The Global Chessboard Reconsidered

The two main knocks against the US from global investors have been largely addressed.  The US budget deficit has been reduced from 10% of GDP to less than 3%.  The current account deficit has been halved.  Nevertheless, many observers, including some Americans themselves still think that the US is in an irreversible decline that affects all great powers.  

China is often touted as the US successor.   Some media reports claim that when adjusted for purchasing power parity, China's economy is poised to surpass the size of the US as early as this year.  This is an improper use of purchasing power parity (PPP).  

In the world of athletics, the equivalent to PPP is the concept of pound-for-pound.  A man who weighs 80 kilos and can lift 160  kilos is said to be stronger pound-for-pound than a man who weighs 120 kilos and can lift  200 kilos.  The smaller man cannot lift more than the larger man.  He is not stronger in that sense.    He is stronger only in a particular and narrow sense.  It seems that only a few observers and journalists  say that China is bigger than the US because of PPP.  Chinese officials do not tread down this path.

China is often portrayed as a revisionist power in the sense that it is challenging the status quo.  However, there are some important exceptions.  Perhaps unnoticed by many distracted by the recent holiday, not only did China lose a case before the World Trade Organization, but it announced intentions on complying with the decision.  

The US had filed a case challenging China's export quotas of rare earths.  The case was later joined by Europe and Japan.  China had argued that is quotas were necessary on environmental grounds, but the WTO recognized that the restrictions were really an attempt to boost its domestic electronic manufacturers.  There is some evidence that this worked as some foreign electronics manufacturers did relocate to China.  Moreover, some Chinese companies found a familiar work around.  By lightly processing some of the rare earths, they were able to circumvent the export restrictions. 

Faced with an ineffective system and the WTO ruling, China has scrapped its quota system. The US (and Europe) have won several other cases against China's trade practices at the WTO.    China, like other countries, have used WTO rulings and international trade agreements to advance their own domestic reform agenda.  

This ruling may also be used by reformers in the US.  For nearly 40 years, the US has banned the export of crude oil.   With the booming US oil production, there is a push in the US to lift the ban.  There are some exceptions to the ban, and this is leading to strong US export growth (from a low base).   

Many observers had heralded the China-Russia energy deal last may as another nail in the dollar's coffin.   Prices were to be denominated in rubles and yuan rather than dollars.  The ruble's collapse means that this agreement may need to be re-worked.  

China was to operate through establishing parallel institutions as the US has done to exert influence.  Its numerous swap lines lie unused.  With China's leadership, the BRICS launched their own institution that was to rival the IMF to provide short-term balance of payments support.     Yet now Russia could use some assistance but it is not available.  South Africa, with a 6% current account deficit and low reserves, may also need assistance if the pressure on emerging markets continues as we suspect it will.  However, the BRICS bank is unlikely to be helpful for it either.  

China's Foreign Minister Wang offered Russia bilateral assistance as pressure on Russia grew in Q4 14.  Many observers saw in this another challenge to US and European sanction regime.  However, this may have simply been polite diplomacy, like "sure we can help our neighbor", but it seems nothing concrete has come of these platitudes.  

The latest IMF COFER reserve data, which covers Q3 14. shows the dollar was the main beneficiary of the shift out of the euro.  We would expect more of the same when Q4 data is released at the end of March. 

When the euro was launched, many thought it could rival the dollar.  Even at its peak, it was little more than the sum of its parts.  Its share of global reserves was about the same the combination of legacy currencies such as the German mark, French franc, and ECU.  For a brief moment, some observers thought the Bitcoin could challenge the dollar, with at least one analyst at a major bank calling on central banks to use it as a reserve asset.  There has been a flirtation with SDRs (of which the dollar is the biggest component).  More recently, the internationalization of the yuan has captured the popular imagination.   

There were those who thought the desire for an alternative to the dollar itself was significant.  Yet this may say less about the flaws of the dollar and more about the desire for an alternative for the sake of an alternative.   The isolation of Russia and falling commodity prices, and poor policy choices in Brazil, have undermined the BRICS as such an alternative.   With the commodity and emerging market cycle turning, the BRICS have been reduced to IC, which has considerably less marketing appeal.