A V Rajwade: Beginning of the transfer of power?

In the economic and political fields, Asia and particularly China are becoming a rival power centre to the US.

In an earlier article (Business Standard, February 10, 2006), I had argued that the US is showing many of the symptoms of "The Decline and Fall of Great Powers" as argued by Paul Kennedy. It is worth pondering whether economic and, indeed, political power has/is in the process of being transferred across the Pacific, to Asia, in general, and China, in particular. (Americans themselves seem to agree""a large majority has consistently said in polls that their country is going down.) If so, this would mean that the pendulum has once again shifted towards the west. In the 18th and 19th centuries, it was imperial Europe, particularly Britain, France and Germany, which was the dominant military, economic and industrial power, which was also at the cutting age of research. The 20th century witnessed much of this leadership being transferred across the Atlantic to the United States""not that Europe declined in economic well-being. For more than a quarter century after the end of the Second World War, the Soviet Union tried to compete in military and political power with the United States, also advocating a different economic model. It imploded in the late 1980s, leaving the United States as the sole super power. Various developments suggest that in the economic and political fields, though not in military power, Asia and particularly China are becoming a rival power centre.

Both the time and external values of the US dollar (i.e. the interest and exchange rates) probably depend more on what China and Japan do with their reserves, and not so much on the US Federal Reserve. A significant shift in the composition of reserves, by no means to be ruled out, could well lead to a crash of the dollar and a sharp rise in bond yields.

In contrast with the way Japan and Germany bowed down in the mid-1980s to US political pressure and engineered a sharp appreciation of their currencies against the dollar, China has so far resisted political pressures to appreciate its currency and the economic threat of a 27.5 per cent import duty on Chinese exports to the US. Perhaps it has learnt from its neighbour: by 1995, the Japanese currency had appreciated so much that this was surely one of the causes of "the lost decade" for Japan. Chinese employment and growth prospects are even more dependent on an undervalued currency.

Armed with foreign currency reserves in excess of $800 bn, and expected to touch $1 trillion by the end of the year, the Chinese are busy buying influence (through aid) and enterprises (through investments), particularly in Latin America and Africa. Its influence in the former continent is likely to be strengthened by the recent emergence of many leftist governments there.

The single-largest force behind the sharp rise in commodity prices has been the ever-growing Chinese demand""crude, ferrous and non-ferrous metals, steel, etc. China has already become the world's largest importer of iron ore and the traditional price setters, namely the Japanese steel giants, are waiting for China to fix the current year's prices before opening their own negotiations with Australian and Brazilian suppliers.

By one estimate, the on-going construction in Beijing, ahead of the 2008 Olympics, is more than the entire construction work in the European Union!

A recent Lex column in the Financial Times started by claiming that "when China raises interest rates (as it recently did), the world trembles". Even after making allowances for the journalistic temptation to paraphrase Napoleon Bonaparte ("Let sleeping China lie because, when she wakes up, the world will tremble"), there is a kernel of truth in the statement: many stock markets fell in response to the Chinese move.

And, China's acceptance of conditions similar to those in the Indo-US nuclear pact, as a precondition to Australian uranium supplies, shows political realism and maturity. Only the confident can make concessions.

There have been many false alarms about the US's decline as an economic power""OPEC in the 1970s and Japan in the 1980s were supposed to "buy" the US economy. And, there are pitfalls which could derail the Chinese juggernaut:

The threatened imposition of a 27.5 per cent duty in the United States;

A disorderly and a sharp fall of the dollar with the yuan not keeping pace (the dollar has now been falling for the last four weeks);

A banking crisis in China. A recent report estimated aggregate NPAs of $900 bn""or 50 per cent of China's GDP!

The growing income disparities between the urban and the rural, the coastal and the landlocked provinces, leading to social unrest on a mass scale.

Of these, the first two are probably the more immediate threats. Bilaterally, the US and China have not succeeded in reaching an agreement on the exchange rate and the trade surplus/deficit. Will they do any better with the help of an "intellectual honest broker" (Martin Wolf, Financial Times), the International Monetary Fund? It is a $64 billion question even if one hypothesises the IMF's intellectual honesty. Tailpiece: In his article "The year of Asia?" in this paper (March 29, 2006) Suman Bery argued: "Economically, developing Asia has been floating on the sea of liquidity unleashed by the US Federal Reserve and the Bank of Japan. This has been a major factor boosting growth in the region, and has helped in the rescue and repair of financial systems throughout the region." This seems to create an impression that the growth in Asia is due substantially to monetary policies elsewhere, and only peripherally to the domestic policy and environment in Asian countries. To my mind, the latter need to be given far more credit than the former""else, why the difference between, say, much of Africa and much of Asia? To be sure, Asians being large exporters and therefore registering surpluses on the current account is nothing new. The East India Company, for a long time, had to pay for its purchases in gold""since Asia had little to purchase from Europe. At that time, Asia was accumulating gold; now it is dollars!

avrco@vsnl.com