[NSP Research Report] The US-China Competition for Monetary and Financial Hegemony and Currency Wars Since the Global Financial Crisis: A Perspective on Monetary and Financial Strategies

Abstract

The US-China competitive relationship is no exception in monetary policy. In particular, monetary and financial hegemony is a powerful tool of governance, as it allows one to directly or indirectly impose economic orders and systems on other countries. China's financial markets, which had lagged behind its economic growth, experienced a turning point after the 2007 financial crisis, and its progress in capital and bond markets has been remarkable. While still incomparable to the US market in absolute scale, its growth momentum is evident. At the institutional level, China is gradually promoting capital market liberalization and financial liberalization for the internationalization of the RMB, and it is well known that it has led the establishment of institutions such as the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB) as potential rivals to the Bretton Woods system. Furthermore, by signing currency swap agreements with various countries, China is promoting bilateral trade and investment while expanding the use of the RMB. In response, the US gradually increased pressure for RMB appreciation, and (partly as a result) as the RMB appreciated, the friction between the two countries entered a temporary lull. However, since the inauguration of President Trump, there is a possibility that pressure on China will increase again, with strong measures against currency manipulators being discussed and changes in the US Treasury's criteria for countries of concern regarding currency manipulation. Nevertheless, considering the US's enormous external debt, the need for cooperation with China on security issues, and China's agreement to the "100-day action plan" to resolve the trade deficit, the possibility of Trump's aggressive rhetoric being fully realized is low. Despite this, the risk remains that the stray bullets of the so-called 'currency war,' which is intensifying behind the scenes, could fall upon neighboring countries, including South Korea, in the form of US designation of currency manipulators or Chinese financial retaliation.

Main Text

"Given these historical experiences, the future US-China monetary and financial relationship is unlikely to proceed smoothly. The most fundamental reason is that monetary and financial issues are not only economic but also security issues. Indeed, strategic reports published in the US after the global financial crisis point to the increasing emphasis on geoeconomics (NSC 2010; Blackwill and Harris 2016; Shatz 2016). In this context, it is by no means an exaggeration to assess that the first of the six components of the world order in the US-China hegemonic competition is 'the UN-Bretton Woods system, rules, institutions, and procedures that regulate the global monetary system' (Swaine et al 2013, 175). China also does not view monetary and financial issues solely from an economic perspective. Through economic diplomacy, China is demonstrating its will to become a 'builder' (構建者) of the global monetary and financial system rather than remaining an 'adapter' (適應者) (Reilly 2013; Heath 2016; Zha 2106; Dargnat 2016). Its active involvement in the establishment of new international financial institutions clearly shows that China's ultimate goal is not to maintain the status quo but to form a 'counter hegemony' ((Ikenberry and Lim 2017))."

" The goals of RMB internationalization can be broadly divided into three categories. First, to enhance China's status and influence in the global monetary and financial order commensurate with its economic size. Second, to reduce exchange rate risk by narrowing the fluctuation range of exchange rates accompanying the increase in foreign exchange transactions. Third, to reduce foreign exchange reserves as a reserve currency country while enjoying seigniorage (Frankel 2012). "

"In response to the US pressure for RMB appreciation, China has been gradually appreciating the RMB through exchange rate and financial system reforms to prevent measures similar to the Plaza Accord imposed on Japan in 1985 (Kuroda 2004). However, this does not mean that China has acknowledged responsibility for global economic imbalances. China refuted the US's attempt to shift the blame for the imbalances. First, China contributed to overcoming the crisis during the 1997 East Asian financial crisis by not devaluing the RMB. Second, the claim that export tax rebates were implemented to prevent a decline in export competitiveness due to RMB appreciation lacks sufficient evidence. Finally, it is unfair to attribute the US trade deficit to China, despite the fact that China's trade surplus with the US is decreasing (Bowles and Wang 2006)."

" The US adopted an attitude of 'polite disregard' towards China's rebuttal. In fact, the US did not use coercive methods against China similar to those it imposed on Japan in the mid-1980s with the Plaza Accord (McKinnon and Liu 2013; Frankel 2015; Kim Ki-soo 2015). The most fundamental reason, as shown in [Table 7], is that China helped the US maintain low interest rates by reinvesting about one-fifth of its trade surplus in the US capital markets. From the US perspective, there was no reason to be dissatisfied with the virtuous cycle where capital outflow through trade deficits returned as capital inflow through bond purchases—the so-called Chimerica or codependency (Ferguson and Schularick 2007; Hung 2013; Roach 2014; Galantucci 2015)."

" The stock market crash in mid-2015 served as a reminder that the development of China's financial sector is not a linear process. Before the repercussions of this event had subsided, the market-friendly exchange rate system introduced by the People's Bank of China in August reignited the embers of currency war. This system, which reflects the previous day's closing market price in the central parity rate, was part of the financial liberalization essential for RMB internationalization. However, as the RMB exchange rate continuously depreciated after the introduction of this system, it could not avoid criticism from the US as another form of currency war (Morrison 2015b, 50)."

Author

Professor of Political Science and International Relations, Ajou University. Received a Ph.D. in International Politics from the London School of Economics, UK. His main research areas are international political economy and corporate-state relations. His books include "Plurality of Methodologies in International Politics" (2014), "International Organizations and Economic Cooperation and Development" (2015), "International Organizations and Environment, Agriculture, and Food" (2015), "International Organizations and Science and Technology Cooperation" (2015), and "Theories of Complex World Politics" (2012, co-authored). His major articles include "The Crisis of Economics After the Global Financial Crisis - Implications for International Political Economy" (2012, Journal of International Politics), "Beyond the Dichotomy of Convergence and Diversity" (National Strategy, 2012), and "Pulling South Korea away from China's Orbit: The Strategic Implications of the Korea-US Free Trade Agreement" (Journal of East Asian Affairs, 2007).