Links Between China’s Military and Economic Strategy

Robert Reich has an interesting post today, “Why China Announces Military Buildup the Same Week Paulson Visits,” about how China is pursuing inter-related economic and military strategies in its drive to become a superpower.

Although much of what Reich says is cogent, I disagree with one point, namely, that “America’s indebtedness to China gives the U.S. huge leverage over China — if we allowed the dollar to fall, China would lose a bundle.”

That is just plain wrongheaded. If the dollar were to fall sharply, it’s true that “China” would take large losses. But who exactly would feel the pain? My impression (and forgive me for not being clearer about the facts) is that the Chinese banks are making foreign bond purchases. Chinese banks aren’t like banks here. They have been propping up dodgy former state-owned companies (although apparently their balance sheets are somewhat improved by virtue of the very worst businesses being closed). Admittedly, the banks have been implementing modern banking techniques, like credit scoring, but lack of transparency makes us question whether things have improved as much as the officialdom would like us to believe.

In 2006, Ernst & Young released a study, which according to the Economist, in a story titled, “A muffled report,” estimated the total amount of non-performing loans at $911 billion, over 5 times as large as government estimates. This led to a firestorm of criticism and E&Y had to retract the report. Yet the Economist stressed that the analysis captured recent loans that were omitted from other reports, and by implication, was probably more accurate.

So what would it mean to these banks, say if the dollar fell by 30%? Not as much as you would think. They aren’t on mark to market accounting. Their income from their US bonds would fall 30%. That’s not a small number, but these are banks that make loans to domestic companies that can turn out to be complete writeoffs (or worse, they get no income and have no hope of repayment, but have to keep extending credit, although we are told those practices are a thing of the past).

Now presumably, in the end, depositors would be affected and their income on savings would go down somewhat (remember, their domestic loan book is much larger than their US bond purchases). So what? This is a country that has non-existent pollution control, to the point where tens of millions of people live on rivers loaded with carcinogens. Prisoners sentenced to death are rumored (and there is supporting evidence) to have their organs harvested while they are still alive. Beijing recently imposed a rule where citizens could only own one small dog, so non-conforming pets are seized in house raids and killed. And not humanely, either. Believe me, the citizenry endures a lot worse on a routine basis that mere financial losses.

No. our influence over China is that we have a lot more nukes than we do, and the only sizable navy. Only the US can move troops in large numbers. We dream if we think our economic standing carries much weight with China. The might even regard us as foolhardy to have let so much of our manufacturing go overseas (after all, it was in the end the superior production capacity of the US that enabled the Allies to win World War II). And foolishly, we are outsourcing more of our chip manufacturing to China (Taiwan is the biggest single foreign fabricator, which may explain China’s keen interest in reasserting control). Trade in advanced technology products is heavily weighed in favor of China.

But those not-very-competent Chinese banks may be our salvation. As the Economist story noted, “[T]here is little sign that the banks themselves have fundamentally changed their behaviour and become rational lenders.” Japanese banks’ inability to make sensible loans (they too saw themselves as an arm of industry, and were capable only of asset-based, not cash-flow, lending) led first to a bubble, then a collapse, then years of little growth because it was politically and culturally unacceptable to liquidate weak enterprises (the increase in unemployment was feared to be too destabilizing).

From Reich:

China announced this week that it’s planning to increase military spending 18 percent this year this year – its largest military boost in almost a decade – to $45 billion, making it one of the largest defense spenders in the world. That’s not much when compared to America’s military budget of more than $600 billion this year, but it’s large enough – and following so closely on the heels of China’s successful test of an anti-satellite missile – as to spook the Pentagon. What’s going on?

One clue is that China’s announcement of its military buildup comes the same week Treasury Secretary Hank Paulson is scheduled to visit, presumably to continue pressing China to raise the value of its currency in light of the huge and growing trade imbalance with America.

You see, for China, economic security and military security go hand in hand. Both are part of the same strategy to make China a superpower. Maintaining its current 10 percent yearly growth rate necessitates reliable supplies of oil, natural gas, and other raw materials from all over the world; as well as the latest technologies. And China also needs growing export markets to absorb its increasing production, and provide jobs to the tens of millions of its people migrating from the countryside.

All this, in China’s view, necessitates being able to play power politics with both Middle-East and Russian oil producers, when and if tensions arise over energy supplies. And China needs to be able to flex its muscle with Japan, Europe, and America in the competition for energy and other critical raw materials – as well as continue to have access to technologies these nations possess. And it needs to keep its access to these hugely important markets.

Power politics in today’s world doesn’t require the direct exercise of military power so much as the capacity to pressure other major powers indirectly – for example, credibly threatening to use force against Taiwan, or selling advanced weapons systems to oil-rich or raw-materials-rich developing nations, or, in the case of North Korea, becoming the source of food and weapons.

Sound familiar? China is not inventing this strategy of combining economic power with military power. It’s following in the footsteps of the nation that wrote the play book on how it’s done – the United States.

That’s why China’s military announcement was timed to coincide with Hank Paulson’s visit. Some in the U.S. think China has been able to buck American pressure to revalue China’s currency because China is becoming our major creditor. Not true. America’s indebtedness to China gives the U.S. huge leverage over China — if we allowed the dollar to fall, China would lose a bundle. No, the real reason China has been able to hold the line against American pressure is China’s growing influence around the world. Its military strategy is a part of this, and it’s why Paulson’s economic mission will get nowhere.

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