China and a new world economic order
By Henry C K Liu

Merely two years before the end of the first decade of the 21st century, the post-Cold-War world economic order found itself facing its most serious crisis under the weight of unsustainable deregulated debt capitalism created by dollar hegemony. There are clear signs that out of this current crisis a new world economic order will emerge. China is in a promising position to influence this development toward a sustainable, balanced and cooperative world order of global fairness and universal justice.

The root cause of the current crisis can be traced to the dismantlement of the Bretton Woods international finance architecture by the US in 1971 when president Richard Nixon

 
suspended the dollar's link to gold, and the subsequent deregulation of globalized financial markets that has allowed free cross-border movement of funds.

Toward the end of the World War II, the United States, through its dominance in the Bretton Woods Conference of 1944, constructed a post-war international finance architecture based on a gold-back dollar as a reserve currency to revive world trade. The Bretton Woods monetary regime allowed the US, which at that time was in possession of most of the world's gold, to take over the role of financial and economic hegemon in a new age of neo-imperialism under finance capitalism previously played by Britain in the age of imperialism under industrial capitalism.

Economics thinking prevalent immediately after World War II, drawing lessons from the 1930s' Great Depression, had deemed international capital flow undesirable and unnecessary for national economic development. Trade, a relatively small aspect of most national economies at the time, was to be mediated through fixed exchange rates pegged to a gold-backed dollar. These fixed exchange rates were to be adjusted only gradually and periodically to reflect the relative strength of the economies participating in international trade, which was expected to augment, but not overwhelm, the national economies.

The impact of exchange rates was limited to the settlement of international trade. Exchange rate considerations were not expected to dictate domestic monetary and fiscal policies, the chief function of which was to support domestic development and regarded as the inviolable province of national sovereignty.

During the Cold War, there was no global trade. The economies of the two contending ideology blocks were completely disconnected and did not trade outside of their own blocks. Within each block, allied economies interacted through foreign aid from and memorandum trade with their respective superpowers. The competition was not for profit but for the hearts and minds of the people in the two opposing blocks, as well as those in the non-aligned nations in the Third World. The competition between the two superpowers was to give rather than to take from their separate fraternal economies.

Convergence to equality the aim
The population of the superpowers worked hard to help the poor within their separate blocks. Convergence toward equality was the policy aim even if not always the practice. The Cold War era of foreign aid and memorandum trade had a better record of poverty reduction within either of the two camps than post-Cold War, globalized, neo-liberal trade dominated by one single superpower. The aim was not only to raise income and increase wealth, but also to reduce income and wealth disparity between and within economies.

In the world economic order that emerged after the Cold War, income and wealth disparity has been rationalized as a necessity for capital formation even in the rich economies. From 1980 to 2007, the total after-tax income earned by the top 0.1% of earners in the US more than quadrupled, while the share earned by everyone else in the top 10% rose far less and the share of the bottom 90% actually declined in purchasing power.

In China, privatization of state-owned-enterprises since 1978 has pushed a large segment of the working population outside of the socialist sphere of free social benefits in healthcare, education and retirement entitlements. Unemployment is now a serious structural problem everywhere, including in the Chinese socialist market economy.

Excessive reliance on export financed by foreign capital has also left developmental imbalances between China's exporting coastal regions and the isolated interior. Despite recurring big trade surpluses denominated in dollars, China has been prevented by dollar hegemony from using sovereign credit to finance domestic development. China is now the world's biggest creditor nation, yet the Chinese economy continues to require foreign capital that demands rates of return higher than such capital could get in their home economies.

Ironically, much of this "foreign" capital comes from the US which is deeply indebted to China. The US is investing in China with money it borrows from China. The US is able to do this because the debt and capital are both denominated in dollars that the US can print at will.

Today's post-industrial financial market economies are all plagued by overcapacity created by insufficient consumer purchasing power. The Chinese market economy is a glaring example of this structural contradiction which arises from the need of companies to keep down wages to maximize corporate profit. Workers everywhere are not able to afford all the products they produce, thus causing overcapacity that has to be absorbed by export.

American entrepreneur Henry Ford (1867-1943) understood this structural contradiction in industrial market economies and identified rising wages as a solution to overcapacity caused by rising labor productivity. But foreign capital denominated in foreign currency (dollars) rejects the need for high local wages because it earns its dollar profits from export to foreign markets. This is the main reason why emerging economies must avoid excess dependence on export for dollars financed by foreign capital in dollars.

China needs to accelerate its domestic development with sovereign credit denominated in Chinese currency to proportionally reduce its excessive dependence on export for dollars financed by foreign capital in dollars. China needs to denominate its export trade in Chinese currency to break free from dollar hegemony. This is the key strategy for positively influencing a new world economic order of universal justice to replace current predatory terms of international trade under dollar hegemony.

Since the Cold War, which officially ended with the dissolution of the USSR in 1991, world economic growth has been distorted by a shift from aggregate domestic development with sovereign credit within sovereign nations to excessive reliance on globalized neo-liberal trade engineered and led by the US as the sole remaining superpower. International trade has since been denominated in the US dollar, a fiat currency after 1971, as the main reserve currency. International trade has been driven by the huge US consumer market made possible by the high wages of US workers backed, not by rising productivity, but by US dollars that the US, and only the US, can print at will through its central bank.

In China, rising worker productivity has not resulted in higher wages, but only in lower export prices. This is the main reason why the Chinese domestic market lags behind in consumer demand despite enormous rise in Chinese worker productivity. Many Western critics erroneously pressure China to revalue its currency to address the persistently large trade imbalance. The only effective measure to deal with this trade imbalance is for China to raise wages rather than to revalue the exchange rate of its currency.

For the two decades before the global financial crisis that first broke out in mid 2007, economic growth in the dysfunctional world economic order has been, and still is, based primarily on free cross-border flow of capital and speculative funds driven by cross-border wage and regulatory arbitrage. This growth has been sustained by knocking down national tariffs worldwide through the authority of supranational institutions such as the World Trade Organization, and financed by a deregulated foreign exchange market working in concert with a global central banking regime independent of national political pressure, lorded over by the supranational Bank of International Settlement and the International Monetary Fund.

Domestic development overwhelmed
Ever since the end of the Cold War in 1991, which actually began winding down in the early 1970s with US policy of detente, trade has increasingly overwhelmed domestic development in the global economy, as superpower competition to win the hearts and minds of the world in the form of aid subsided. Persistent fiscal and trade deficits forced the US to suspend in 1971 the peg of the dollar to gold at $35 per ounce, in effect abandoning the Bretton Woods regime of fixed exchange rates linked to a gold-back dollar. The flawed international finance architecture that resulted has since limited the global growth engine to operating with only the one cylinder of international trade, leaving all other cylinders of domestic development in a state of permanent stagnation. The venue of sovereign credit for national development has been foreclosed permanently. China needs to free itself from dollar hegemony to use sovereign credit to develop her domestic economy.

Since 1978, China has exposed itself to the disadvantages of export trade denominated in dollars. Much of the wealth created in China during the last 30 years has ended up in the US, leaving China in an extended state of capital shortage despite being the largest holder of foreign reserves in the world. When it comes to consumer power and environmental pollution, China is only the kitchen; the dining room is in the US. In a new world economic order, China should move the dining room back inside China.

The global economy is a comprehensive and complex system of which trade is only one sector. Yet economists and policy-makers promoting neo-liberal globalization tend to view trade as the entire global economy itself, downplaying the importance of non-trade-related domestic development. Neo-liberals promote market fundamentalism as the sole, indispensable path for national economic growth, despite ample evidence in the past three decades that trade globalization tends to distort balanced domestic development in ways that hurt not only the less developed, but also the developed economies.

This is why a new world economic order must restore domestic development, with sovereign credit as the driving force, and reduce world trade as an auxiliary force in which export should be denominated in the exporting country's currency.

The distributional consequences of predatory terms of global trade liberalization under dollar hegemony work against the developing economies in the world. Such predatory terms of trade also work against the poor and the financially weak in all economies, including the advance economies, putting the less-educated and the less-skilled in a downward spiral of chronic unemployment and persistent hopelessness.

Reductions in tariffs reduce tax revenues for public spending that can help poor people and weaken needed protection for endangered domestic industries. While distributional consequences of trade liberalization are complex and country-specific, the general trend has been to exacerbate income disparity everywhere, which in turn leads to economic underperformance and political instability in all countries.

In the United States, the Mecca of free-market entrepreneurship, spending by the statist sectors - government operations, public finance, defense, health care, social security and public education - have kept the economy afloat in recurring protracted recessions, while entrepreneurial ventures in corporate finance, insurance, high-tech manufacturing, airlines and communication languish in extended doldrums needing government bailouts.

Unregulated markets lead naturally to monopolistic consolidation and abuses in corporate governance and finance through the concentration of market power. It has become clear and undeniable that "free" markets are inherently self-destructive of their own freedom. Free markets depend on enlightened government regulations to remain free and to prevent them from turning into failed markets.

Government, from monarchy to democracy, within capitalist market economies or socialist economies, exists to protect the weak from the strong and to maintain socio-political stability with a just socio-economic order. A new world economic order will have to be based on this principle of universal justice between and within sovereign nations. For China to exert influence on the formation of this new world economic order, it must construct its domestic economic order on the same principle of equality and fairness.

World trade is now a game in which the US produces fiat dollars of uncertain exchange value and zero intrinsic value, and the rest of the world produces goods and services that fiat dollars can buy. The world's interlinked economies no longer trade to capture Ricardian comparative advantage; they compete in exports to capture needed dollars to service dollar-denominated foreign capital and debts and to accumulate dollar reserves to stabilize the value of their currencies in world currency markets.

To prevent speculative and manipulative attacks on their currencies, central banks of all trading governments must acquire and hold dollar reserves in amounts that can withstand market pressure on their currencies in circulation. The higher the market pressure to devalue a particular currency, the more dollar reserves its central bank must hold. Only the Federal Reserve is exempt from this pressure, because the US Treasury can print dollars at will with relative immunity. This creates a built-in support for a strong dollar that in turn forces the world's central banks to acquire and hold more dollar reserves, making the dollar even stronger.

Dollar hegemony
This phenomenon is known as dollar hegemony, which is created by a geopolitically constructed peculiarity through which critical commodities, among the most notable being oil, are denominated in dollars. Everyone accepts dollars because dollars can buy oil. The recycling of petro-dollars into other dollar assets is the price the US has extracted from oil-producing countries for US tolerance for the oil-exporting cartel since 1973. The trade value of a currency is no longer tied to the productivity of its issuing economy, but to the size of dollar reserves held by its central bank.

By definition, dollar reserves must be invested in dollar assets, creating an automatic capital-accounts surplus for the dollar economy. Even though the US has been a net debtor since 1986, its net income on the international investment position has remained positive, as the rate of return on US investments abroad continues to exceed that on foreign investments in the US.

This reflects the overall strength of the US economy, and that strength is derived from the US being the only nation that can enjoy the benefits of sovereign credit utilization while amassing external debt denominated in dollars, largely due to dollar hegemony. Unlike other economies, the US economy incurs no foreign debt, only domestic debt denominated in dollars held by foreigners. These debts can always be repaid by the Federal Reserve, the US central bank, printing more dollars.

Since such a move will devalue the exchange rate of the dollar, foreign holders of the US dollar sovereign or private debt are prevented from demanding payment. Further, when basic commodities are denominated in dollars, the US essentially owns all such commodities. Foreign owners of dollar assets are merely unwitting temporary agents of the US dollar hegemony.

Under the Westphalian world order of sovereign nation states, which has framed international relations since 1648, only coordinated economic nationalism that focuses on domestic development can pull the world economy out of its current downward spiral.

Economic nationalism should not be confused with trade protectionism. Decades of predatory cross-border neo-liberal finance and trade have generated strong anti-globalization sentiments in every country around the world. It has become a class struggle between the financial elite and the working poor in rich and poor countries alike.

Before the end of the first decade of the 21st century, in a world where market fundamentalism has become the operative norm, misguided trade protectionism appears to be fast re-emerging and developing into a new global trade war with complex dimensions. The irony is that this new trade war is being launched not by the abused poor economies that have been receiving the short end of the trade stick, but by the US, as leader of rich nations which have been winning more than they have been losing in the current economic order and trade system.

Much of this protectionism is designed to protect industries that the rich nations have voluntarily moved offshore for financial and environmental advantage. Such protectionism aims to protect non-existent economic activities by imposing tariffs on goods that the importing nations chose not to produce.

The biggest battles of this new trade war are being fought on the currency exchange rate front under dollar hegemony, a global monetary regime in which export nation ship real wealth produced with low wages and high environmental abuse in exchange for fiat paper money of uncertain exchange value and zero intrinsic worth.
Rich nations need to recognize that their efforts to squeeze every last drop of advantage at all levels from already unfair finance and trade will only plunge the world into deeper depression. History has shown that while the poor suffer more in economic collapse, the rich, even as they are financially cushioned by their ill-gained wealth and structural advantage, are hurt by the sociopolitical repercussions of such a collapse, in the form of war, revolution or both.

The structural problem of the Chinese economy can be described in one sentence: China produces from plants on its soil financed by foreign investment that operate with low domestic wages for foreign markets that pay with dollars that cannot be used in the Chinese domestic economy.

Domestic markets the key
The solution to this structural problem can also be summed up in one sentence: China must finance Chinese plants with sovereign credit to produce for the domestic market where consumer purchasing power will come from high wages, with sovereign credit repaid by increased tax revenue from a vibrant domestic economy.

The adverse impact from the current global financial crisis on the Chinese economy originates from the bloated export sector financed in large part by foreign capital denominated in dollars. Foreign markets have abruptly contracted since mid-2007 to cause massive closure of tens of thousands of foreign joint-ventures or wholly owned enterprises, big, medium and small, in the Chinese export sector located along the coastal regions that has caused serious unemployment.

Economic recovery through the shifting from export dependency to domestic development requires coordinated actions by both the state and the private sectors. The government's role is to guide state-owned enterprises and private-sector incentives toward a national full employment program through tax incentives and regulatory regimes.

Government fiscal spending should be limited to funding infrastructure, both physical and social, that cannot be efficiently financed by private or even collective capital. Consumer demand should be enhanced as a priority in a national income policy to quickly raise wage levels in parallel with a well-funded social security program to eliminate the need for compulsory over-saving out of concern for emergency health expenses and provision for old-age security.

In conclusion, China can exert a positive influence on a new world economic order by setting an example with its own national development policy. To achieve this goal, China needs to adopt the following policy initiatives:

1. China must recognize that a deregulated market economy is counterproductive to national development. The clear evidence of this is what deregulated markets have done to the US economy, destroying US superpower status within three decades. China must revitalize central planning to guide national development and to use the market mechanism only to augment central planning targets. National destiny and national interest cannot be subjected to the dictation of market profit incentives.

2. China must place full employment with rising wages as a national economic priority and shift from the current market fundamentalist, macro-management on growth in gross domestic product, with unemployment as a natural outcome of a monetary policy of price stability. Economic equality and justice must be the guiding developmental principle within the context of merit-based compensation.

3. China must break free from dollar hegemony to use sovereign credit to finance balanced domestic development and to reduce excessive dependence on export for dollars and reliance on foreign capital denominated in dollars. A first step in this direction is to require all Chinese exports be settled in yuan, not in dollars.

4. China should conduct its foreign trade on the principle of mutual development for both trading partners rather than as a financial profit center for Chinese capital. China must reject the predatory terms of international trade developed during the age of imperialism. Unlike 19th century England and Japan, the huge size of the Chinese economy and its domestic market does not require imperialist terms of trade to survive. The US model failed because it aped the British model of empire after World War II. China must avoid making the same error.

5. China must guard against the fallacy of hoping to use green-tech investment as a stimulus to recover from the current global financial crisis. The global environment needs protection. But the time-scale concerning the needs of the environment is not congruent with that of the current global financial crisis. The environmental protection problem cannot be solved without first solving the global financial crisis. Attempting to use green-tech investment to jump-start the current economic crisis is putting the cart before the horse. Such an approach will only end up falling short on both environmental and economic aims.

Henry CK Liu is chairman of a New York-based private investment group. His website is at http://www.henryckliu.com.

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