US hegemony over the West. US politicians could do what they liked, leaving others to pick up the tab. When the situation became too complicated, the US unilaterally changed the rules. As US Secretary of the Treasury John Connally famously told his European counterparts in 1971: “The dollar is our currency, but your problem.”

On  August 15, 1971, President Richard Nixon ended the direct convertibility of the US dollar into gold. Henceforth it would be mere paper, fluctuating at the whim of the markets and US policy. This strengthened the “exorbitant privilege” of the dollar, which had been denounced in 1965 by General de Gaulle. But since governments gave in, commercial transactions were largely carried out in dollars, which the central banks raked in (along with marks, yens and eventually euros).

The dollar system still dominates the globe. The US can run up debts and have them settled by its “partners”. It can simultaneously attract capital investment (for industry, research or to bail out companies at home) and export it (to facilitate the establishment of multinationals abroad). In 2007 the US was the leading beneficiary of global foreign direct investment; it is also the leading investor abroad (7). It enjoys an unrivalled power of geopolitical selection of capital.

But the system is unstable. States with accumulated reserves are no longer content to put their money in banks as the oil-exporting countries did during the 1970s; they have set up sovereign wealth funds (now worth at least $4trn) to invest in colossal development projects, as in the Gulf states, or to buy up foreign companies (8). Many Western companies are apprehensive.

The weight of the dollar in global currency reserves has fallen almost 10 points in less than a decade. In mid-2008 it made up only 62.4 per cent of the currencies held by central banks, compared with 71.2 per cent at the end of 2000. During the same period the euro’s share rose from 18.3 per cent to 27 per cent. The yen, asymbol of Japanese power between 1970 and 1990, when it inspired prophecies of the decline of the US, also fell, from 6.1 per cent to 3.4 per cent (9). But neither the euro nor the yuan is yet in a position to supplant the dollar. Only the combination of acknowledged economic power and an attractive, original political vision could overthrow the prevailing system or allow all its participants to be treated as equals.

Having plunged into US-style deregulation, the European Union is hardly in a position to confront this challenge. Even the most optimistic experts now anticipate only negligible average growth next year, accompanied by an exponential rise in unemployment and business failures. Politically, the EU is impotent and, whatever the press may say, it has come up with no effective response to the crisis. Nobody will lament the fact that it has jettisoned some of its inviolable principles: so much for the Maastricht limits on public deficits, the ban on state aid to national companies, and the “single program”. Europe’s politicians have adopted the policy of bank nationalization first imposed by Britain’s prime minister Gordon Brown, whose Euro-sceptic country isn’t even a member of the euro zone.

China not immune to chaos

But what about China? Shen Dingli, professor of international relations at Fudan university in Shanghai, states: “This is not a time for China to be on a par with America. But the relative shift of the centre of gravity does bring China more confidence” (10). As the world’s third economic power, closely involved in the financial tsunami, China is not immune to the chaos. Chinese economists already estimate that “all the big offshore investments made last year are in the red” (11). Holdings in the banks Morgan Stanley ($5bn) and Blackstone ($3bn), which symbolised China’s arrival as a financial force, have been heavily written down.

There has been debate on current policy within leading echelons of the Communist party and on the internet. China’s government refused to bail out the US bank Lehman Brothers. One official explained that the Chinese should no longer be regarded as “sleeping partners”, or their investments as “dumping grounds for toxic shares”, and pointed to the bailout of Morgan Stanley by the Japanese bank Mitsubishi UFJ, which will acquire a seat on the board.

So far China has been relatively unaffected by the worst insanities of the investment markets. The Financial Times reported a story that did the rounds in Beijing: “At a secret meeting of top Communist officials at the start of this decade, Zhu Rongji, then China’s premier, summoned senior academics and finance officials to teach a crash course on complex financial instruments. Financial derivatives. . . were described as like putting a mirror in front of another mirror, allowing a physical object to be reflected into infinity” (12). This is a good description of a mechanism with a worldwide value of more than a $1,000 trillion – the equivalent of 20 years’ global production – resting on sand.

Zhu and his successors trod carefully. Although, as an economist from the Industrial and Commercial Bank of China (ICBC) in Shanghai said, “we don’t know how many skeletons there are in the cupboard”, China’s banks seem to have limited their exposure to investments of this sort. But there must be doubts about the recent decision to authorize margin lending and short selling at a time when some western countries were introducing restrictions to curb speculation. Another potential problem is the housing bubble, which remains significant despite some deflation over the past two years. But as the ICBC economist pointed out, in public building the demand for profit is less pressing since “the Chinese state can wait”.

Globally China has preserved its safeguards. Professor Yang Baoyun of the school of international studies at Beijing University claimed “the financial system is still under control”. Despite international pressure, China has retained a largely-nationalized banking sector and maintained control over its currency and foreign exchanges (13). The IMF had intended to move against these regulations in October; this has now been postponed until a more favorable moment. As the IMF’s managing director Dominique Strauss-Kahn said, without irony: “China’s imbalance is a long-term problem and can wait one more month” (14). China has retained the capacity for state intervention and has, significantly, kept growth tied to production and research. The systemic crisis affecting the US and Europe is proof that services and finance cannot be decoupled from material production for ever.

Chinese development is driven by exports, so the expected fall in consumption in its main client countries (the US and the EU) may undermine sales and levels of production (15). At the beginning of this year, many analysts argued that since 60 per cent of China’s trade is with other Asian countries, its development would not be damaged by the collapse of the developed world. But the rest of Asia is not immune to the slowdown (Japan is on the edge of recession, South Korea is struggling and India is in no better shape); and between half and two-thirds of intra-Asian trade, in the words of Sopanha Sa, an economist at the Société Générale, “winds up in the markets of the G3 (the US, the EU and Japan)”. The disappearance of this final destination would have immediate consequences. There are already fears that 2.5 million people could lose their jobs in China’s most export-oriented region, the Pearl River delta.

An unsigned editorial in the Chinese Communist Party newspaper, the People’s Daily, summed the situation up perfectly: “Disillusionment with Wall Street myth has further endangered the already downward global economy, and posed a fresh threat to China’s foreign trade, which is already on the verge of collapse… In the long run, the relative advantages of `Made-in-China’ would possibly be offset, and China’s competitiveness in exports would be dulled. The global geopolitics is getting increasingly complex, neo trade protectionism is looking up, and in future, the trade barriers against China would increase rather than decrease” (16).

Aware that it is entering a new phase, the Chinese government is looking for sources of growth. Professor Yang was clear: “Our only option is to develop our internal markets. We’ve been talking about it for a long time; now it’s time to get down to it.” The authorities must tackle inequalities between town and country. Rocketing food prices raised farmers’ incomes by 17.9 per cent during the first half of this year (17). But it takes more than increased purchasing power to drive consumption: some of this increase is squirreled away (China has the highest savings rate in the world) as families put money aside for sickness or retirement. So the government must increase incomes and build the current embryonic system of collective social security into something effective.

But the internal forces that drive growth have already begun to change. According to Li Xiaochao, a spokesman for the National Bureau of Statistics, China’s 11.4 per cent growth in 2007 “broke down into 4.4 per cent driven by consumer spending, 4.3 per cent from investments and 2.7 per cent contributed by net exports” (18). Growth is expected to be 10 per cent this year and 7-8 per cent in 2009. Western leaders would be ecstatic about these rates, but given the internal challenges facing China (poverty, rural discontent, the political unpredictability of the middle classes) they suggest trouble on the horizon. And any future growth must consider impact on the environment.

Another day, another dollar?

Externally, China is looking for ways to loosen the dollar’s stranglehold. It has recycled some of its profits from Africa as loans, ignoring conditions imposed by the World Bank and the IMF. It is signing bilateral trade agreements to guarantee its energy supply (Venezuela, Russia, Iraq and Iran) and to create new outlets (Japan, India). It supports the idea of an Asian Monetary Fund, proposed in May 2007 in conjunction with Japan and South Korea. This would have $80bn to play with, allowing its three founders, and the 10 members of the Association of Southeast Asian Nations, to guarantee their financial stability without having to go to the IMF, which the region has yet to forgive.

There are similar initiatives in other parts of the world that seek to escape the shadow of the dollar. Argentina, Bolivia, Brazil, Ecuador, Paraguay, Uruguay and Venezuela are all members of the Bank of the South, intended to support infrastructure funding outside the Bretton Woods system. Argentina and Brazil have agreed to conduct reciprocal payments in local currency, bypassing the dollar. Brazil, Russia, India and China have come together in an informal bloc known as BRIC. Russia’s self-assertive stand in Europe is due to more than just its control of raw materials. Brazil is a major player in South America, despite its vulnerability to the US recession. Trade is expanding rapidly between countries within the developing world. But we are still a long way from a united front with the capacity to impose new international rules or dethrone the dollar and its institutional props, the IMF and the World Bank.

Professor Arvind Subramanian, a senior fellow at the Peterson institute for international economics in Washington DC, has suggested that China might lend money to the US, but with strings attached. “First, it would declare that the offer of money was conditional on the US government adopting a particular approach to rescuing the banks – the use of government money to recapitalize the banks. . . The second condition would relate to social safety nets, which had become standard embellishments to World Bank/IMF adjustment programmes.” Such moves “would seal China’s status as a responsible superpower” (19). So far China has neither the desire nor the means to do this. But tomorrow is another day.


(1) Neil MacFarquhar, “Upheaval on Wall Street stirs anger in UN”, International Herald Tribune, 24 September 2008.

(2) These and subsequent quotes from Yann Rousseau, “Quand Pékin donne des leçons de capitalisme à l’Amérique”, Les Echos, Paris, 29 September 2008.

(3) “Foreign holdings of US securities”, United States Department of the Treasury, Washington DC, 29 February 2008.

(4) Fareed Zakaria, “We should join hands”, Newsweek, New York, 6 October 2008.

(5) The World Factbook, Central Intelligence Agency, Washington DC.

(6) Keynes proposed a comprehensive global architecture with an International Trade Organisation supported by a central bank, the International Clearing Union. See Susan George, “Alternative finances”, Le Monde diplomatique, English edition, January 2007.

(7) At the end of 2007, FDI inflows to the US amounted to $237.6bn, compared with outflows of $333.3bn. See “World Investment Report 2008”, United Nations Conference on Trade and Development, New York, 24 September 2008.

(8) See Ibrahim Warde, “Where poverty leads to death”, and Akram Belkaïd, “1754”, Le Monde diplomatique, English edition, respectively May and August 2008.

(9) “Currency Composition of Official Foreign Exchange Reserves (COFER)”, International Monetary Fund, Washington DC, 30 September 2008.

(10) David Pilling, “America’s chance to kick its Asian addiction”, Financial Times, 2 October 2008.

(11) Jamil Anderlini, “Prudence guides China’s outook”, Financial Times, 24 September 2008.

(12) Ibid.

(13) See Martine Bulard, Chine, Inde. La course du dragon et de l’éléphant, Fayard, Paris, 2008.

(14) “IMF delays China report”, South China Morning Post, Hong Kong, 1 October 2008.

(15) According to the National Bureau of Statistics (NBS), 19 per cent of Chinese exports go to the US and 20 per cent to EU countries.

(16) “Wall Street turmoil tests China’s foreign trade”, People’s Daily, October 6 2008

(17) NBS, October 2008. But rising prices have eroded the purchasing power of the urban population.

(18) “Consumption edges ahead as the most powerful engine of China’s economic growth”, People’s Daily, 30 January 2008.

(19) Arvind Subramanian, “A master plan for China to bail out America”, Financial Times, 7 October 2008.

Translated by Donald Hounam

This article appears in the November  edition of this excellent monthly, Le Monde Diplomatique, whose English language edition can be found at This full text appears by agreement with Le Monde Diplomatique. CounterPunch features one or two articles from LMD every month.