China’s financial clout will be hard to reverse
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Felix Martin
LONDON, March 4 (Reuters Breakingviews) -The ongoing debt crisis in developing countries has exposed an important but underappreciated fact about the global economy: China’s multi-decade emergence as the world’s premier exporter has made it into a superpower of international finance as well. The crisis has also revealed how unprepared the People’s Republic is for that role. Yet the unavoidable logic of international economics means that it will not be vacating it any time soon.
The “China shock” which followed the accession by the People’s Republic to the World Trade Organization (WTO) in 2001 is so famous that it has its own Wikipedia page. It is well deserved. China’s emergence as the workshop of the world comprehensively reshaped the global economy, raised the living standards of its 1.2 billion citizens faster than any other country in history, and provided manufactured goods to the rest of the world at unbeatable prices.
It also had some epoch-making negative effects, however. It played a leading role in accelerating the deindustrialisation of large parts of the United States, spurring a lurch into protectionism, and may have hastened the general political meltdown in several Western democracies.
Now a second China shock is quietly detonating in international finance. Two decades of current account surpluses enabled the country to accumulate the largest trove of foreign savings the world has ever seen. Since the turn of the millennium, it has amassed net foreign assets worth $4.3 trillion, making it by some distance the largest creditor nation. Having this gigantic stock of dollars at its disposal has made China into a titan of global finance as well as manufacturing.
Like the trade shock, this upending of the global financial order has had both good and bad effects. In its first phase, between 2001 and 2008, China’s net foreign savings took the form of official reserve assets which it mostly invested in U.S. Treasury bonds. The country was behind what then Fed Chair Ben Bernanke called the “global savings glut” that drove the United States’ yawning current account deficit, depressed real interest rates, and – abetted by lax regulation and reckless speculators – eventually sparked the credit crisis of 2008.
The next phase of China’s financial shock has until recently been less visible. After the financial crisis, developing countries were initially a favourite destination for return-seeking private funds. But this ended after the “Taper Tantrum” of 2013, when the Fed toyed with shrinking its balance sheet. A multi-year retrenchment by private investors threatened a drought of U.S. dollar finance in the developing world.
China’s Belt and Road Initiative (BRI), launched that year, filled the gap. China recycled the majority of its $1.6 trillion of foreign currency earnings over the next decade into infrastructure in developing countries. This overturned decades-old patterns of international finance. By 2017, China had become the single biggest official creditor to developing country governments: its exposure was larger than that of the World Bank, the International Monetary Fund, and the Paris Club of 22 advanced economy lenders combined. A recent study by the AidData research lab at William & Mary’s Global Research Institute puts China’s current portfolio of lending to emerging market sovereigns at $1.1 trillion to $1.5 trillion.
Yet as in the case of the original trade shock, this financial shock now risks being swamped by its unintended consequences. The steep rise in U.S. and euro zone interest rates since 2022 has choked off private capital flows to developing countries, leaving many borrowers in the lurch. The IMF now classifies almost half of all low-income countries as being in debt distress or at high risk of it. China, as the largest official creditor in most of these cases, has become the claimant-in-chief in an incipient developing country debt crisis.
It has not yet proved ready for prime time. Efforts to restructure developing countries’ debts have been stymied by multiple factors. These include disagreements over whether lending by Chinese institutions should be treated as official or private; complications due to China’s habit of lending against collateral; confusion stemming from a lack of data sharing; and disputes over what constitutes comparable treatment between different classes of creditors. The AidData study points out that China is learning rapidly on the job, and still pumping some $80 billion a year into developing countries. Nevertheless, the Group of 20’s much heralded 2020 Common Framework for sovereign debt restructuring has thus far proved a dead letter. Just ask Zambia, which is still in suspended animation three years after its 2020 default.
In today’s tense geopolitical environment, it is tempting to conclude that it would be better to wind back the clock to the days when the West dominated development lending. Thus in 2019, the U.S. established a new International Development Finance Corporation, billed as re-establishing the U.S. as “a stronger and more competitive leader on the global development stage”. Two years later it pledged $200 billion to launch the Partnership for Global Infrastructure and Investment – an alternative to China’s BRI. Yet the history of attempts to fight the original China trade shock show why such efforts to reverse China’s emergence as a preeminent power in sovereign finance is unlikely to work.
The fungibility of global money and commerce means that international trade and finance resist the attempts of any single country to control them. Unless tariffs are coordinated across all major trading partners, for example, trade protection tends simply to reshuffle bilateral deficits and surpluses while leaving overall imbalances untouched. That is the logic behind the multilateralism embodied in the WTO. The latest proof of its coherence was the failure of the Trump administration’s 2018 anti-China tariffs to achieve their desired effect. Over the next four years the U.S. trade deficit ballooned by two-thirds. China’s exports of goods vaulted to a new all-time high.
China’s global financial firepower reflects these same imbalances – so the same constraints apply. Any attempt simply to displace China’s international lending ignores the fact that its gigantic foreign earnings must find a home somewhere. As with international trade there really is no alternative to a multilateral approach. Engagement, rather than competition, is the world’s best chance of ensuring the second China shock is absorbed more positively than the first.
Follow @felixmwmartin on X
Graphic: The US and China’s trade balances have continued to diverge https://reut.rs/49FFpc8
Graphic: Chinese savings have flowed to the developing world https://reut.rs/3TfvUdE
Graphic: China has become the world’s largest creditor https://reut.rs/48AVhv1
Editing by Peter Thal Larsen and Oliver Taslic
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