Upping the Ante

The U.S. Holds the High Cards and It’s Time to Call China’s Bluff

Forget about ‘common ground’ and ‘managing the differences’ when Xi Jinping visits this week. The U.S. is strong, China’s weakening. Let’s play it that way.

09.22.15 5:00 AM ET

Most of the commentary about Chinese President Xi Jinping’s upcoming state visit is wrong, or at least out of date.

Yes, there are many disagreements between the U.S. and an increasingly assertive China. But no, the Obama administration does not have to find “common ground” and “manage the differences,” the current mantra in D.C. Moreover, the White House can ignore Peking University’s oft-quoted Zhu Feng, who told the Associated Press that “both sides need to make concessions.” Instead, Washington should be looking to accomplish all its goals, to put the relationship on America’s terms.

The dominant narrative—that the U.S. has to accommodate a rising Chinese state—is obsolete now that the Communist Party is facing its worst crisis since the Beijing Spring of 1989. China, since mid-June, has been showing signs of severe stress. The stock market is plunging, the currency is falling, the economy is growing only in the low single digits, if it is growing at all. 

The economy was the motor of China’s rise, and now it looks like the engine of the fall. And unfortunately for Beijing’s technocrats, nothing they’re doing is working to arrest the accelerating downward trajectory. Five reductions in benchmark interest rates since November and four reductions of the bank reserve-requirement ratio since February have had no noticeable effect in stimulating growth. Monetary stimulus is tapped out because there is a fundamental lack of demand for money.

Fiscal stimulus could grow gross domestic product, so Beijing is readying another massive spending plan. Yet almost no analyst is cheering, and the technocrats seem embarrassed by the extent of their new stimulus program. Just about everyone knows China does not need another “ghost city” or high-speed rail line to nowhere.

And government spending will also add to already worrisome debt woes. McKinsey Global Institute put the country’s debt-to-GDP ratio at a dangerous 282 percent at the end of June 2014, but the number is surely higher than that now. In reality, the ratio could be somewhere in the vicinity of 350 percent once all hidden obligations are counted and gross domestic product is accurately assessed.

At the same time, two other government tactics have come a cropper: the reckless promotion of stock prices beginning last fall and the inexplicable devaluation of the renminbi this August.

There is only one thing the Communist Party could do to trigger another round of sustainable growth: implement structural economic reform. Change of that sort is unlikely, however, because powerful vested interests are blocking it, and in any event Xi Jinping’s idea of change is regressive, Maoist-inspired even.

Since coming to power, he has been reversing Deng Xiaoping’s policy of “reform and opening up.” He has, for instance, been closing off the Chinese market to foreigners, recombining already large state enterprises back into formal monopolies, and increasing state subsidies to favored market participants.

Xi has strangled the financial markets in order to keep share prices high and currency values elevated. His signature initiative, encapsulated by the phrase “Chinese dream,” contemplates a strong state, and a state-dominated China does not sit easy with the notion of market-oriented reform.

And even if Xi opted for the right kind of change, it might take too long to rescue an economy that is, in reality, growing only in the low single digits, not at the claimed 7.0 percent pace. In Beijing, elites are privately talking about 2.2 percent growth.

China, in short, could be well beyond the point of no return. Chinese are losing confidence in the ability of Xi Jinping and his economic czar, Premier Li Keqiang, who are now merely applying patches to gashes. 

Xi and Li are in a race with time because money is flooding out of the country at unprecedented rates. Wind Information, the leading Chinese data provider, recently reported that cash is leaving China at the pace of $135 billion a month. As the Financial Times noted in August, Beijing is burning through $20 billion a day defending the currency and could, in the absence of inflows, exhaust its foreign exchange reserves in a year.

Almost all analysts say China’s economic difficulties are temporary, but with Beijing out of solutions and Xi Jinping pushing China in the wrong direction the country now faces a dark future. The best-case scenario is that China endures two decades of recession or recession-like stagnation, much like Japan in the 1990s and the first part of this century.  

A more probable scenario for China is even worse. Chinese leaders have tried to prevent their economy adjusting—in other words, contracting—with centrally directed intervention. The last Chinese recession, according to the official National Bureau of Statistics, was in 1976, the year Mao Zedong died. Xi, who believes in a strong Communist Party role in all aspects of society, will prevent the economy correcting until he no longer has the ability to do so. When that happens, his system will go into free fall. China is almost at that critical point of a 1930s-style adjustment, a plunge followed by years of deep contraction.

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In these circumstances, the Chinese need America far more than America needs them, so it is time for Washington to show Xi Jinping what the exercise of U.S. power would look like if he continues his aggressive path.

Washington, for instance, can impose costs that are greater than the benefits China receives from unacceptable conduct. Xi will huff and puff, but the U.S. has the ability to outlast him. China is in no shape for a prolonged contest with America.

Chinese leaders have traditionally been recalcitrant, but a resurgent U.S. has the means to get them to see things Washington’s way. Not to use leverage at this point would be a strategic miscalculation of the first order.

For years, Chinese leaders have believed that Americans perceived themselves as weak, and in fact American attitudes toward China today resemble those toward the Soviet Union in the Nixon, Ford, and Carter eras. Where others saw Soviet strength, however, Reagan recognized weakness. His belief that Moscow was vulnerable permitted him to wield American power effectively.

It’s time to let Xi Jinping know that Americans now realize their nation is strong—and that he is in no position to stand against the U.S. and the international community.