The Newest Superpower

In the midst of the worst economic crisis since the Great Depression, a newworld order is emerging -- with its center gravitating towards China. Thestatistics speak for themselves. The International Monetary Fund (IMF) predictsthe world's gross domestic product (GDP) will shrink by an alarming 1.3% thisyear. Yet, defying this global trend, China expects an annual economic growthrate of 6.5% to 8.5%. During the first quarter of 2009, the world's leadingstock markets combined fell by 4.5%. In contrast, the Shanghai stock exchangeindex leapt by a whopping 38%. In March, car sales in China hit a record 1.1million, surpassing the U.S. for the third month in a row.

"Despite its severe impact on China's economy," said Chinese PresidentHu Jintao, "the current financial crisis also creates opportunity for thecountry." It can be argued that the present fiscal tsunami has, in fact,provided China with a chance to discard its pioneering reformer's leadingguideline. "Hide your capability and bide your time" was the wayformer head of the Communist Party Deng Xiaoping once put it. No longer.

Recognizing that its time has indeed come, Beijing has decided to play anactive, interventionist role in the international financial arena. Backed byChina's $2 trillion in foreign exchange reserves, its industrialists have goneon a global buying spree in Africa and Latin America, as well as in neighboringRussia and Kazakhstan, to lock up future energy supplies for its ravenouseconomy. At home, the government is investing heavily not only in majorinfrastructure, but also in its much neglected social safety net, its healthcare system, and long overlooked rural development projects -- partly to bridgethe increasingly wide gap between rural and urban living standards.

Among those impressed by the strides Beijing has made since launching its $585billion stimulus package in September is the Obama administration. It views thecontinuing rise in China's GDP as an effective corrective to the contracting GDPof almost every other major economy on the planet, except India's. So it hasstopped arguing that, by undervaluing its currency -- the yuan -- with respectto the U.S. dollar, China is making its products too cheap, thus puttingcompeting American goods at a disadvantage in foreign markets.

The Secret of China's Success

What is the secret of China's continuing success in the worst of times? As astart, its banking system -- state-controlled and flush with cash -- has openedits lending spigots to the full, while bank credit in the U.S. and the EuropeanUnion (EU) still remains clogged up, if not choked off. Therefore, consumerspending and capital investment have risen sharply.

Ever since China embarked on economic liberalization under the leadership ofDeng Xiaoping in 1978, it has experienced economic ups and downs, including highinflation, deflation, recessions, uneven development of its regions, and awidening gap between the rich and the poor, as well as between the urban and therural -- all characteristics associated with capitalism.

While China's Communist leaders have responded with a familiar range of fiscaland monetary tools like adjusting interest rates and money supply, they haveachieved the desired results faster than their capitalist counterparts. This isprimarily because of the state-controlled banking system where, for instance,government-owned banks act as depositories for the compulsory savings of allemployees.

In addition, the "one couple, one child" law, enacted in 1980 tocontrol China's exploding population, and a sharp decline in the state'ssocial-support network for employees in state-owned enterprises, compelledparents to save. Add to this the earlier collapse of a rural cooperative healthinsurance program run by agricultural cooperatives and communes -- and manyChinese parents were left without a guarantee of being cared for in theirdeclining years. This proved an additional incentive to set aside cash. Theresulting rise in savings filled the coffers of the state-controlled banks.

On top of that came China's admission to the World Trade Organization (WTO) in2001, which led to a dramatic jump in its exports. An average economic expansionof 12% a year became the norm.

When the credit crash in North America and the EU caused a powerful drop inChina's exports, throwing millions of migrant workers in the industrializedcoastal cities out of work, the authorities in Beijing focused on controllingthe unemployment rate and maintaining the wages of the employed. They can nowclaim an urban unemployment rate of a mere 4.2% because many of the laid-offfactory workers returned to their home villages. Those who did not wereencouraged to enroll in government-sponsored retraining programs to acquirehigher skills for better jobs in the future.

Whereas most Western leaders could do nothing more than castigate bankersfilling their pockets with bonuses as the balance sheets of their companies wentcrimson red, the Chinese government compelled top managers at major state-ownedcompanies to cut their salaries by 15% to 40% before tinkering with theremuneration of their workforce.

To ensure the continued rapid expansion of China's economy, which is directlyrelated to the country's level of energy consumption, its leaders are inkingmany contracts for future supplies of oil and natural gas with foreigncorporations.

Energy Security

Once China became an oil importer in 1993, it proved voracious. Its importsdoubled every three years. This made it vulnerable to the vagaries of theinternational oil market and led the government to embed energy security in itsforeign policy. It decided to actively participate in hydrocarbon prospectingand energy production projects abroad as well as in transnational pipelineconstruction. By now, the diversification of China's foreign sources of oil andgas (and their transportation) has become a cardinal principle of its foreignministry.

Conscious of the volatility of the Middle East, the leading source of oilexports, China has scoured Africa, Australia, and Latin America for petroleumand natural gas deposits, along with other minerals needed for industry andconstruction. In Africa, it focused on Angola, Congo, Nigeria, and Sudan. By2004, China's oil imports from these nations were three-fifths the size of thosefrom the Persian Gulf region.

Nearer home, China began locking up energy deals with Russia and the CentralAsian republic of Kazakhstan long before the current collapse in oil prices andthe global credit crunch hit. Now, reeling from the double whammy of low energyprices and the credit squeeze, Russia's leading oil company and pipelineoperator recently agreed to provide 300,000 barrels per day (bpd) in additionaloil to China over 25 years for a $25 billion loan from the state-controlledChina Development Bank. Likewise, a subsidiary of the China National PetroleumCorp agreed to lend Kazakhstan $10 billion as part of a joint venture to developits hydrocarbon reserves.

Similarly, Beijing continued to make inroads into the oil and gas regions ofSouth America. As relations between Hugo Chavez's Venezuela and the Bushadministration worsened, ties with China strengthened. In 2006, during hisfourth visit to Beijing since becoming president in 1999, Chavez revealed thatVenezuela's oil exports to China would treble in three years to 500,000 bpd.Along with a joint refinery project to handle Venezuelan oil in China, theChinese companies contracted to build a dozen oil-drilling platforms, supply 18oil tankers, and collaborate with PdVSA, the state-owned Venezuelan oil company,to explore new oilfields in Venezuela.

During Chinese Vice President Xi Jinping's tour of South America in January2009, the China Development Bank agreed to loan PdVSA $6 billion for oil to besupplied to China over the next 20 years. Since then China has agreed to doubleits development fund to $12 billion, in return for which Venezuela is toincrease its oil shipments from the current 380,000 bpd to one million bpd.

The China Development Bank recently decided to lend Brazil's petroleum company$10 billion to be repaid in oil supplies in the coming years. This figure isalmost as large as the $11.2 billion that the Inter-American Development Banklent to various South American countries last year. China had established itscommercial presence in Brazil earlier by offering lucrative prices for iron oreand soybeans, the export commodities that have fuelled Brazil's recent economicgrowth.

Similarly, Beijing broke new ground in the region by giving Buenos Aires accessto more than $10 billion in yuans. Argentina was one of three major tradingpartners of China given this option, the others being Indonesia and South Korea.

Will the Yuan Become an International Currency?

Without much fanfare, China has started internationalizing the role of itscurrency. It is in the process of increasing the yuan's role in Hong Kong.Though part of China, Hong Kong has its own currency, the Hong Kong Dollar.Since Hong Kong is one of the world's freest financial markets, the projectedarrangement will aid internationalization of the yuan.

In retrospect, an important aspect of the G-20 Summit in London in early Aprilcentered around what China did. It aired its in-depth analysis of the currentfiscal crisis publicly and offered a bold solution.

In a striking on-line article, Zhou Xiaochuan, governor of China's central bank,referred to the "increasingly frequent global financial crises" thathave embroiled the world. The problem could be traced to August 1971, whenPresident Richard Nixon took the dollar off the gold standard. Until then, $35bought one ounce of gold stored in bars in Fort Knox, Kentucky -- the ratehaving been fixed in 1944 during World War II by the Allies at a conference inBretton Woods, New Hampshire. At that time, the greenback was also named as theglobe's reserve currency. Since 1971, however, it has been backed by nothingmore tangible than the credit of the United States.

A glance at the past decade and a half shows that, between 1994 and 2000 alone,there were economic crises in nine major countries which impacted the globaleconomy: Mexico (1994), Thailand-Indonesia-Malaysia-South Korea-the Philippines(1997-98), Russia and Brazil (1998), and Argentina (2000).

According to Zhou, financial crises resulted when the domestic needs of thecountry issuing a reserve currency clashed with international fiscalrequirements. For instance, responding to the demoralization caused by the 9/11attacks, the U.S. Federal Reserve Board drastically reduced interest rates to analmost-record low of 1% to boost domestic consumption at a time when rapidlyexpanding economies outside the United States needed higher interest rates tocool their growth rates.

"The [present] crisis called again for creative reform of the existinginternational reserve currency," Zhou wrote. "A super-sovereignreserve currency managed by a global institution could be used to both createand control global liquidity. This will significantly reduce the risks of afuture crisis and enhance crisis management capability."

He then alluded to the Special Drawing Rights (SDR) of the InternationalMonetary Fund. The SDR is a virtual currency whose value is set by a currency"basket" made up of the U.S. dollar, the European euro, the Britishpound, and the Japanese yen, all of which qualify as reserve currencies, withthe greenback being the leader. Ever since the SDR was devised in 1969, the IMFhas maintained its accounts in that currency.

Zhou noted that the SDR has not yet been allowed to play its full role. If itsrole was enhanced, he argued, it might someday become the global reservecurrency.

Zhou's idea received a positive response from the Kremlin, which suggestedadding gold to the IMF's currency basket as a stabilizing element. Its owncurrency, the ruble, is already pegged to a basket that is 55% the euro and 45%the dollar. Within a decade of its launch, the euro has become the second mostheld reserve currency in the world, garnering nearly 30% of the total comparedto the dollar's 67%.

Treasury Secretary Timothy Geithner's immediate reaction to Zhou's article was:"China's suggestion deserves some consideration." Nervous financialmarkets in the U.S. took this as a sign from the Treasury Secretary that thedollar was losing its primacy. Geithner retreated post-haste. And PresidentObama quickly joined the fray, saying: "I don't think there is need for aglobal currency. The dollar is extraordinarily strong right now."

Actually, maintaining the customary Chinese discretion, Zhou never mentioned thestate of the U.S. dollar in his article, nor did he even imply that the yuanshould be included in the super-sovereign currency he proposed. Yet it was clearto all that at a crucial moment -- with world leaders about to meet in London todevise a way to defuse the most severe fiscal crisis since the Great Depression-- that a China which had bided its time, even though it had the third largesteconomy on the planet, was now showing its strong hand.

All signs are that Washington will be unable to restore the status quo anteafter the present "great recession" has finally given way to recovery.In the coming years, its leaders will have to face reality and concede, howeverreluctantly, that the economic tectonic plates are shifting -- and that it islosing financial power to the thriving regions of the Earth, the foremost ofwhich is China.