ChinaóThe Global Economyís ìOther Engineî

ìChina Anxiously Seeks a Soft Economic Landing,î by Keith Bradsher, New York Times, 7 May, p. C1.

ìEmerging Markets Lose Their Darling Status: Global Investors Are Reassessing As China Tries to Slow Its Growth And U.S. Looks to Raise Rates,î by Craig Karmin, Wall Street Journal.

Chinese leaders are promising to do whatever must be done to slow down the countryís red-hot growth of recent months, but admit that getting their currency off its peg to the dollar canít happen until banking reforms proceed.

As the NYT article says, ìMuch is riding on Beijingís efforts. The global recovery now depends on China as one of its twin engines, along with the United States.î Thatís not just some temporary assessment of Chinaís importance, but a reality that weíll be facing from here on out. Chinaís economy wonít be overtaking that of the U.S. in sheer size any time soon, and yet, it is already logically considered the second-most influential force on the global economyís health.

Yes, the EU is hugely important, but so much of what the EU does in the global economy involves itself. For example, the World Bankís figures for the EUís inflow and outflow of foreign direct investment makes it look like the worldís biggest source of FDI, when in reality it isnít, because roughly half of that flow ìinî and ìoutî of EU member states goes merely to other EU member states. If the U.S. counted ìFDIî from Florida to Michigan and vice versa, our numbers would be astronomical, thus reminding us that these United States are the oldest and most successful multinational economic and political union in world history.

When you discount those intra-EU flows, itís actually the U.S. that is the biggest source of inter-regional FDI flows, as well as the biggest target. Why China is so important is because of its tremendous growth, its rising status as manufacturing and export superpower, its rising draw on the worldís raw materials, itís status as one of the worldís great targets of FDI, its ability to set the worldís prices on low-price manufactured goods, and its huge trade surplus with the outside world that generates massive cash supplies (estimated at $400b) which the Chineseóin turnóplow back into U.S. Treasury bills. Put that package all together, especially those crucial linkages to the world economyís number 1 engine, and you begin to understand why our economic fate is becoming increasingly intertwined with that of Chinaís.

Thus my problem with the Pentagonís enduring penchant to cast China as the rising near-peer competitor, something I saw on full display from several speakers at the Gulf Coast Military Expo I just attended (although this nonsense comes mostly from those elements most desperately in need of such a force-sizing measureómeaning the Navy in general and the submarine community in particular).

If China slows down its economic engine, itís still likely to grow in the 7% range, according to experts. But the fact that its currency is pegged to the dollar is not something to simply brush aside. As the WSJ article points out, one reason why a possible slowdown in emerging markets doesnít frighten global investors in the way it did with the Asian Flu back in 1997 is that few emerging markets today peg their currencies, preferring to let them float. The currency crises that triggered the flu were started by yawning gaps opening up between those countriesí currencies and the dollar, and the perception on the part of investors that a correction (devaluing) was in the works, thus they started betting against the local currency, expecting to clean up once the devaluation occurred (buying the currency back later at a cheaper price).

Well, if your currency floats, that sort of build-up of speculative pressure is managed on a day-to-day basis, instead of released in fell swoop one morning. What does China have in its tool-kit to avoid such an outcome? First off, its currency is basically unconvertible, meaning only the government there can buy and sell the yuan. Thatís a lot of power in their hands, but it also forces Beijing to use other methods to slow down the economy, and hereís where it gets tricky.

China wonít let the yuan float until banking reforms are much further along, but until they are pushed, China remains fundamentally without any bankruptcy laws and foreclosure proceedings. So how to weed out the bad investments? The only route available for now are corruption investigations and criminal fraud investigations, which can be rather blunt in effect and quite frightening to foreign investors.

Why are foreign investors so important? China eschews short-term loans (another big cause of the Asian Flu) or ìhot moneyî flowing into stock markets (which remain fairly controlled in China), so FDI is the main conduit of foreign investment flowing into China.

Where is a lot of that FDI going right now in China? Energy infrastructural development. Why? Generating electricity is the key bottleneck on development right now.

I know you know where Iím going with all this: Chinaís status as a potential source of stability or instability in the world right now is very much captured by my Decalogue on the military-market nexus, which is why itís so crucial that the U.S. and China not facetiously treat one another as long-term military threats simply to justify long-term military R&D and acquisition plans.

In reality, our fates are highly intertwined in the Middle East, which is the region from which China will inevitably be drawing the vast bulk of its energy in coming years and decades. But instead of seeing Chinese peacekeepers side-by-side with Americans in Iraq (imagine what a different ìoccupationî that is), what we see instead are Pentagon plans for a missile shield in East Asia with North Korea and China on one side, and Japan, South Korea, and Taiwan on the other.

So as I keep pushing my book and its larger ideas, one of the key ones being the need to get off the near-peer competitor focus and start thinking more about war within the context of everything else, I honestly believe Iím working to secure that increasingly intertwined fate that links China and the United Statesónot to mention our new Chinese baby girl and this American family.