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U.S.-CHINA RELATIONS: SHORT AND LONG-TERM IMPLICATIONS FOR THE GLOBAL ECONOMY

U.S.-CHINA RELATIONS: SHORT AND LONG-TERM IMPLICATIONS

FOR THE GLOBAL ECONOMY
The war in Ukraine is a focusing event in the shifting economic and political dynamics between the
United States and China. Key to sketching the implications of these dynamics on the global
economy are four interrelated topics: U.S.-China decoupling, the Ukraine war, major economies’
balancing acts between the U.S. and China, and implications for the short and long-term future of
the international economic order. This article summarizes these developments and makes a few
short and long-term predictions.

Decoupling
In recent years, China has publicly criticized the U.S.-led, dollar-based international economic
order, calling (https://www.clevelandfed.org/en/newsroom-and-events/publications/economic-
Kenneth Gatten III, MPP '23, is
commentary/economic-commentary-archives/2009-economic-commentaries/ec-20090309-
pursuing his public policy degree to
replacing-the-dollar-with-special-drawing-rights-will-it-work-this-time.aspx) to replace the dollar as
help human and economic
the premier currency for settlements, invoices, and foreign exchange reserves. China has even
development efforts in formulating
promoted (https://www.airuniversity.af.edu/Portals/10/CASI/documents/Translations/2022-02-
sound evidence-based policies.
04%20China%20Russia%20joint%20statement%20International%20Relations%20Entering%20a%
20New%20Era.pdf) a new “multipolar” world order split between itself and the U.S.

Since 2008, the U.S. has talked about decoupling from China. Arguments cite the U.S.’s trade
deficit with China and China’s intellectual property theft, currency manipulation, human rights
abuses, maritime law violations in the South China Sea, and more.
intro - Q1
Financially, however, neither country has seriously moved to decouple.

In possession of $1.05 trillion of low-return U.S. Treasury securities, China’s central bank has tried
to diversify its portfolio but must continue buying these securities to create demand for the dollar,
which boosts its value relative to the renminbi, making Chinese exports more competitive and
preserving the value of its central bank’s dollar-denominated holdings.

Nor has the U.S. begun to decouple financially from China, whose purchases of Treasury securities
paper over the U.S. trade deficit.

But whether the U.S. and China are decoupling in trade is more complicated.

The U.S. and China are economically interdependent. The U.S. is China’s largest export market,
interdependence
and China is the U.S.’s largest import market. China relies on the U.S. for roughly
(https://www.worldstopexports.com/chinas-top-import-partners/) $580 billion of exports per year,
total foreign direct investments of $124 billion, joint ventures in high-growth industries, and more.
The U.S. relies on China for economic growth in investments, people flow, idea flows, and trade in
key industries. Estimates suggest (https://www.uschamber.com/international/understanding-us-
china-decoupling-macro-trends-and-industry-impacts) that decoupling would cost the American
aviation industry up to $875 billion by 2038; the semiconductor industry up to $159 billion and
100,000 jobs; the medical services industry more than $479 billion over the next decade; and
more.

But China is transitioning to a value-added, high-growth, high-tech economic model to replace its china new model
cheap manufactured goods export-led model, which is suffering from increasing labor prices.
China wants to establish its companies as leaders in sectors like 5G, artificial intelligence,
semiconductors, and more. They desire the rents of technological leaders and control over
strategic sectors that shape the on-ramping and growth of technology.

In response, the U.S. is attempting to stymie the development of Chinese technology, in part by
levying export controls against U.S. manufacturers of technologies such as semiconductors and
import controls against the purchase of Chinese technology like Huawei smartphones.

Ukraine War
The Ukraine war has confirmed that trade does not engender political and economic liberalization.
Many in the West are now worried that authoritarian states like Russia and China will form anti-
Western economic blocs. Circumstantial evidence
(https://www.foreignaffairs.com/articles/ukraine/2022-03-21/china-helping-russia-hide-money) that
China might be helping Russia hide money is making waves.

But China is still afraid of U.S. secondary sanctions: so far, it has refused
(https://www.atlanticcouncil.org/blogs/econographics/global-sanctions-dashboard-special-russia-
edition/) to use a swap line with Russia’s central bank to rapidly convert its assets to cash.

China is clearly differentiating itself from the U.S.; however, calling

(https://www.scmp.com/business/banking-finance/article/3174030/crazy-us-sanctions-against-
china-russia-weaponise) U.S. sanctions on Russia “crazy” and intimating that China is a better
place to do business. This is not a coincidence, given China’s strategy of spearheading economic
growth in East Asia, where the new China-led Regional Comprehensive Economic Partnership
(RCEP) is projected (https://www.brookings.edu/blog/order-from-chaos/2020/11/16/rcep-a-new-
trade-agreement-that-will-shape-global-economics-and-politics/) to add $500 billion to global
trade by 2030.

China also caters to East Asian clients with its Cross-Border Interbank Payment System (CIPS),
billed as a renminbi-based alternative to Western payments systems.

Despite China’s ambition

(http://www.pbc.gov.cn/goutongjiaoliu/113456/113469/4467138/2022020818374845311.pdf) to
become a leader in global finance, it is running into significant hurdles. One is the renminbi’s share
of global currency, which is only 1.92 percent—disproportionate to China’s share of the global
economy. Capital controls imposed on the renminbi also lend it poor convertibility, which, given
China’s resistance to undergo capital account liberalization, does not seem poised to change any
time soon.

Balancing Acts
If the United Kingdom Foreign Secretary Liz Truss’s April 2022 speech
(https://www.gov.uk/government/speeches/foreign-secretarys-mansion-house-speech-at-the-lord-
mayors-easter-banquet-the-return-of-geopolitics) on “the return of geopolitics” is any indication,
EU leaders are more likely to heighten their political expectations of countries with which they do
business in the future. Advocating a newly outward-looking G7 and EU, Truss takes aim at China
and denounces its human rights abuses, and attempts to leverage economic ties to exact political
concessions around the world, suggesting China should be countered by a bloc of newly assertive
democracies led by the West.

In the wake of Russia’s invasion of Ukraine, these strict, values-based expectations of China
recently saw the EU ease off (https://www.theguardian.com/world/2021/may/04/eu-suspends-
ratification-of-china-investment-deal-after-sanctions) trade and investment deal negotiations with
China, with whom the bloc was already reluctant to deal after news of China’s human rights
abuses against Uyghur Muslims.

Future of the International Economic Order

In the short run, the U.S. will not reduce its financial dependence on China as the latter continues
to finance its current account deficit and stimulate growth in critical domestic industries. But the
U.S. will begin to attempt to shift its supply chains elsewhere, including
(https://www.marketplace.org/2022/05/02/shifting-supply-chains-settle-on-mexico/) Mexico, where
labor costs are in some cases cheaper than in China.

Over the next decade or two, this will become increasingly attractive to the U.S. as China faces a
slowing birth rate, a diminishing workforce of cheap labor, and an aging population with few social
security benefits.
It also remains to be seen whether China’s play to court developing countries will work out in the
long run. Of course, China is struggling to generate the same kind of material wealth for its
average citizen compared to the U.S., given domestic constraints on arable land and natural
resources. So, China must compete with the U.S. for commodities from developing countries in
Africa, South America, and East Asia.

But the mixed record of China’s Belt and Road Initiative has hurt its reputation and earned China
few political allies. In fact, China has few allies at all and unreliable
(https://asia.nikkei.com/Opinion/China-s-friends-are-few-and-unreliable) ones at that.

Also, China’s unwillingness to liberalize its capital account and relinquish capital controls prevent it
from internationalizing the renminbi. This is a fundamental hurdle to the expansion of the CIPS
system, which will not become a viable alternative to Western payments systems until the renminbi
is easily convertible.

In the meantime, the West’s united response to Russia’s invasion of Ukraine will only result in a
more hostile relationship between China and democracies allied with the West. Some even argue
(https://www.washingtonpost.com/outlook/2022/04/28/sanctioning-russia-future-dollar/) that it will
strengthen the ascendancy of the dollar-based economic order for the foreseeable future.

Though, it remains to be seen whether a united West and allied democracies can present a
coherent, united front in the evolution of the global economic order.

The transparency and openness of financial markets in Western democracies make them a more
desirable (https://www.cnas.org/publications/commentary/how-u-s-sanctions-depend-on-the-
federal-reserve) place to do business. But the U.S. must establish a stronger economic presence in
East Asia if it should win over developing countries with ties to China. These countries prioritize
building competitive domestic industries and enriching their citizens over enforcing the values of
an open, rules-based international order. India is a barometer of this dynamic, currently taking
advantage of Western sanctions against Russia to purchase its weapons systems and oil at low
prices.

Currently, reports indicate (https://www.politico.com/news/2022/05/02/antony-blinken-china-

asean-summit-00029368) that the Biden administration is now developing a more “sophisticated”
approach toward China. But chances that the U.S. will open itself to increased trade with
developing East Asian countries seem low given the continued presence of isolationist political
elements in the U.S., such as those that blocked the adoption of the Trans-Pacific Partnership in
2017. Over time, the U.S. risks hampering its ability to project leadership abroad if it does not stem
sources of political dysfunction at home, including widening income inequality and prohibitive
costs of higher education.

So, in the realms of trade and foreign investment, the world economy could fracture into discrete
blocs in the short term. Western economic powers, including allied democracies like Japan and
South Korea, might form one bloc; China, its major trading partners in East Asia, and other allied
pariah states could form another. But China’s financial infrastructure will not be robust or
independent enough to circumvent its reliance on Western systems. China will also wish to
maintain its robust ties to the U.S. in trade and investment as long as they fuel its targeted high
growth rates.

In the long run, however, things could look different. If alliances led by the West succeed in
forming larger economic and security-based partnerships that win over developing powers like
India and China and maintain capital controls on the renminbi, then China’s rise in global finance
could be effectively countered. China’s shrinking workforce and comparatively worse ability to
attract talented labor from abroad will also prove more difficult to overcome as it transitions to a
value-added, high-tech economic model. And the U.S. will more cheaply decouple its supply
chains from China over time.

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