The yuan plays the dollar
Think of the Middle East as a giant chessboard stretching from Turkey’s European border in the West to Iran’s border with Afghanistan in the East. On this surface, two global powers – China and the United States – are playing out a strategic power game. Theirs is not a traditional military battle over territory but a tactical struggle for control of international capital and natural resources.
Of course the Middle East is not neutral in this game. The region’s 22 countries – and their competing interests – don’t always provide a stable base on which to play. However, the region is united on one point: the need to reduce the international domination of the United States. In China, the Middle East sees an opportunity to do just that.
To understand the two contenders more clearly we need to take a step back from the board. Some 30 years after opening its economy to the outside world, China has just overtaken Germany as the world’s third largest economy after the US and Japan. It is the only country that continues to expand in the wake of the current financial crisis.
Manufacturing has been the engine of China’s continuing growth. Over the last two decades a substantial proportion of China’s goods have been bound for the US. What has been less clear until recently is that this process has locked the two countries into an uncomfortable mutual dependency, with the balance tipping China’s way. With high exports to the US and relatively few imports, China has amassed over $1.9 trillion worth of international reserves; 70 per cent of these are thought to be in US dollars.
The traditional analysis is that these massive holdings give China a stranglehold over the US. With so much US currency on hand, China’s Central Bank, the People’s Bank of China, could effectively make or break the dollar depending on its decision to buy or sell greenbacks. Add to that the United States’ phenomenal debts and massive balance of trade deficit and you see why many economists still believe that the only thing stopping the dollar from a Latin American-style collapse is China’s continuing demand for it.
But Gouda Abdel-Khalek, an economics professor at Cairo University who has published widely on this issue, does not believe China has the US in checkmate. After all, if China is so powerful, why hasn’t it just pulled out the stops and wiped out its opponent? ‘The fact is that China has a stake in the stability of the dollar. China has been looking for an alternative international currency. But if they push too hard they’ll not only destabilize the dollar; they’ll also erode the value of their own reserves.’
Here is a paradox. The more dollars China piles up, the more wealth it has to lose if the dollar crashes in value. Not only that, but a fall in the dollar would wipe out the competitiveness of China’s currency (the renminbi, whose principal unit is the yuan) in the US, something that even China cannot afford. On a chessboard this is the equivalent of being able to take out an opponent’s key player only by sacrificing one of your own.
A similar bind prevents the Middle East from exploiting its control over the dollar. Since the end of World War Two, oil prices have been pegged to the US dollar and most oil trade is conducted in that currency. If the oil-producing Middle Eastern countries were to de-peg from the US – perhaps by seeking an alternative with China – then the dollar would lose much of its standing as the dominant international currency.
But as Abdel-Khalek explains, this is unlikely to happen: ‘Iran and Venezuela have been calling for an alternative international reserve currency, but there simply aren’t many stable choices available. Japan doesn’t want to see the yen taking the dollar’s place, and I don’t think China wants to see the renminbi there either [because] it’s a huge pressure. Everyone is watching the performance of the home economy and that takes away a degree of policy freedom from the government concerned. It will take some time for a viable alternative to the dollar to emerge.’
It seems then that – in the short-term at least – bringing down the US through the financial system is doomed to deadlock. The competing powers are too closely tied and too concerned with stability to risk taking each other on. But there is scope for other Chinese challenges to the US.
By shifting battlegrounds from financial to physical resources the winner can take the gains without exposure to a corresponding loss. In Abdel-Khalek’s assessment: ‘China looks to the Middle East as a source of energy and raw materials, not for action on international reserves. Since China became a net importer of oil in 1993, the country has been trying to secure oil in the Middle East and treading on the toes of the US in the process.’
One look at the facts and you can see why. At present, the Middle East is estimated to hold over 70 per cent of the world’s known oil reserves. China, meanwhile, holds just under two per cent and the US three per cent. The US already consumes vast amounts of the world’s oil, guzzling its way through 20 million barrels a day. Now China is catching up, directly competing with the US and Europe for prime Middle East oil.
At present the region provides approximately 60 per cent of China’s oil and 20 per cent of US consumption. China’s demand for oil grew by 90 per cent from 1993 to 2002 and shows no signs of slowing. And the US has done little to cut petroleum use or CO2 emissions. I asked Abdel-Khalek whether a clash over resources was inevitable.
‘China has proven pretty apt at handling these things. They’re not targeting Saudi or Iraqi supplies, for example, because they know that’s traditional US territory. Instead China is targeting the fringes of the Middle East that are out of reach to the Americans – places like Iran and Sudan. But the fact is that China has moved in. You can’t ignore that Iran is next door to Iraq. In chess you don’t have to go all the way to make a threat.’
These changing power dynamics come with political implications. China is trying to introduce itself to the Middle East as a developer and peacemaker – in contrast to the US, which is increasingly perceived as a colonial warmonger. Through the support it gives to the Middle East this aspiring global power is not only aiming to guarantee control over energy supplies; it also wants to win the Middle East’s backing on the international stage.
At present the Middle East backs China’s moves for an increased say in international institutions, a shift that Abdel-Khalek believes could ‘hold great potential in terms of the interests of the global South’. In 2001, China joined the World Trade Organization and argued for the opening of Western markets to the Far and Middle East. At the G20 Summit in London this April, China was also pushing hard to increase its three per cent representation in the International Monetary Fund (IMF), perhaps by taking some of the US’s 16 per cent. This move would give China a greater say over the priorities and conditions attached to the Fund’s lending schemes, a change which might well benefit some of the Middle East’s poorer, non-oil producing countries.
But perhaps more significantly, Abdel-Khalek tells me that China could use an enhanced position on the IMF to start building a credible alternative to the dollar as an international reserve currency. With a bit of support, the IMF could provide a globally backed system of Special Drawing Rights (SDRs) that could finally displace the dollar’s dominance.
So which contender will win? China’s star is undoubtedly still rising in the Middle East, but it is unlikely to displace US influence in the region anytime soon. The two powers are too mutually dependent to risk wiping each other out. Ironically, the Middle East may be the real winner. Too fragmented to be on an equal footing with either China or the US, the best the region can hope for is to keep the power split. It is in the region’s interest to let the game continue.