Chinese leaders like their slogans and where foreign policy is concerned, two have reflected Beijing’s thinking over the past decades. The first is the cautious principle of tao guang yang hui (韜光養晦), usually translated as “hide your light and bide your time,” which long guided Chinese policy for decades after former Chinese leader Deng Xiaoping (鄧小平) established it in the 1980s.
However, in late 2013, Chinese President Xi Jinping (習近平) coined a new slogan to define a more assertive, muscular approach: fen fa you wei (奮發有為), or “strive for achievement.”
The drift toward a more assertive foreign policy under Xi has been evident everywhere, from China’s declaration of an air defense identification zone over the East China Sea in late 2013, to the creation of “facts on the ground” in the South China Sea, to the the Belt and Road Initiative.
Illustration: Yusha
Yet there have been signs that China might be having second thoughts about its ability to keep striving for achievement. Xi’s government seems clearly to have entered concessionmaking mode in its relations with the US and some prominent Chinese academics have begun questioning whether China has been guilty of strategic overstretch.
For example, Tsinghua University Institute of International Studies director Yan Xuetong (閻學通), a doyen of Chinese foreign-policy scholarship, has argued that Xi has gone too far and that China should limit its ambitions to a narrower, regional sphere.
Another Beijing-based expert, Renmin University of China international relations professor Shi Yinhong (時殷弘), has called for “strategic retrenchment” in Chinese foreign policy.
An easy explanation for this Chinese shift toward retrenchment is US President Donald Trump, who has applied his own brand of assertiveness to the US-China relationship, with the apparent support of the entire US political class, as well as much of Europe’s. Confronted by pushback from the West, China is unsurprisingly warier of pushing forward.
However, China’s new-found caution also owes much to the fragility of its economic performance. As anyone who has recently traveled to Beijing will tell you that the sense of economic pessimism there has rarely been as tangible as it is now.
To a degree, sagging Chinese growth is a self-induced problem. Since Xi’s declaration in 2017 that financial stability is a national security concern, risk-taking by local governments and the financial sector has generally been frowned upon. Because these actors have been the two main engines of China’s growth over the past 10 years, risk aversion among provincial officials and financiers has naturally sapped energy from the economy.
Yet there is another, undernoticed, source of China’s economic fragility: the capital account of its balance of payments. Since 2014, when China’s foreign reserves began to fall from their US$4 trillion peak to about US$3 trillion today, the authorities have been nervous about the damage that excessive capital outflows might inflict on China’s economic self-confidence and global role.
In any emerging economy, there is an important connection between the health of the capital account and that of the domestic economy. If money is voting with its feet, how can anyone expect domestic confidence to be strong?
Furthermore, the most important single driver of capital flows in and out of any emerging economy is the state of US monetary conditions. Loose US monetary policy in the aftermath of the 2008 financial crisis pushed capital toward China and other developing countries. That is what helped reserves grow to US$4 trillion in the first place: the US Federal Reserve’s quantitative easing made it profitable for Chinese firms to borrow dollars and sent investors on a global quest for yield, so money flowed to China.
Conversely, the progressive tightening of US monetary conditions over the past five years has undeniably helped to suck US dollars away from China, causing the country to lose reserves and self-confidence. This is partly because Chinese companies tend to repay debt when the dollar is strengthening and the cost of servicing dollar liabilities goes up. In addition, foreign portfolio investors are less willing to buy Chinese government bonds when the China-US interest differential narrows, as it has over the past few months.
The main reason why reserves have not fallen below US$3 trillion, which would make Chinese policymakers even more nervous, is the network of controls on capital outflows introduced in late 2016 and early 2017. However, the controls might not be completely watertight: The history of capital flows tells us that when money wants to leave a country, it will.
A fragile capital account and the economic self-doubt it can create are hardly strong foundations for aggressive Chinese foreign policy. The next time Trump feels like excoriating Fed Chairman Jerome Powell for tightening monetary policy too quickly, he might pause to consider the role that higher US rates and a stronger US dollar have played in taming China’s self-confidence. A dovish Fed is a gift to Beijing.
David Lubin is head of emerging markets economics at Citigroup and an associate fellow at think tank Chatham House in London.
Copyright: Project Syndicate
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