Implications of the Financial

Crisis for the US–China Rivalry

Aaron L. Friedberg

The dramatic economic developments that began to unfold in the summer

of 2008 have been widely compared to the Great Depression of the 1930s.1 At
that time, a sharp drop in stock prices was accompanied by a banking crisis,
which led to a protracted slowdown in global growth, the rise to power
of fascist regimes in Europe and Asia and, ultimately, the outbreak of the
Second World War. While the first several steps in the current crisis appear
similar (market crash, bank failures, global slowdown), its full economic,
political and strategic implications are not yet clear.2
Among the many potential consequences of the recent downturn and its
aftermath could be increased friction between the United States and China
and an intensification in their evolving military and diplomatic rivalry.  In
addition to altering their bilateral interactions, the global slump could affect
the ability of both countries to pursue a long-term strategic competition, as
well as changing their position in, and relationship to, the rest of the inter-
national system.
Several caveats are in order here. Firstly, and most obviously, the crisis
that began in 2008 has yet to run its course. The ultimate duration and depth
of the current economic slowdown will go a long way towards determin-
ing the full extent and character of its strategic implications. Other things
equal, the more protracted and severe the slump, the greater the likelihood

Aaron L. Friedberg is Professor of Politics and International Affairs at Princeton University. A new edition of
his 1988 book The Weary Titan: Britain and the Experience of Relative Decline, 1895–1905 will be released in the
autumn by Princeton University Press. His latest book on the emerging US–China rivalry will be published in
spring 2011 by W.W. Norton.

Survival | vol. 52 no. 4 | August–September 2010 | pp. 31–54 DOI 10.1080/00396338.2010.506817

32 | Aaron L. Friedberg

of dramatic and potentially dangerous effects. A full accounting of the likely

economic impact of various scenarios on the United States and China would
also require a systematic analysis of their trade and investment with the rest
of the world, and with each other, something that is beyond the scope of
this article.
Finally, as will quickly become apparent, the three aspects of the Sino-
American relationship discussed here are closely intertwined. Thus, for
example, the growth trajectories of the United States and China will depend,
in part, on the state of their bilateral relations and will in part determine
their future roles in the international system. Dividing the problem into
three separate pieces helps to make it more tractable analytically, albeit at
the cost of some oversimplification.

Internal effects
In broad outline, the United States and China passed through similar expe-
riences following the start of the global financial meltdown nearly two years
ago. Both experienced sharp drops in aggregate demand and a decline in
growth rates (in the US case triggered by a contraction of credit and the
collapse of consumer spending, in China as the result of a sharp fall-off in
exports) and both initiated large-scale stimulus programmes designed to
boost demand and restore growth. In the US case the slowdown was suf-
ficient to tip the economy into a protracted recession; in China expansion
slowed briefly and then resumed at near pre-crisis rates. The difference in
the two countries’ performance has caused some observers to conclude that
China must be the ‘winner’ in the current crisis.
From a geopolitical perspective what matters most are relative rather
than absolute gains; not how fast each economy is growing (or contracting),
but how wide the differential is between their respective growth rates. Since
the end of the Cold War the US economy has been expanding at an average
of about 3% per year while China has enjoyed annual growth rates closer to
10%. It is this persistent seven-point gap that has caused many economists
to predict that, by the middle of this century, at the latest, China will have
overtaken the United States in terms of total output. If both countries return
quickly to their pre-crisis growth trajectories the date of expected conver-
 Implications of the Financial Crisis for the US–China Rivalry | 33

gence will not change. If, on the other hand, one recovers more rapidly or
more completely than the other, that moment could either be moved up, or
pushed even further into the future.
While there are some optimistic outliers, the emerging consensus among
forecasters is that the United States will not bounce back immediately to its
pre-crisis performance. Instead of averaging 3–3.5% per year (to say nothing
of the 4% some had predicted at the turn of the century, before the dot.com
bubble burst) growth is expected to remain at about 2–2.5% for much of this
decade and perhaps beyond.3 As for China, after rising to a peak of 13% in
2007, its annual growth was cut almost in half (to around 7% on a year-on-
year basis), during the initial stages of the global crisis.4 Thanks to a very
aggressive response by the central authorities, growth climbed back to just
under 9% in 2009. Some estimates show it hovering between 9 and 10% for
at least the next few years, while others are even more bullish, at least in the
near term.5 If China can return to something near its pre-crisis, double-digit
growth rates while the United States continues to limp along at roughly
0.5–1% less than its earlier performance, the gap between the two countries
will obviously close even more rapidly than it was before.
Whether or not China can sustain its initial recovery remains to be seen.
At least in the near term, Beijing responded to the crisis by doubling down on
a development model that was already approaching the limits of its utility.
Rather than taking aggressive steps to boost consumer spending as a share
of GDP, a course that both outside experts and many Chinese officials have
identified as essential to sustaining long-term growth, the regime chose ini-
tially to pump even more money into infrastructure projects and to provide
both direct and indirect support for a variety of export industries.6 While
this approach may have been effective in preventing an even steeper short-
term drop in output, it threatens to create massive excess capacity, fuelling
asset bubbles, weighing down banks with more non-performing loans and
setting the stage for another slowdown that will be even deeper and more
difficult to manage. As economist Stephen Roach points out, Beijing appears
to have acted on the assumption that, as in previous recessions, foreign (and
especially US) demand would soon recover, leading to a rise in exports and
a resumption of rapid growth. If this turns out not to be the case, however,
 34 | Aaron L. Friedberg

Roach concludes that China ‘runs the real risk of facing a more pronounced
shortfall in economic growth’.7 In sum, short-term expedients may end up
hastening the day of reckoning for China’s investment-heavy, export-led
development strategy. While the regime has recently taken steps to encour-
age domestic demand, permitting workers wages to rise and the renminbi
to appreciate, the changes to date have been small and tentative.8
Despite its magnitude, Beijing’s stimulus programme was insufficient to
forestall a sizeable spike in unemployment. The regime acknowledges that
upwards of 20 million migrant workers lost their jobs in the first year of
the crisis, with many returning to their villages, and 7m
recent college graduates are reportedly on the streets in
Beijing’s search of work.9 Not surprisingly, tough times have been
accompanied by increased social turmoil. Even before the
stimulus was crisis hit, the number of so-called ‘mass incidents’ (such
insufficient as riots or strikes) reported each year in China had been
rising. Perhaps because it feared that the steep upward
trend might be unnerving to foreign investors, Beijing stopped publishing
aggregate, national statistics in 2005.10 Nevertheless, there is ample, if frag-
mentary, evidence that things got worse as the economy slowed. In Beijing,
for example, salary cuts, layoffs, factory closures and the failure of busi-
ness owners to pay back wages resulted in an almost 100% increase in the
number of labour disputes brought before the courts.11 Since the early days
of the current crisis, the regime has clearly been bracing itself for trouble.
Thus, at the start of 2009, an official news-agency story candidly warned
Chinese readers that the country was, ‘without a doubt … entering a peak
period of mass incidents’.12 In anticipation of an expected increase in unrest,
the regime for the first time summoned all 3,080 county-level police chiefs to
the capital to learn the latest riot-control tactics, and over 200 intermediate
and lower-level judges were also called in for special training.13
At least for the moment, the Chinese Communist Party (CCP) appears
to be weathering the storm. But if in the next several years the economy
slumps again or simply fails to return to its previous pace, Beijing’s trou-
bles will mount. The regime probably has enough repressive capacity to
cope with a good deal more turbulence than it has thus far encountered,
 Implications of the Financial Crisis for the US–China Rivalry | 35

but a protracted crisis could eventually pose a challenge to the solidarity

of the party’s leadership and thus to its continued grip on political power.
Sinologist Minxin Pei points out that the greatest danger to CCP rule comes
not from below but from above. Rising societal discontent ‘might be suf-
ficient to tempt some members of the elite to exploit the situation to their
own political advantage’ using ‘populist appeals to weaken their rivals and,
in the process, open[ing] up divisions within the party’s seemingly unified
upper ranks’.14 If this happens, all bets will be off and a very wide range of
outcomes, from a democratic transition to a bloody civil war, will suddenly
become plausible. Precisely because it is aware of this danger, the regime
has been very careful to keep whatever differences exist over how to deal
with the current crisis within bounds and out of view. If there are significant
rifts they could become apparent in the run-up to the pending change in
leadership scheduled for 2012.
Short of causing the regime to unravel, a sustained economic crisis
could induce it to abandon its current, cautious policy of avoiding con-
flict with other countries while patiently accumulating all the elements of
‘comprehensive national power’. If they believe that their backs are to the
wall, China’s leaders might even be tempted to lash out, perhaps provok-
ing a confrontation with a foreign power in the hopes of rallying domestic
support and deflecting public attention from their day-to-day troubles.
Beijing might also choose to implement a policy of ‘military Keynesianism’,
further accelerating its already ambitious plans for military construction in
the hopes of pumping up aggregate demand and resuscitating a sagging
domestic economy.15
In sum, despite its impressive initial performance, Beijing is by no means
on solid ground. The reverberations from the 2008–09 financial crisis may
yet shake the regime to its foundations, and could induce it to behave in
unexpected, and perhaps unexpectedly aggressive, ways.
The impact of the financial crisis on the United States is more likely to be
one of lingering debilitation than radical destabilisation. After a brief inter-
val of surpluses in the late 1990s, a combination of tax cuts and spending
increases during the George W. Bush years pushed the federal budget back
into the red. The recession has caused tax revenues to fall and the deficit to
36 | Aaron L. Friedberg

grow, and the federal government’s efforts to contain the banking crisis and
stimulate the economy have produced even bigger imbalances. In the span
of only a year the deficit quadrupled in size from $459 billion (or 3.2% of
GDP) to $1.85 trillion (13.1% of GDP).16 This would be the most rapid dete-
rioration on record, far worse than any previous recession.17
More important than the speed with which this gap has opened is its
sheer size: the deficit is now larger in relation to the economy as a whole
than at any time since the end of the Second World War.18 In order to cover
the difference between revenues and expenditures, Washington has had to
borrow at an unprecedented rate, with the result that the federal debt has
ballooned from 41% of GDP to 60%.19 For the moment, low interest rates
have helped hold down the cost of servicing this massive increase in debt.
As interest rates rise from their current low levels, so too will the size of the
federal government’s payments to its creditors. Within the next decade, for
the first time on record, annual payments on the federal debt will exceed
outlays for national defence.20
This transition is symbolic; higher debt payments do not necessarily
have to mean downward pressure on defence spending. For a variety of
reasons, however, this is likely to be the case. The combination of rising
interest costs, slower growth and the long-awaited explosion in entitlement
programmes due to population aging will tend to squeeze all forms of ‘dis-
cretionary spending’.21 Of these, the defence budget is the biggest and, in
political terms, it may turn out to be the most vulnerable. As the United
States disentangles itself from Iraq and Afghanistan, there will be calls to
pocket the resulting ‘peace dividend’ and to direct more resources to urgent
domestic needs. Instead of being freed to spend more on systems relevant
to a possible long-term competition with China, the Defense Department is
likely over the coming decade to face the necessity of making cuts in R&D
and procurement.22
Barring some galvanising event, the United States may lack not only the
resources to conduct a sustained rivalry with China but the inclination to do
so. Recent opinion polls show a sharp increase in the number of Americans
who believe their country should ‘mind its own business and let others get
along on their own’. Indeed, nearly half of those questioned in 2009 agreed
 Implications of the Financial Crisis for the US–China Rivalry | 37

with this proposition, the largest fraction on record, bigger even than at
the end of the Vietnam War. These sentiments no doubt reflect the nation’s
unhappy experiences over the last eight years with terrorism and insur-
gency, but they are also clearly a product of the recent economic downturn.
Since the start of the crisis the number of Americans who see their country
as the world’s leading economic power has fallen sharply (from 41% in
February 2008 to 27% in November 2009), even as those who see China in
this role have grown more numerous (from 30% to 44%). While ordinary
citizens remain wary of China, they show little sign of wanting to compete
with it for influence. To the contrary, the American people at present seem
far more inclined to want to tend to their own problems than to go out into
the world looking for trouble.23 What remains to be seen is whether and if so
how China will try to exploit an interval of American introspection.

Bilateral relations
From the Nixon administration’s first feelers to Beijing until the Tiananmen
Square ‘incident’ and the end of the Cold War, the United States and China
were drawn together mainly by their shared opposition to the Soviet Union.
For the last 20 years, by contrast, the two powers have been united primarily
by trade. The benefits from increasingly close commercial ties have helped
to at least partially offset underlying ideological and geopolitical impulses
toward mutual mistrust and strategic rivalry. To be sure, economic issues
were, at times, a source of contention. Still, recurrent disputes over intel-
lectual property rights, subsidies and currency values were never serious
enough to threaten bilateral flows of trade and investment, still less to poison
the larger political relationship between the United States and China.
The current crisis may mark the end of a period in which trade served to
stabilise Sino-American relations and the beginning of one in which it will
become a source of increasing friction and conflict. Recent events may also
lead to at least a partial decoupling of the two nations’ economies, a devel-
opment that could have significant implications for their dealings with each
other, and with the rest of the world.
For the better part of two decades the United States has been import-
ing more from China than it exports and paying for the difference with
38 | Aaron L. Friedberg

Treasury bills and other dollar-denominated assets. Despite the fact that
it was heavily lopsided, this arrangement had clear benefits for both sides.
American consumers enjoyed inexpensive goods and lower interest rates
than would otherwise have been possible. For their part, Chinese manufac-
turers (or, more precisely, manufacturers with final production facilities in
China, some of which were actually owned by American and other foreign
companies) gained access to the vast US market. The Chinese government
helped boost exports by holding down the value of the renminbi (by using it
to buy dollars) and invested the resulting surplus in Treasury securities and
other dollar-denominated assets that were generally assumed to be safe,
stable investments.
Over time, cheap Chinese imports did cost some Americans their jobs, but
with the US economy growing steadily through most of the 1990s, these neg-
ative effects were small in comparison to the actual and perceived potential
benefits of more trade with China. In terms of their political clout, the indus-
tries that hoped to gain from this trade (aerospace, electronics and financial
services, among others) and which therefore opposed the imposition of any
protectionist measures were also far stronger than their opponents. From
the early 1990s the executive branch was thus able to deflect demands for
tariffs or other industry-specific measures by ‘jaw-boning’ Beijing into
making small adjustments in exchange rates that were presumed to help
all American exporters. In spite of this, between 2005 and 2007, 45 pieces
of legislation were introduced in Congress for the purpose either of raising
the cost of specific Chinese imports or, by threatening to impose across-the-
board tariffs, compelling Beijing to modify its exchange-rate policy. None of
these bills could generate sufficient support, in large part because, as Roach
notes, ‘they were introduced during a period of prosperity and low unem-
ployment’. With the onset of the crisis both conditions have changed, with
the result that ‘long-standing pressures on American workers are intensify-
ing – as are related pressures on their elected representatives to act’.24
If growth remains slow and unemployment stays high, the balance of
political forces could begin to shift in favour of protection. Even as calls
for trade restrictions grow, the increasing frustration of many American
companies at their inability to protect intellectual property, compete with
 Implications of the Financial Crisis for the US–China Rivalry | 39

favoured local rivals, and make money in the Chinese market means that
the advocates of continued openness are less united and less powerful than
they once were.25 Serious measures to restrict imports from China would
endanger that country’s recovery and long-term growth and would likely
trigger an escalatory response and a downward spiral in trade and political
relations. Despite the obvious dangers, the odds of this happening over the
next several years are probably greater than at any time since Tiananmen
and perhaps since the era of ‘reform and opening up’ began in the late
1970s. Indeed, the possibility of a US–China trade war has been identified
by some market analysts as ‘the biggest risk to global stability over the next
few years’.26
For the moment, trade tensions have been channelled into the continuing
dispute over currency values. Here, although they have thus far behaved
cautiously, Beijing and Washington are playing what amounts to a game of
‘chicken’. Rather than proceed immediately with a formal
accusation of currency manipulation, as future Treasury
Secretary Timothy Geithner hinted that it might during Beijing and
the 2008 presidential campaign, in its first year in office the
Barack Obama administration allowed congressional pres-
Washington
sure to build, while at the same time hinting that it might not are playing
be able to hold back popular demands for action.27 Public
statements by top US officials seemed designed to convey
a game of
the message that, whatever sound economic reasoning ‘chicken’
might dictate, and regardless of the preferences of leaders
on both sides, failure to make adjustments could have grave consequences
that neither will be able to control. As Obama himself put it towards the end
of 2009, if the two countries do not succeed in correcting deep economic
imbalances, they will impose ‘enormous strains’ on their relationship.28
Beijing’s announcement in June 2010 that it would ‘enhance’ the renmin-
bi’s ‘exchange rate flexibility’ seems to have been designed in large part to
deflect pressure from the United States and China’s other advanced indus-
trial trading partners.29 Whether the resulting adjustments will be sufficient
to achieve this end remains, at this writing, unclear, but there are reasons to
doubt it. Within hours of its formal statement, the People’s Bank of China
 40 | Aaron L. Friedberg

indicated that it did not consider large-scale shifts in currency values to be

justified, provoking angry responses from American politicians and trade-
association representatives.30
Whatever its economic effects, an escalating Sino-American commer-
cial conflict presents the most likely near-term path to a far more hostile
political relationship and a much more intense and open strategic rivalry.
Rising trade tensions would also increase the chances that China might try
at some point to use the potential leverage it appears to have acquired by
becoming America’s leading creditor. If Beijing were to dump its stash of
dollar-denominated assets US interest rates would climb, the value of the
dollar would fall and the American economy would be thrust into a deep
and protracted recession. Such a scenario is generally thought to be implau-
sible in large measure because, even as it inflicted pain on
the United States, China would also do be doing grave
Clinton damage to itself. A falling dollar and a decline in aggregate
demand in the United States would mean fewer American
downplayed imports of Chinese goods, and this is to say nothing of
disputes the likelihood that Washington would retaliate for what
it would doubtless see as an act of economic warfare by
over human imposing steep tariffs on all products from China. Equally
rights troubling from Beijing’s perspective is the prospect that a
sudden shift in exchange rates would greatly diminish the
value of its remaining assets, most of which would still be denominated in
dollars. Because any attempt to use it would risk unleashing something akin
to mutually assured destruction, China is widely assumed to be constrained
from exploiting its position as America’s banker.31
This assessment is basically correct, but with two caveats. Potential
leverage does not necessarily have to be exercised in order to be effective.
The behaviour of US officials is already being shaped to an unprecedented
degree by their concern over the possibility of Chinese action (or inaction) in
global financial markets. While this is surely not the only reason, the current
administration appears to have adopted a more conciliatory tone towards
China in part because of its desire to ensure future purchases of America’s
ballooning debt. Thus, during her first visit to Beijing in 2009, Secretary
 Implications of the Financial Crisis for the US–China Rivalry | 41

of State Hillary Clinton publicly downplayed disputes over human-rights

issues while at the same time taking the unusual step of publicly asking
Chinese officials to continue to buy US Treasuries.32
Whatever the Obama administration intends, its conciliatory posture is
widely perceived to be a direct result of straitened financial circumstances.
Prior to the president’s November 2009 visit to China, a piece in the New
York Times argued that US indebtedness had ‘changed the core’ of the Sino-
American relationship. ‘The result: unlike his immediate predecessors, who
publicly pushed and prodded China … Mr. Obama will be spending less
time exhorting Beijing and more time reassuring it.’33 This is a change that
many in China clearly welcome and, indeed, have come to expect. As one
high-ranking banking official put it in an interview with journalist James
Fallows: ‘your economy is … built on the support, the gratuitous support,
of a lot of countries. So why don’t you come over and ... I won’t say kowtow
[with a laugh], but at least be nice to the countries that lend you money.’34
Even those who are sceptical that Beijing can use financial leverage to
compel the United States to change its behaviour on specific issues agree
that it is now in a much better position to deter overt American influence
attempts. In a careful analysis of this issue Daniel Drezner notes, for example,
that by spring 2009, US government officials had decided that their finan-
cial position made it too dangerous to risk a showdown with China over
exchange rates. Drezner concludes that ‘although China could not compel
the United States, it could deter Washington from trying to apply its own
foreign policy pressure’.35
The assumption that deep financial interdependence will lead to stable,
mutual deterrence is more comforting than it ought to be. It may well be
true that economic warfare, like nuclear war, would do terrible damage to
all involved but, as with nuclear weapons, this does not mean that such a
conflict is impossible. Leaders may miscalculate the extent of the damage
they would suffer, conclude that the stakes in a given confrontation are so
high that they justify running extraordinary risks, or feel compelled to act
in potentially self-destructive ways by domestic political pressure. As risky
as a confrontation between two nuclear-armed nations might be, there are
also special dangers of unintended escalation in the financial arena where
 42 | Aaron L. Friedberg

‘panics’ are always possible and relevant decisions are made not merely by
a handful of ‘national command authorities’, but by large numbers of inde-
pendent investors.
China’s accumulation of dollars is a reflection of its trade surplus
with the United States and that, in turn, is a manifestation of the symbi-
otic imbalances between savings and consumption in the two countries.
Broadly speaking, the United States has been saving little, consuming much
and making up the difference by borrowing from others, especially China.
For its part, China saves a great deal, consumes relatively
little, and exports its excess savings, mainly to the United
The US has States. The mid- to long-term impact of the current crisis
will depend on whether and how these imbalances are ulti-
been saving mately addressed.
little and If both countries return to business as usual, the recent,
crisis-induced increase in US household savings will soon
consuming evaporate, the federal budget deficit will remain lodged at
much all-time high levels and the nation’s indebtedness, and its
vulnerability to financial leverage, will be greater than ever.
Meanwhile, China will continue to accumulate dollars in order to maintain
a favourable exchange rate and keep its exports cheap. The potential costs to
both sides of a future crisis will remain high, but the impact of even greater
imbalances on the ability and willingness of the United States to sustain
a strategic competition with China would probably be disproportionately
negative. If Washington is already wary of doing anything to offend Beijing,
it will likely become even more so in this scenario. Moreover, as Fred
Bergsten notes, assuming that a crisis can be avoided, ‘the steadily rising
transfer of US income to the rest of the world to service foreign debt would
seriously erode Americans’ standard of living’ and with it their inclination
to support a costly, far-flung global military posture.36
Chastened by recent experience, the American people may change their
ways and demand that their government do likewise. In this case, house-
hold savings rates will remain elevated, even after fears of foreclosure and
unemployment have receded. Once the need for a massive stimulus has
passed the federal government will move to bring expenditures into closer
 Implications of the Financial Crisis for the US–China Rivalry | 43

alignment with revenues. The goal of US policymakers will be to reduce

debt and the value of the dollar, increase investment and exports and, after
a period of adjustment, restore growth to at or near pre-crisis levels, albeit
this time on a firmer and more sustainable footing.
Beijing could respond to such shifts in American policy either by making
substantial changes of its own or by attempting to maintain its existing devel-
opment strategy. If it follows the latter course and tries to sustain export-led
growth, the stage will be set for protracted economic conflict and diplomatic
friction. As political economist Jeffry Frieden observes, countries desperate
to maintain exports and trade surpluses are prone to ‘embark on aggressive
unilateral moves to force open foreign markets, or attempts to close their
own’. The response from their trading partners is ‘likely to be hostile, and the
results damaging’.37 Unless Beijing takes steps to boost domestic consump-
tion, concludes economist Michael Pettis, ‘the Chinese savings juggernaut
will clash with American attempts to force savings up’. The consequences
will include slower growth, ‘more trade tension and rising hostility within
China’.38
The outcome preferred by most Western analysts, and the path toward
which Washington appears to be aiming, is one in which the two countries
would engage in a process of mutual, synchronised rebalancing of both
their domestic economies and their bilateral trade relationship. Ideally, as
America’s savings rise and its trade deficit diminishes, China would promote
domestic consumption (including imports of US goods) and wean itself from
its dependence on industrial exports. A properly managed transition would
permit both countries to return to high rates of GDP growth and to sustain
them without the unwholesome distortions and mutual dependencies that
have come increasingly to characterise their commercial relations.39
Achieving such a result will be difficult, to say the least. On both sides of
the Pacific, powerful political forces favour a continuation of the status quo.
The American people may be sympathetic in principle to the virtues of thrift
and to the notion that nations, as well as individuals, should ‘live within
their means’. But if this means taxes on consumption, reduced government
benefits, restrictions on credit and an interval of slower than usual growth,
public enthusiasm will doubtless dwindle. Meanwhile, in China, a shift
44 | Aaron L. Friedberg

away from state-directed investment in infrastructure and export industries

would break the ‘iron rice bowl’, diminishing the opportunities for bribes
and backroom deals involving bankers, businessmen, party apparatchiks
and local government officials.
Assuming it can be attained, the strategic implications of a fundamentally
altered bilateral economic relationship are uncertain. Ideally, the existing
structural imbalance in trade would be reduced, not simply by a drop in
US imports, but by an increase in Chinese consumption of American-made
products enabled in part by a revaluation of the renminbi. With trade more
balanced, long-standing disputes would fade and commerce would once
again become a source of cohesion rather than friction. At the same time,
a growing reliance on domestic consumption would help make China’s
economy more stable, thereby reducing the danger of possible crisis-induced
military build-ups or external adventurism. In the best of all possible worlds,
the growing empowerment of the Chinese consumer would also have politi-
cal side-effects, leading to more urgent demands for choice in the selection of
leaders as well as cars, apartments and mobile phones.
There are other possibilities, however. The shift to a more balanced devel-
opment model could make it easier in the long run for China to sustain high
levels of GDP growth and defence spending, while at the same time enabling
the Communist Party to buy the support of an ever-expanding consumer
class. The bilateral trade relationship could also achieve equilibrium at a
lower level of overall exchange, alleviating irritation but at the same time
weakening what in recent years has been the most potent source of con-
straint on an escalating Sino-American rivalry. Finally, China’s increasing
importance as a consumer of finished products could help it cement a posi-
tion as the leader of an emerging East Asian economic bloc, possibly one in
which the US role would be, at best, marginal.40

Global power and prestige

As the financial panic approached its peak, some observers were quick
to proclaim the end of the ‘unipolar moment’ and the start of a ‘post-
American’ era. In addition to revealing the dangers inherent in the
American (or ‘Anglo-Saxon’) model of free-market capitalism, the crisis was
 Implications of the Financial Crisis for the US–China Rivalry | 45

said to herald the demise of the dollar as the world’s reserve currency. The
‘Washington Consensus’ would soon be displaced by a ‘Beijing Consensus’
blending market economics with authoritarian politics, and the dollar would
eventually be replaced by the renminbi.
If they were to occur, these shifts in beliefs and policies would have pro-
found strategic consequences. As the American model fell out of favour in
Asia, Africa and elsewhere, US soft power would diminish. With it would go
Washington’s ability to get its way on specific issues and, more broadly, its
capacity to reshape the world according to its own values and preferences.
Assuming that China came to be seen increasingly as the world’s most suc-
cessful and dynamic society, Washington’s loss would be Beijing’s gain.
The decline of the dollar as the world’s reserve currency would have
more concrete effects. If foreigners lose their appetite for dollars, future
US governments will no longer enjoy what has been termed the ‘exorbi-
tant privilege’ of being able to finance their expenditures at relatively low
cost (and with no exchange-rate risk) simply by issuing more debt. The
ability of the United States to sustain an assertive foreign policy and, in par-
ticular, a costly global competition with China would be correspondingly
diminished.41
With the advantage of some perspective it seems clear that announce-
ments of the evaporation of American soft power and the collapse of the
dollar are, at best, premature. There are several long leaps of logic from a
harsh critique of the US government’s deregulation of parts of the financial
industry to a more fundamental judgement that the current crisis (like the
Great Depression before it) proves the necessity of a permanently enlarged
role for government in the economy; to the conclusion that much of the
world requires an entirely new approach to economic development; to the
claim that China presently provides such a model. The first step is one that
many Americans, as well as most foreign observers, would be willing to
take; the last would likely be rejected by most informed commentators in
China, to say nothing of the rest of the world.
In East Asia on the eve of the current crisis, the United States contin-
ued to hold an advantage in soft power. A survey completed in spring 2008
found that, albeit by narrow margins, respondents in Japan, South Korea
46 | Aaron L. Friedberg

and Vietnam still saw the United States as a more important economic
partner than China (the two were tied in Indonesia). However, attempts to
measure the various dimensions of soft power (including cultural appeal
and diplomacy, as well as economic influence) found that, in each country,
the United States ranked either first or second (to Japan), while China came
in third across the board. When asked to look ahead, most of those surveyed
expressed the view that China will ‘be the leader of Asia’. But this was a
prospect that many regarded with considerable discomfort.42
Recent events have probably strengthened each element in this complex
but coherent mix of attitudes. China is important economically and likely
to become more so, but this fact will not necessarily lead to immediate,
proportionate increases in the perceived attractiveness of its culture, the
applicability of its economic model or the persuasiveness of its diplomacy.
Indeed, to the contrary, it is possible that the growing weight of China’s
economy will cause others to regard it with increasing fear and suspicion.
A serious domestic crisis could also raise doubts about the viability of the
‘Chinese model’ and its potential applicability to other societies. For all of
the fascination and even awe that it currently inspires, in a few years’ time
China’s economy could appear to be no more of a model for the rest of the
world than Japan’s economy is today. Barring a major setback, however, it is
reasonable to expect that, as was true for the United States over the course of
the twentieth century, China’s soft power will grow along with its economy
and the other elements of its hard power.
Despite the public musings of some Chinese officials about the desir-
ability of finding an alternative to the dollar, in the short run at least, the
financial crisis has served to underline its status as the world’s reserve
currency. When the global system seemed to be tottering on the brink of col-
lapse, the US economy still looked like the safest bet and the dollar the most
reliable store of value. The result, described by one observer as ‘counterintu-
itive and annoying to many non-Americans’, was that the failure of several
large domestic financial institutions led to even larger flows of capital into
the United States.43
The recent crisis may have accelerated an eventual Chinese shift away
from the dollar by highlighting in dramatic fashion the risk of investing
 Implications of the Financial Crisis for the US–China Rivalry | 47

so heavily in an asset whose value Beijing cannot control. This was hardly
something of which Chinese planners were unaware. The problem for the
moment is that there is nowhere else for them to go. As one official told an
American audience in February 2009, ‘except for U.S. Treasuries, what can
you hold? … U.S. Treasuries are the safe haven. For everyone, including
China, it is the only option … We hate you guys. Once you start issuing
$1–$2 trillion … we know the dollar is going to depreciate, so we hate you
guys but there is nothing much we can do.’44
This is true, at least in the short run. In the somewhat longer term,
however, what China can do is to move gradually away from the dollar
while encouraging others to make greater use of its own currency. The
primary obstacle here has long been Beijing’s refusal to allow the renminbi
to trade freely on global markets. Because this step would mean surrender-
ing control over capital flows in and out of the country, it is one the regime
has thus far been reluctant to take. Nonetheless, by making plain that the
status quo also has its risks, the recent crisis may have tipped the balance
in internal debate towards those who favour a somewhat more rapid tran-
sition. Assuming that China continues on its present upward trajectory
the renminbi will eventually join the dollar as a medium for international
exchange. For the time being, however, the United States will continue to
enjoy its exorbitantly privileged position.45

* * *

The full effects of the financial crisis have yet to be felt because, in many
respects, the crisis is not yet over. We do not yet know if the mix of policies
presently in place in the United States, China and elsewhere will be sufficient
over the next several years to restore steady global economic growth and
head off further resort to protectionism. Nor is it clear how Washington and
Beijing will address the structural imbalances in trade and finance brought
so plainly into view by the current crisis. With that said, let us close with
some speculative thoughts on the three sets of issues analysed above: the
impact of the crisis on the capacities of the two Pacific powers, their bilateral
relations and their dealings with the rest of the world.
48 | Aaron L. Friedberg

At least for the next several years, and possibly for much of the coming
decade, the 2008–09 crisis will make it more difficult for the United States
to generate the financial resources necessary to wage an escalating arms
competition with China. On the other hand, China’s seemingly rapid recov-
ery from the recent downturn may be illusory and could prove fleeting.
Unless they are supplemented by more effective measures aimed at increas-
ing domestic consumption, the policies used to revive aggregate demand
could end up hastening a deeper and more wide-ranging systemic crisis.
Finally, it is possible that concern over the consequences of a protracted
economic slowdown for social stability could introduce an element of
unpredictability and variance into China’s leadership politics, as well as
its defence and foreign policies. Among the more negative consequences,
from a US perspective, would be a succession struggle in which the winners
used extreme nationalist appeals to help discredit their opponents and gain
power, boosted military spending to pump up the economy and adopted a
more confrontational stance towards the rest of the world.
Even without such dramatic shifts in Beijing, economic issues are likely
to become a source of increasing friction in Sino-American relations over
the next several years. This will make it even more difficult for each country
to adopt the kinds of policies necessary to rebalance their overall economic
relationship. Instead of helping to damp down underlying geopolitical and
ideological impulses towards competition, economic factors could become
an accelerant. The recent crisis may also be speeding a degree of separation
between the US and Chinese economies, as American imports of Chinese
manufactured goods drop, China’s surpluses shrink and Beijing begins to
diversify its investments and increase its reliance on domestic demand and
internally generated capital.
Weakening interdependence across the Pacific could be accompanied by
a more open and direct attempt by China to build an East Asian economic
and political ‘community’ centred on itself and marginalising the United
States. (Such a tendency would be intensified if the United States adopts a
more protectionist stance towards others in the region, as well as toward
China.) While reports of the imminent demise of the dollar and of America’s
soft power relative to China’s are exaggerated, both developments have
 Implications of the Financial Crisis for the US–China Rivalry | 49

been made more plausible by the events of the past two years. The belief
that China’s rise is inevitable and may be accelerating is generating respect,
but also anxiety, and this is likely to intensify impulses toward balancing
that are already present across Asia. The inclination of others to bet on the
United States and to follow its lead will be determined, at least in part, by
perceptions of its willingness and ability to meet the economic challenges it
now confronts.

Acknowledgements
An earlier version of this paper was prepared for a seminar sponsored by the Long-Term
Strategy Group. The author wishes to thank Jonathan Kirshner and Jacqueline Newmyer
for their helpful comments.

Notes
1 For a comparison that goes beyond the
usual superficial parallels see Harold
James, The Creation and Destruction
of Value: The Globalization Cycle
(Cambridge, MA: Harvard University
Press, 2009). I will use the term ‘crisis’
here to refer both to the wave of bank
failures triggered by the bursting of
the American real-estate bubble and
the sharp and sustained slowdown in
global growth that followed.
2 For early efforts to assess the range of
cfm?fa=view&id=22851; Matthew
J. Burrows and Jennifer Harris,
‘Revisiting the Future: Geopolitical
Effects of the Financial Crisis’,
Washington Quarterly, vol. 32, no.
2, April 2009, pp. 27–38; Robert
D. Blackwill, ‘The Geopolitical
Consequences of the World
Economic Recession – A Caution’,
OP-275-RC (Santa Monica, CA: RAND
Corporation, 2009).
3 David J. Lynch, ‘U.S. May Face Years

possible effects see Aaron Friedberg of Sluggish Growth’, USA Today, 8

and Gabriel Schoenfeld, ‘The
Dangers of a Diminished America’,
Wall Street Journal, 21 October
2008, http://online.wsj.com/article/
SB122455074012352571.html; David
Rothkopf, ‘A World Transformed: The
Great Hollowing Out and the Rise of
New Threats’, Testimony before the
Armed Services Committee of the US
House of Representatives, 11 March
May 2009, http://www.usatoday.com/
money/economy/2009-05-07-slow-
us-economic-growth_N.htm. For a
relatively optimistic prediction of 2.6%
for the period 2010–20 see Martin S.
Feldstein, ‘U.S. Growth in the Decade
Ahead’, National Bureau of Economic
Research, Working Paper 15685,
January 2010.
4 Pieter Bottelier, ‘China and the

2009, http://www.carnegie International Financial Crisis’, in

endowment.org/publications/index. Ashley J. Tellis, Andrew Marble and
50 | Aaron L. Friedberg
Travis Tanner (eds), Strategic Asia
2009–10: Economic Meltdown and
Geopolitical Stability (Seattle, WA:
National Bureau of Asian Research,
2009), pp. 72–6.
5 See ‘OECD Sees Strong Growth,
Low Inflation in China’, Reuters, 19
November 2009, http://www.reuters.
com/article/idUSSGR00205520091119.
As of summer 2010, the World Bank
projected a 9.5% growth rate for the
year, falling to 8.5% in 2011. World
Bank, ‘China Quarterly Update:
June 2010’, p. 1, http://siteresources.
worldbank.org/CHINAEXTN/
Resources/318949-1268688634523/
Quarterly_June_2010.pdf. Based
on surprisingly strong growth
in exports, Morgan Stanley pre-
dicted that China would grow at
around 11% in 2010. Qing Wang,
‘China: Upgrading 2010 Forecasts
on Improved External Outlook’,
MorganStanley.com, 5 February 2010,
http://www.morganstanley.com/
views/gef/archive/2010/20100205-Fri.
html#anchorbafdbc0b-1262-11df-8ed5-
77be4e01ae79.
6 Much of the $585 billion in stimulus
spending was funnelled to local gov-
ernments through bank loans. See
Keith B. Richburg, ‘China’s Stimulus
Spending Created Infrastructure
Projects That May Not Be Needed’,
Washington Post, 18 June 2010, p. A22,
http://www.washingtonpost.com/
wp-dyn/content/article/2010/06/17/
AR2010061705794.html. Since the
onset of the crisis the share of national
income devoted to investment has
grown from 40% (a figure that is
already higher than that seen in
other Asian countries at the peak of
their growth) to 45%. Simon Tilford,
‘Rebalancing the Chinese Economy’,
Centre for European Reform, Policy
Brief, November 2009, p. 5.
7 Stephen P. Roach, ‘Manchurian
Paradox’, The National Interest, 27
April 2009, http://www.national-
interest.org/Article.aspx?id=21316.
For details of the stimulus plan see
Wayne M. Morrison, China and the
Global Financial Crisis: Implications for
the United States (Washington DC:
Congressional Research Service, 2009),
pp. 5–7.
8 Edward Wong, ‘China’s Export
Economy Begins Turning Inward’,
New York Times, 24 June 2010, http://
www.nytimes.com/2010/06/25/world/
asia/25china.html.
9 Mary Hennock, ‘Going Back to
the Farm’, Newsweek, 21 February
2009, http://www.newsweek.
com/2009/02/20/going-back-to-the-
farm.html.
10 The last published figures reported a
total of 89,000 incidents. Unconfirmed
reports suggest that there may have
been as many as 58,000 incidents
in the first quarter of 2009 alone.
The latter figure has circulated on
various left-wing blogs and web-
sites in the West. See Charlie Hore,
‘Will This Be China’s Century?’,
Socialist Review, January 2010, http://
www.socialistreview.org.uk/article.
php?articlenumber=11111.
11 ‘China Braces for Social Unrest’, Radio
Free Asia, 22 December 2008, http://
www.rfa.org/english/news/china/
unrest-12222008100212.html.
12 Chris Buckley, ‘China Seen
Facing Wave of Unrest in 2009’,
Reuters, 6 January 2009, http://
 Implications of the Financial Crisis for the US–China Rivalry | 51
www.reuters.com/article/
idUSTRE5050F520090106.
13 See Malcolm Moore, ‘China Summons
Police Chiefs to Crisis Meeting Over
Unrest’, Telegraph, 27 February 2009,
http://www.telegraph.co.uk/news/
worldnews/asia/china/4862517/
China-summons-police-chiefs-to-
crisis-meeting-over-unrest.html;
‘China to Train Judges on Social
Unrest’, AFP, 2 September 2009, http://
www.google.com/hostednews/afp/
article/ALeqM5h4mr3DSeqS9CV
vd8bGFxH1TYNOuw.
14 Minxin Pei, ‘Will the Chinese
Communist Party Survive the
Crisis?’, Foreign Affairs, March
2009, http://www.foreignaffairs.
com/articles/64862/minxin-pei/
will-the-chinese-communist-party-
survive-the-crisis.
15 Military spending could be a sub-
stitute for yet more investment in
civilian infrastructure. This possibility
is mentioned in passing (with refer-
ence to both China and India) in an
article by two members of the staff
of the National Intelligence Council
but, so far as I am aware, it has not
been explored in any detail. Matthew
J. Burrows and Jennifer Harris,
‘Revisiting the Future: Geopolitical
Effects of the Financial Crisis’,
Washington Quarterly, vol. 32, no. 2,
April 2009, p. 37.
16 ‘Seeing Red’, Economist, 13 June 2009,
p. 33.
17 Center for Geoeconomic Studies,
‘Quarterly Update: The Recession in
Historical Context’, 5 June 2009, avail-
able at www.cfr.org/cgs.
18 Congressional Budget Office,
‘The Long Term Budget Outlook’,
June 2009, p. 2, http://www.cbo.
gov/ftpdocs/102xx/doc10297/
SummaryforWeb_LTBO.pdf.
19 Ibid.
20 Center for Geoeconomic Studies, ‘U.S.
Interest vs. Defense Spending’, 26
October 2009, available at http://blogs.
cfr.org/geographics/.
21 The intensity of this pressure will
depend in part on the ultimate fiscal
impact of recent health-care reforms.
If these winds up slowing the growth
of health-care costs, as promised,
the pressures will obviously be less.
Unfortunately, the opposite scenario
is at least equally plausible. For one
pessimistic assessment see Robert
Samuelson, ‘Passing Health Reform
Could be a Nightmare for Obama’,
Washington Post, 21 December 2009,
http://www.washingtonpost.com/
wp-dyn/content/article/2009/12/20/
AR2009122002127.html.
22 See Dov S. Zakheim, ‘Security
Challenges Arising from the Global
Economic Crisis’, remarks to the
House Committee on Armed Services,
11 March 2009, http://www.fpri.org/
enotes/200903.zakheim.security
economiccrisis.html.
23 Pew Foundation, ‘America’s Place in
the World, 2009’, December 2009, pp.
1–3, http://people-press.org/reports/
pdf/569.pdf. 53% of the public sees
China as a ‘major threat’ versus only
21% of members of the Council on
Foreign Relations.
24 Roach, ‘Manchurian Paradox’.
25 Recent polls find American executives
increasingly disenchanted with the
Chinese market. See Jamil Anderlini,
‘U.S. Companies Find China Less
Welcoming’, Financial Times, 22
52 | Aaron L. Friedberg
March 2010, http://www.ft.com/
cms/s/0/66958052-355c-11df-9cfb-
00144feabdc0.html.
26 See, for example, ‘Escalation of
U.S.–China Trade Row Biggest Global
Threat – M. Stanley’, 20 November
2009, http://www.reuters.com/article/
idUSSIN47883220091120.
27 In March 2010 a bipartisan group of 14
senators introduced legislation calling
for measures intended to force Beijing
to appreciate the renminbi. Bruce
Stokes, National Journal, 20 March
2010, p. 61. The fact that some eminent
economists now agree that ‘something
must be done about China’s currency’
gives such proposals a legitimacy and
credibility they previous lacked. Paul
Krugman, ‘The Chinese Disconnect’,
New York Times, 22 October 2009,
http://www.nytimes.com/2009/10/23/
opinion/23krugman.html.
28 ‘Obama Warns Strains Unless
U.S., China Balance Growth’,
Reuters, 11 November 2009,
http://www.reuters.com/article/
idUSTRE5A85AQ20091111.
29 See People’s Bank of China, ‘Further
Reform the RMB Exchange Rate
Regime and Enhance the RMB
Exchange Rate Flexibility’, 19 June
2010, http://www.pbc.gov.cn/english/
detail.asp?col=6400&id=1488.
30 Rebecca Christie and Ian Katz,
‘Geithner Welcomes China’s
Yuan Move, Calls for “Vigorous
Implementation”’, Bloomberg, 20 June
2010, http://www.bloomberg.com/
news/2010-06-19/geithner-welcomes-
china-s-yuan-move-calls-for-vigorous-
implementation-.html.
31 For an early use of this analogy see
Lawrence H. Summers, ‘The United
States and the Global Adjustment
Process’, speech at the Institute
for International Economics,
23 March 2004, http://www.iie.
com/publications/papers/paper.
cfm?researchid=200.
32 Glenn Kessler, ‘Clinton’s Candor
Draws Mixed Reviews’, Washington
Post, 23 February 2009, http://www.
washingtonpost.com/wp-dyn/content/
article/2009/02/22/AR2009022200867.
html; Indira A.R. Lakshmanan,
‘Clinton Urges China to Keep Buying
U.S. Treasury Securities’, Bloomberg,
22 February 2009, http://www.
bloomberg.com/apps/news?pid=20601
070&sid=apSqGtcNsqSY.
33 Helene Cooper, Michael Wines
and David E. Sanger, ‘China’s Role
as Lender Alters Dynamics for
Obama’s Visit’, New York Times, 14
November 2009, http://www.nytimes.
com/2009/11/15/world/asia/15china.
html.
34 See the interview with Gao Xiqing,
president of the China Investment
Corporation in James Fallows, ‘Be
Nice to the Countries that Lend You
Money’, Atlantic, December 2008, p.
68.
35 Daniel W. Drezner, ‘Bad Debts:
Assessing China’s Financial Influence
in Great Power Politics’, International
Security, vol. 34, no. 2, Fall 2009, pp.
7–45. Quote on page 42.
36 C. Fred Bergsten, ‘The Dollar
and the Deficits’, Foreign Affairs,
November–December 2009,
http://www.foreignaffairs.com/
articles/65446/c-fred-bergsten/the-
dollar-and-the-deficits. For an analysis
that assumes that neither country will
dramatically alter its policies, despite
 Implications of the Financial Crisis for the US–China Rivalry | 53
the crisis, see Geoffrey Garrett, ‘G-2
in G-20: China, the United States and
the World after the Global Financial
Crisis’, Working Paper, University
of Sydney, United States Studies
Centre, November 2009. Among his
other findings, Garrett concludes that
‘after a decade of wary but stable
coexistence, China–US relations are
poised to turn increasingly conflictual
… After the financial crisis, Sino-
American economic frictions will be
more intense and more important
than ever before’ (p. 1).
37 Jeffry A. Frieden, ‘Global Imbalances,
National Rebalancing, and the
Political Economy of Recovery’,
Council on Foreign Relations,
Center for Geoeconomic Studies and
International Institutions and Global
Governance Program, Working Paper,
October 2009, p. 6.
38 Michael Pettis, ‘Sharing the
Pain: The Global Struggle Over
Savings’, Carnegie Endowment for
International Peace, Policy Brief 84,
November 2009, p. 7.
39 For a discussion of this and other
scenarios, see ibid., pp. 6–7. For
one proposal along these lines see
Richard Rosecrance, ‘Improving U.S.–
China Relations: The Next Steps’,
U.S.–China Relations Project Policy
Memo, Harvard University, John
F. Kennedy School of Government,
August 2009.
40 The link between domestic con-
sumption and regional integration is
suggested in Michael Mastanduno,
‘Economics, Security and China’s
Rise: Five Future Scenarios’, Five-
University Collaboration on East
Asian Security Cooperation and
Regional Governance, Princeton
University, December 2009.
41 For a thorough analysis of the pos-
sible implications of the dollar’s
loss of reserve-currency status see
Jonathan Kirshner, ‘Dollar Primacy
and American Power: What is at
Stake?’, Review of International Political
Economy, vol. 15, no. 3, August 2008,
pp. 418–38.
42 Christopher B. Whitney and David
Shambaugh, ‘Soft Power in Asia:
Results of a 2008 Multinational Survey
of Public Opinion’, The Chicago
Council of World Affairs in partner-
ship with the East Asia Institute,
http://www.thechicagocouncil.org/
UserFiles/File/POS_Topline Reports/
Asia Soft Power 2008/Soft Power
202008_full report.pdf.
43 James, The Creation and Destruction of
Value, p. 196.
44 Luo Ping, Director-General of China’s
Banking Regulatory Commission,
quoted in Drezner, ‘Bad Debts’, p. 41.
45 For a number of recent assess-
ments, all of which reach similar
conclusions, see Michael Schuman,
‘Replacing the Dollar: China’s Big
Plans for its Currency’, Time, 20 July
2009, http://www.time.com/time/
world/article/0,8599,1911671,00.
html?iid=tsmodule; Melissa Murphy
and Wen Jin Yuan, ‘Is China Ready
to Challenge the Dollar?’, PacNet
Newsletter, no. 72, Pacific Forum
CSIS, Honolulu, Hawaii, 5 November
2009, http://csis.org/files/publication/
pac0972.pdf; Barry Eichengreen, ‘The
Irresistible Rise of the Renminbi’,
Project Syndicate, December 2009,
http://www.project-syndicate.org/
commentary/eichengreen11/English.
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