The renminbi seems to be back in business as a Chinese tool of retaliation against US tariffs. A 1.5 per cent fall in the currency early this month in response to proposed new US tariffs was only a start. Since the middle of August the renminbi has weakened further, and the exchange rate is now 4 per cent weaker than at the start of the month. We may well see more of a ‘weaponized’ renminbi, but there are four good reasons why Beijing might be wise to think before shooting.

The first has to do with how China seeks to promote its place in the world. China has been at pains to manage the collapse of its relations with the US in a way that allows it to present itself as an alternative pillar of global order, and as a source of stability in the international system, not to mention moral authority. This has deep roots.

Anyone investigating the history of Chinese statecraft will quickly come across an enduring distinction in Chinese thought: between wang dao, the kingly, or righteous way, and ba dao, the way of the hegemon. Since Chinese thinkers and officials routinely describe US behaviour since the Second World War as hegemonic, it behoves Chinese policymakers to do as much as possible to stay on moral high-ground in their behaviour towards Washington. Only in that way would President Xi be able properly to assert China’s claim to leadership.

Indeed, China has a notable track record of using exchange rate stability to enhance its reputation as a force for global stability. Both in the aftermath of the Asian crisis in 1997, and of the Global Financial Crisis in 2008, Chinese exchange rate stability was offered as a way of demonstrating China’s trustworthiness and its commitment to multilateral order.

Devaluing the renminbi in a meaningful way now might have a different rationale, but the cost to China’s claim to virtue, and its bid to offer itself as a guardian of global stability, might be considerable.

That’s particularly true because of the second problem China has in thinking about a weaker renminbi: it may not be all that effective in sustaining Chinese trade. One reason for this is the increasing co-movement with the renminbi of currencies in countries with whom China competes.

As the renminbi changes against the dollar, so do the Taiwan dollar, the Korean won, the Singapore dollar and the Indian rupee. In addition, the short-run impact of a weaker renminbi is more likely to curb imports than to expand exports, and so its effects might be contractionary. 

An ineffective devaluation of the renminbi would be particularly useless because of the third risk China needs to consider, namely the risk of retaliation by the US administration. Of this there is already plenty of evidence, of course.

The US Treasury’s declaration of China as a ‘currency manipulator’ on 5 August bears little relationship to the actual formal criteria that the Treasury uses to define that term, but equally the US had warned the Chinese back in May that these criteria don’t bind its hand. By abandoning a rules-based approach to the definition of currency manipulation, the US has opened wide the door to further antagonism, and Beijing should have no doubt that Washington will walk through that door if it wants to.

The fourth, and possibly most self-destructive, risk that China has to consider is that a weaker renminbi might destabilize China’s capital account, fuelling capital outflows that would leave China’s policymakers feeling very uncomfortable.

Indeed, there is already evidence that Chinese residents feel less confident that the renminbi is a reliable store of value, now that there is no longer a sense that the currency is destined to appreciate against the dollar. The best illustration of this comes from the ‘errors and omissions’, or unaccounted-for outflows, in China’s balance of payments.

The past few years have seen these outflows rise a lot, averaging some $200 billion per year during the past four calendar years, or almost 2 per cent GDP; and around $90 billion in the first three months of 2019 alone. These are scarily large numbers.

The risk here is that Chinese expectations about the renminbi are ‘adaptive’: the more the exchange rate weakens, the more Chinese residents expect it to weaken, and so the demand for dollars goes up. In principle, the only way to deal with this risk would be for the People's Bank of China (PBOC) to implement a large, one-off devaluation of the renminbi to a level at which dollars are expensive enough that no one wants to buy them anymore.

This would be very dangerous, though: it presupposes that the PBOC could know in advance the ‘equilibrium’ value of the renminbi. It would take an unusually brave central banker to claim such foresight, especially since that equilibrium value could itself be altered by the mere fact of such a dramatic change in policy.

No one really knows precisely by what mechanism capital outflows from China have accelerated in recent years, but a very good candidate is tourism. The expenditure of outbound Chinese tourists abroad has risen a lot in recent years, and that increase very closely mirrors the rise in ‘errors and omissions’. So the suspicion must be that the increasing flow of Chinese tourists – nearly one half of whom last year simply travelled to capital-controls-free Hong Kong and Macao – is just creating opportunities for unrecorded capital flight.

This raises a disturbing possibility: that the most effective way for China to devalue the renminbi without the backfire of capital outflows would be simultaneously to stem the outflow of Chinese tourists. China has form in this regard, albeit for differing reasons: this month it suspended a programme that allowed individual tourists from 47 Chinese cities to travel to Taiwan.

A more global restriction on Chinese tourism might make a devaluation of the renminbi ‘safer’, and it would have the collateral benefit of helping to increase China’s current account surplus, the evaporation of which in recent years owes a lot to rising tourism expenditure and which is almost certainly a source of unhappiness in Beijing, where mercantilism remains popular.

But a world where China could impose such draconian measures would be one where nationalism has reached heights we haven’t yet seen. Let’s hope we don’t go there.

This article was originally published in the Financial Times.

Seeing geo-strategic rivalry between the US and China as the sole variable in Asia-Pacific security risks becoming a self-fulfilling prophecy, according to a forthcoming Chatham House paper.            

As Xi Jinping’s visit to the US approaches, The Asia-Pacific Power Balance: Beyond the US–China Narrative, warns against deploying Cold War-type narratives that pit the two countries against each other. Such narratives not only misunderstand the complexity of the region and the growing influence of India, Japan and Indonesia, but also risk increasing the likelihood of conflict and of missing vital opportunities for future cooperation.                

The paper, by John Nilsson-Wright, Tim Summers and Xenia Wickett argues that by focusing too heavily on the US and China, policymakers risk narrowing the aperture through which they evaluate policy choices regarding major regional challenges. Some of the key findings include the following:

Military

• Despite rapidly rising defence spending across Asia, the relative importance of traditional military means is declining relative to instruments such as development assistance and cyber offence.
• The militaries of Japan and India are becoming – in very different ways – more versatile and potentially expanding their remits. In the future, there will be a larger number of more capable military powers in the region, including South Korea and Vietnam.
• Current perceptions that the main dynamic is China’s rising military capabilities outstripping others in the region, therefore, need to be tempered. India’s defence spending, for example, as a percentage of GDP has surpassed China’s for the past several decades.

Economics

• Although China has the world’s second-largest economy and – despite recent problems – is growing faster than most major economies, its growth rate is in secular decline. China has gone from near-constant double-digit growth over the past four decades to 7.4 per cent in 2014 and could dip below 7 per cent this year.
• Whilst India’s economy remains notably smaller than those of China, the US and Japan, it will surpass China’s growth rate this year and has a lot of potential.
• If the Trans-Pacific Partnership (TPP) is successfully negotiated, the potential for integration and growth between the United States, Japan and the other 10 TPP members may reduce their current trade dependence on China.

Demography

• The demography of Asia is another reason to look beyond the US-China nexus, as China faces the challenge of an aging society, while countries such as India have the advantage of a younger population and decades of demographic dividend ahead of them.
• Likewise populations across much of Southeast Asia, such as the Philippines and Indonesia are growing rapidly and expanding their middle classes. 

Read all our analysis on the Coronavirus Response

The coronavirus outbreak comes at a difficult time for China’s ruling party. A tumultuous 2019 saw the country fighting an economic slowdown coupled with an increasingly hostile international environment. As authorities take assertive steps to contain the virus, the emergency has - at least temporarily - disrupted global trade and supply chains, depressed asset prices and forced multinational businesses to make consequential decisions with limited information. 

Against this backdrop, panellists reflect on the country’s nascent economic transition from 2020 onward. What has been China’s progress towards a sustainable innovation-led economy so far? To what extent is the ruling party addressing growing concerns over job losses, wealth inequality and a lack of social mobility? And how are foreign investors responding to these developments in China?

The coronavirus outbreak in China poses a tremendous test for Beijing. Beyond the immediate public health crisis, the Chinese Communist Party faces a stuttering economy, growing public anger and distrust, and a potentially heavy blow to its global reputation.

The hesitant early response to the outbreak sheds light on the way the Chinese bureaucracy approaches crises at a time when the party leadership is tightening control at almost all levels of society. At first, officials in Wuhan attempted to censor online discussions of the virus. This changed only after President Xi Jinping’s call for a much more robust approach was followed by a sudden increase in the state media coverage of the outbreak. There is no doubt that Xi’s intervention will greatly speed up the response to the crisis, which should be welcomed.

Despite China’s experience with the SARS epidemic between 2002 and 2004, the sluggish reaction by officials in Wuhan should not have come as a surprise. The tendency among bureaucrats to play down crises is deeply entrenched. And, ironically, the party leadership’s recent push for greater bureaucratic accountability and its promise of stiffer punishment for those who take a 'do little' approach have also contributed to the habit of covering up disasters.

Xi has launched an ambitious programme to reform the governance of the Communist Party and re-centralize political control. This has reinforced the tendency of officials to avoid making important decisions and instead to wait for instructions from the party leadership.

For decades, local governments have made things happen in China. But with tighter regulation of lower-level bureaucrats, civil servants across the system now seem less ready, and able, to provide their input, making ineffective and even mistaken policy more likely.

Moreover, the coronavirus outbreak could not have happened at a worse time. Last year was tumultuous and saw China fighting an economic slowdown while also dealing with an increasingly hostile international environment. Now, as the authorities take steps to contain the disease, economic activity has come to a near standstill, with public transport curbed and restaurants and entertainment venues shuttered.

This contrasts with SARS, when double-digit growth in gross domestic product enabled Beijing to raise government expenditure to tackle the outbreak. Today, the Chinese economy is running into some of the most difficult challenges it has faced since the global financial crisis.

In response to the slowdown in growth, Beijing has adopted loose fiscal policy, with an emphasis on public investment. It also continues to push big banks to cut interest rates for individual borrowers and small businesses which were already suffering from the effects of the trade war with the US before the coronavirus struck.

The outbreak should give new impetus to governments, not least those that have close economic ties with China. Being a great power with ambitions for global leadership, as well as domestic reform, is not easy. Even without multi-party elections, it involves increasing, and often uncomfortable, scrutiny. As President Xi himself has put it: the road is long and the task is weighty.

This article was originally published in the Financial Times.

As the COVID-19 crisis roars on, so have debates about China’s role in it. Based on what is known, it is clear that some Chinese officials made a major error in late December and early January, when they tried to prevent disclosures of the coronavirus outbreak in Wuhan, even silencing healthcare workers who tried to sound the alarm.

China’s leaders will have to live with these mistakes, even if they succeed in resolving the crisis and adopting adequate measures to prevent a future outbreak. What is less clear is why other countries think it is in their interest to keep referring to China’s initial errors, rather than working toward solutions.

For many governments, naming and shaming China appears to be a ploy to divert attention from their own lack of preparedness. Equally concerning is the growing criticism of the World Health Organization (WHO), not least by Donald Trump who has attacked the organization - and threatens to withdraw US funding - for supposedly failing to hold the Chinese government to account.

Unhelpful and dangerous

At a time when the top global priority should be to organize a comprehensive coordinated response to the dual health and economic crises unleashed by the coronavirus, this blame game is not just unhelpful but dangerous.

Globally and at the country level, we all desperately need to do everything possible to accelerate the development of a safe and effective vaccine, while in the meantime stepping up collective efforts to deploy the diagnostic and therapeutic tools necessary to keep the health crisis under control.

Given there is no other global health organization with the capacity to confront the pandemic, the WHO will remain at the center of the response, whether certain political leaders like it or not.

Having dealt with the WHO to a modest degree during my time as chairman of the UK’s independent Review on Antimicrobial Resistance (AMR), I can say that it is similar to most large, bureaucratic international organizations.

Like the International Monetary Fund (IMF), the World Bank, and the United Nations, it is not especially dynamic or inclined to think outside the box. But rather than sniping at these organizations from the sidelines, we should be working to improve them.

In the current crisis, we all should be doing everything we can to help both the WHO and the IMF to play an effective, leading role in the global response. As I have argued before, the IMF should expand the scope of its annual Article IV assessments to include national public-health systems, given that these are critical determinants in a country’s ability to prevent or at least manage a crisis like the one we are now experiencing.

I have even raised this idea with IMF officials themselves, only to be told that such reporting falls outside their remit because they lack the relevant expertise. That answer was not good enough then, and it definitely isn’t good enough now.

If the IMF lacks the expertise to assess public health systems, it should acquire it. As the COVID-19 crisis makes abundantly clear, there is no useful distinction to be made between health and finance. The two policy domains are deeply interconnected, and should be treated as such.

In thinking about an international response to today’s health and economic emergency, the obvious analogy is the 2008 global financial crisis which started with an unsustainable US housing bubble, fed by foreign savings owing to the lack of domestic savings in the United States.

When the bubble finally burst, many other countries sustained more harm than the US did, just as the COVID-19 pandemic has hit some countries much harder than it hit China.

And yet not many countries around the world sought to single out the US for presiding over a massively destructive housing bubble, even though the scars from that previous crisis are still visible. On the contrary, many welcomed the US economy’s return to sustained growth in recent years, because a strong US economy benefits the rest of the world.

So, rather than applying a double standard and fixating on China’s undoubtedly large errors, we would do better to consider what China can teach us. Specifically, we should be focused on better understanding the technologies and diagnostic techniques that China used to keep its - apparent - death toll so low compared to other countries, and to restart parts of its economy within weeks of the height of the outbreak.

And for our own sakes, we also should be considering what policies China could adopt to put itself back on a path toward 6% annual growth, because the Chinese economy inevitably will play a significant role in the global recovery.

If China’s post-pandemic growth model makes good on its leaders’ efforts in recent years to boost domestic consumption and imports from the rest of the world, we will all be better off.

This article was originally published in Project Syndicate

Summary

• The stakeholders in the transatlantic relationship – the US, Canada and Europe – have long sought to stabilize international politics and economies by spreading support for the liberal goals of free markets, democracy and human rights. As their own commitment to this agenda appears to waver, China is becoming wealthier and more assertive. This briefing explores the extent to which these goals – along with the unity of the transatlantic relationship – are now in jeopardy.
• Great uncertainty surrounds this question, including over the direction of US foreign policy, risks to European cohesion and slowing growth in China. However, two decades of revisionist behaviour by the authorities in Beijing show that China’s values and interests already conflict with transatlantic goals in trade, cyberspace, international development, security and human rights.
• On trade, China pursues protectionist policies while engaging actively in intellectual property theft. China’s military modernization and its view of maritime law challenge the territorial status quo in East Asia and raise the risk of military crisis there. China lends unconditionally to countries that abuse human rights and are corrupt, undermining efforts by Western governments to promote good governance and human rights.
• Defending liberal goals is complicated by asymmetric interests among the transatlantic partners, especially over security. China also uses ‘wedge’ strategies to pick off potential allies, thus diluting the power and will of any counterbalancing effort.
• This briefing argues that China’s rise has worrying implications for the liberal international order. In response, the US should recognize its own strong interest in European unity, while Europeans must be ready to align more with the US (and East Asian allies) in order to temper Chinese behaviour.

This will be done through examining transatlantic approaches and responses to China through the lens for four key themes (digital technology; trade and investment; governance of global commons; and climate change and the environment) that have been identified as crucial to developing effective policy responses and fostering collaboration.

The project will strengthen national, regional and international responses to the risks and opportunities posed by China’s changing role within the global economy and international rules-based order.

In response to the changing geopolitical landscape in Asia, both China and the United States attempt to alter the regional order in their own favour, both in the economic and security realms. This article shows how diverging views on future arrangements are leading to strategic shifts and increasing tension between these two Great Powers. As part of its quest for Great-Power status, China has been actively pushing its regional initiatives such as the Belt and Road Initiative (BRI) and the Asian Infrastructure Investment Bank (AIIB), as well as adopting assertive security policies towards its neighbours. In contrast, in order to counter China's growing influence America's regional strategy is undergoing a subtle shift from ‘rebalancing to Asia’ to focusing on the ‘Indo-Pacific’ region. However, amid an intensifying trade war and other challenges facing the region, China has chosen to moderate its proactive foreign policy-orientation in the past few years. In particular, China has made attempts to downplay its domestic rhetoric, rebuild strategic relationship with India and Japan, and to reassure ASEAN states in the South China Sea. In response to the Indo-Pacific strategy, it would be more effective for China to articulate a more inclusive regional vision and promote an institutional framework that also accommodates a US presence in the region.

The ‘free and open Indo-Pacific’ (FOIP) strategy, actively promoted by the United States with support from its allies and partners, is a significant geopolitical response to China's growing power and expanding influence in Asia and beyond. Beijing has adopted various new strategies to cope with the challenges related to FOIP. One of these strategies is to secure a robust relationship with south-east Asia in order to make these regional states either neutral to or less supportive of the Indo-Pacific vision. In addition to economic statecraft and soft power, Beijing believes that it can also tap into the domain of non-traditional security (NTS) to strengthen relations with this region to position itself better in the intensifying regional geopolitical competition. The article addresses the following question: what is the impact of China's NTS cooperation with south-east Asia on Beijing's geopolitical rivalry with other major powers in the Indo-Pacific region? The article argues that China's NTS cooperation with south-east Asian countries may help China maintain its geopolitical standing in the region, but it is unlikely to lead to any dramatic increase of China's strategic influence in the region. This essentially means that Beijing may be able to prevent ASEAN or most ASEAN member states from lending substantive and strong support to the Indo-Pacific construct, but it will not be able to stop ASEAN states from supporting some elements of the FOIP.

Japan's primary objective of the ‘free and open Indo-Pacific’ (FOIP) strategy is to shape and consolidate regional order in the Indo-Pacific region based on the existing rules-based international order. The concept initially aimed to achieve two different objectives—shaping a regional order in the Indo-Pacific and ensuring the defence of Japan; however, Japan has gradually shifted its strategic focus onto the former, separating national defence from the FOIP concept, which reflects a change in the degree of its commitment to the two objectives. On the one hand, as its overall security strategy, Japan has determined to steadily enhance its national defence by increasing its own defence capabilities and strengthening the US–Japan alliance, while transforming its partnerships with like-minded states, such as Australia and India, into a diplomatic, and potentially military, alignment. This has been brought about by shifts in the regional balance of power, particularly the rise of China and the relative decline of the United States. On the other hand, as part of its FOIP strategy, Japan's attempts to build a new regional order in the Indo-Pacific region aim to defend the existing rules-based order established by the United States from challengers, particularly China. Yet, given the strategic uncertainty over Japan's international coalition-building efforts to create a new regional order, Japan has made its approach flexible; Tokyo is using its ambiguous FOIP concept to gauge other states' responses, understand their perspectives, and change its strategic emphases accordingly—so-called ‘tactical hedging’. Japan has pursued similar means to achieve the two key objectives. Nevertheless, the country's core interest, the defence of Japan, is more imperative than building a regional order in the Indo-Pacific region, and Japan faces different types of challenges in the future.