The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (17 page)

In the mid-1980s, Chinese entrepreneurs travelled to Como in northern Italy and returned with six high-end tie-looming machines. At the time, Como was famous for its silk ties. Now there are over a thousand tie-makers in Shengzhou, and hundreds of computerised weaving machines. Tie City serves some, though not all, of the top global fashion brands. While US net entrepreneurs sell high-quality silk ties made in Shengzhou for $15 over the internet, tens of thousands of jobs in the silk industry have been lost in Como.

But in Tie City, they point to the fact that Shengzhou has been making silk for centuries. The tie merchants intend to develop in-house design and branding skills to capture even more of the profits from this industry. Five thousand years ago, Confucius wrote legends that told of the start of the silk industry in China. The silkworms have returned to their home mulberry trees, three millennia on from the opening of the Silk Road.

China’s astonishing manufacturing surge did much more than just cut prices for Western consumers and increase profits for Western multinationals. The dollars, pounds and euros that flowed in to pay Chinese manufacturers had to go somewhere, if not to the workers.

Petrodollars and eurodollars were the names given in the 1970s to US currency earned by oil states but traded, re-used and spent in Europe and not in the USA. In the twenty-first century, a new kid arrived on the block: enter the Sinodollar. China is making so much money from foreign exports that it is throwing up surpluses to match those of the richest oil economies. China’s migrant workers have become a tradable commodity.

Take our US tie entrepreneur who sells a dozen Chinese silk ties for $180. Most of that money stays in the USA in the form of higher profits and cheaper goods. Just $12 goes to China to pay the manufacturer in Shengzhou. From that money, the Chinese manufacturer has to pay his workers and suppliers in Chinese renminbi, as well as taking a profit. So, say he goes to a Shengzhou branch of the Agricultural Bank of China to cash the dollars in. At this point, a bank in the UK or USA would be able to retrade the dollars wherever it thought it could make the most money. Not in China. Here, by law, the surplus dollars have to be passed up to the People’s Bank of China, the Chinese equivalent of the Bank of England or the US Federal Reserve. The People’s Bank of China then passes them on to the guardian of China’s dollars: the State Administration for Foreign Exchange (SAFE). The clue is in the acronym. China’s SAFE contained less than $25 billion in 1994, and around $200 billion in 2000. By 2012, its war chest stood at $3.3 trillion.

From ties to T-bonds, the dollars flow in from multinational firms to Chinese manufacturers, and from them, to SAFE, via the People’s Bank of China. And SAFE reinvests a hefty $1.2 trillion chunk of this dollar windfall back into US government debt, known as Treasury bonds, effectively creating a cheap loan for the US government, and bailing them out of spiralling debt costs. This colossal intercontinental cashflow makes China the USA’s principal lender alongside Japan and the Gulf nations, and increases China’s political influence on the global stage.

China’s rise as the new banker to the USA was swift and decisive. In 1997 China was the seventh largest lender to the USA. Between 2003 and 2010, a third of all the new debt issued to foreigners by the US government was snapped up by China. An extra trillion dollars helped to pay for President George W. Bush’s wars in Afghanistan and Iraq. China officially overtook Japan as the largest lender to the USA in 2008.

Looked at another way, by 2011 SAFE had lent America the equivalent of just under $1,000 from every man, woman and child in China. It would take a single Chinese worker, on average, four months to earn $1,000. It would take Deng Zhi nearly a year. This huge investment in US debt left every single American citizen effectively indebted to Deng Zhi and his colleagues, to the tune of $4,000 per head. The USA is estimated to pay about $40 billion annually in interest on this debt, or about $30 for every Chinese person – the equivalent of three days’ work in a toy factory.

The net result of all of this is that long-term interest rates in the USA and parts of western Europe have plummeted, helping people, companies and governments. China also bought hundreds of billions of dollars of ‘agencies’, government-guaranteed US mortgage bonds issued by the eccentrically named Fannie Mae and Freddie Mac. So China was essentially lending the cash for the loans that underpin the American housing market. In fact, just before Lehman Brothers’ collapse in June 2008, China actually owned more Agency bonds ($544 billion) than US Treasury bonds ($535 billion). China was pouring its Sinodollars into these Agencies at an incredible rate – much faster than into conventional US government debt. In two years, pre-crisis, its Agency holdings doubled. Small wonder that Fannie Mae and Freddie Mac were effectively nationalised in September 2008. China could have faced massive losses. The Chinese government sold off their Agency holdings almost as rapidly as they were built up, halving it within three years, and shifting to US Treasury bonds.

Thus not only were the Chinese peasants migrating en masse, lowering the living costs of the wealthiest people in the world, some of the fruits of their labour were being lent back at low interest to those very same people. Two Thank-Yous are necessary, one for the cheap goods, and another for the cheap loans. It was an insane form of pan-Pacific bonded-labour-vendor-finance. A dim sum, one might say. It surely can’t last.

A sign of things that may be to come was glimpsed in September 2012, when a fifty-strong crowd broke away from an anti-Japanese protest in Beijing to surround the car of Gary Locke, the US ambassador to China. ‘Pay us back our money!’ the crowd chanted. ‘Down with US imperialism!’ Some of the demonstrators hurled projectiles, damaging the embassy car. Video of this extraordinary protest was captured by dissident artist Ai Weiwei on his iPhone.

The massive stockpile of Sinodollars has begun to enter public consciousness in China and the USA. It is the fundamental axis of global economic geography: a mammoth insurance policy, China’s currency con, an economic aneurysm for America – and perhaps even the actual root cause of the financial crisis. There is some truth in all of these explanations. On opposite sides of this dim sum, however, opinions are polarising.

For America, China is manipulating its currency artificially to prolong its export boom. The size of China’s foreign currency reserves, at one point half of China’s GDP, far outweighs its needs. For China, the reserves are a consequence of the efforts of its people, a sensible insurance policy against the speculative attacks made against the currencies of neighbouring countries during the East Asian financial crisis of 1997. China vowed that the agony, indignity and loss of sovereignty inflicted on its near neighbours then would not occur to it.

China does not have a happy historic memory of how its large trade surpluses have been dealt with by more powerful nations. For centuries, China was not really interested in the goods the West was trying to sell it, as attested by a letter written in the late eighteenth century to George III by the Emperor Qianlong: ‘We possess all things and of the highest quality… I set no value on the strange and useless objects and have no use of your country’s manufactures.’ (Chinese officials today are likely to say very much the same thing.) At this time, China was exporting teas, silks and porcelain to Europe, and Britain was obliged to settle three-quarters of its trade deficit by transferring silver to China. Britain – somewhat less than ethically – sought to change the balance in the mid-nineteenth century by growing opium in Bengal for export to addicts in China. British banks such as HSBC (originally the Hong Kong and Shanghai Banking Corporation) have their origins in this trade. Emperor Daoguang objected, and ordered raids on the opium dealers, carried out by the celebrated Chinese administrator and scholar Lin Zexu. In a letter to Queen Victoria in 1839, Lin Zexu wrote: ‘The wealth of China is used to profit the barbarians… By what right do they then in return use the poisonous drug to injure the Chinese people?’ The British remained deaf to his appeals, and in June 1840 an expeditionary force of barracks ships, gunboats and smaller vessels carrying 4,000 sailors and marines arrived in the Pearl River Delta, so launching the First Opium War. The Chinese have not forgotten this humiliation. The original pits where British opium was seized and burnt are still maintained in Dong Guan, itself now a symbol of Chinese global trade, alongside a statue of Lin Zexu. In 2010, the Chinese government even objected to David Cameron wearing the unrelated Remembrance poppy on his lapel during a trade visit to China.

For opium then, substitute US Treasury bonds today. China’s wider surpluses are effectively balanced out by these epic purchases of government debt. Purchases continued through the depths of the financial crisis and past the downgrade of America’s AAA credit rating. That seems like an addiction. Arguably it was the USA and parts of western Europe that became addicted to the wave of cheap credit that this trade unleashed. The bond binge was part of the mechanism used by the Chinese government to keep exports booming with a cheap Chinese currency. Buying dollars helps keep the Chinese currency weaker. The exchange rate offered by the bank to the factory and by the central bank to the bank, is also centrally controlled and managed.

What is particularly amazing about this trading relationship, this monetary marriage, this curious economic embrace, is how little either player wanted to talk about it as the imbalance grew. It was not until the debates during the 2008 presidential elections that Senator Obama expressed regret that the USA had borrowed the money. ‘Nothing is more important than us no longer borrowing $700 billion or more from China and sending it to Saudi Arabia. It’s mortgaging our children’s future,’ he said.

Fast forward just four months, and President Obama was sending his Secretary of State, Hillary Clinton, to Beijing with the words: ‘I appreciate greatly the Chinese government’s continuing confidence in United States Treasuries.’ Not exactly weaning America off the teat of Chinese credit.

The noises that were previously all about reassurance then began turning rather combative. Again I was dumbfounded in July 2009 by an audience intervention at a speech by White House chief economic adviser Larry Summers. A member of the state-run Chinese press publicly asked Mr Summers if he could guarantee the safety of China’s investments in the USA. Mr Summers started talking about healthcare policy. These were the first skirmishes in a new currency war.

The uncertainty over those $544 billion of Agency mortgage bonds, worth 10 per cent of its GDP, must have spooked the Chinese leadership in 2008. Some leading US economists suggested a ‘haircut’ on the holders of Agency bonds. In the words of US economist Brad Setser, they were ‘Too Chinese To Fail’. The then US Treasury secretary put the Agencies into ‘conservatorship’ – a euphemism for nationalisation. The Chinese, however, started to sell these bonds rapidly. As luck would have it, two months later, in November 2008, the US Federal Reserve announced, under its version of quantitative easing (see
here
), that it would be buying $600 billion of Agency bonds and debts. It was precisely enough to offset the Chinese sell-off.

But when in November 2010 America announced that the Federal Reserve was going to print an additional $600 billion, the quiet reserve of economic diplomacy was jettisoned for the monetary megaphone. Trillions of dollars of extra US government borrowing was seen in Beijing as an attempt at backdoor devaluation of the dollar, to boost US exports and make Chinese goods more expensive for Western consumers. China began to send clear messages, even threats, that it was pondering reining in its purchases of dollar debt. As Premier Wen Jiabao said, ‘We’ve lent a huge amount of capital to the United States, and of course we’re concerned about the security of our assets.’

And then, in November 2010, Dagong, China’s international credit-rating agency (a rival to the Western triumvirate of Standard & Poor’s, Moody’s and Fitch) downgraded US government debt to A+. Naturally it maintained China’s rating as AAA. This downgrading was generally dismissed as a joke or propaganda, though S&P followed suit less than a year later. Put simply, though, whose credit rating matters – the lender’s or the borrower’s? Dagong predicted a world heading for ‘utter chaos in the international currency system’.

The statement from Dagong continued, taking no prisoners: ‘In essence the depreciation of the US dollar adopted by the US government indicates that its solvency is on the brink of collapse, therefore it wants to cut its debt through the act of devaluation… ; such a move has severely harmed the interests of creditors.’

The joke in Shanghai was that as the Chinese had just paid for their own much-needed £400 billion stimulus entirely from their own pockets, they did not feel the need to pay for America’s stimulus too. At the time of the crisis, China stopped treading carefully, and instead decided to show the world it had some muscle – financial muscle.

‘Don’t take Polonius’s words at face value,’ I am told by Jin Liqun, the official who supervises China’s national piggy bank, the China Investment Corporation. I had suggested to him that the CIC followed the advice offered by Polonius to his son in Shakespeare’s
Hamlet
: ‘Neither a borrower nor a lender be.’ In 2007 the CIC was allocated $200 billion of those massive Chinese foreign-exchange reserves to make strategic investments for China.

Mr Jin, a 63-year-old Shakespeare scholar, does have plenty of advice for the debt-addled, formerly industrialised Western nations. ‘You can borrow. We in China borrowed a huge amount of money over the past few decades. Those moneys were invested in basic infrastructure, upgrading our technology. Now we have very strong export performance. So to borrow or to lend is alright,’ he advises. ‘Don’t do it excessively,’ he adds.

In its early years, the CIC made some fairly spectacular mis-steps in financial services. It lost billions on investments on Wall Street. Within China, there was mounting criticism that the nation’s carefully accumulated savings were being squandered on saving greedy Western financiers.