The votes have been counted in the presidential and legislative elections that Taiwan held earlier today. The Democratic Progressive Party (DPP) won a sweeping victory in both contests, displacing the Kuomintang (KMT).

There will no doubt be extensive and useful analysis on what the election means, particularly on the underlying preferences of the Taiwan public. But attention is already shifting to the policies that the new administration will pursue, and whether they will complicate relations on the three sides of the Taiwan-China-United States triangle.

By the numbers

On the election itself, Tsai Ing-wen, the DPP’s chairperson and presidential candidate, won with 56.1 percent of the vote, with virtually all polling places reporting. Eric Chu, the leader and candidate of the more conservative KMT, received 30.1 percent. James Soong, chairman of the People First Party (PFP), a small spinoff from the KMT, got 12.8 percent. This is the second time that the DPP candidate won in an open contest; Chen Shui-bian was the first to do so, in 2000, but only with 40 percent of the vote in a previous three-person race. 

For the elections for the Legislative Yuan (LY), voters cast two ballots. One is for a candidate to represent their geographic election district, of which there are 78. The other is for the voter’s preferred political party—that outcome produces 35 legislators, drawn from party lists. Final results are not yet available for all of the 78 geographic seats, but the Central News Agency reports that the DPP will have at least 60 seats, enough for an absolute majority. We do know the final result in the party vote: DPP with 44.1 percent; KMT with 26.9 percent; PFP with 6.5 percent; New Power Party with 6.1 percent; the pro-unification New Party with 4.2 percent; and the pro-independence Taiwan Solidarity Union with 2.5 percent.

Not a fluke

Several tentative implications flow from these results.

The DPP victory is similar to the KMT’s in 2008, when voters rejected the eight-year presidency of DPP leader Chen Shui-bian. Tsai’s percentage this time is slightly less than the 58 percent that Ma Ying-jeou won in his first election in eight years ago (in 2008, the KMT won 81 legislative seats). Both elections have a “throw the bums out” flavor.

Although Tsai will not have a totally free hand, she has gained significant political capital and freedom of action. The question now is how she will use them. She has the scope to address a number of domestic problems that were on voters’ minds when they went to the polls. I suspect that she will want to conduct her presidency in a way that helps ensure that the DPP will be Taiwan’s majority party for a long time to come. Whether succeeds will depend a lot on the response of the Legislative Yuan, including the DPP caucus, to her agenda and whether the legislature is willing to undertake reforms that would make it a more effective institution.

Although Tsai will not have a totally free hand, she has gained significant political capital and freedom of action. The question now is how she will use them.

The size of the DPP victory should induce Beijing to reconsider the hardline stance that it has taken during the run-up to the election. It said, in effect, that Dr. Tsai would have to accept its own parameters preserving the status quo if she is to secure mutually beneficial cross-Strait relations. But today’s result was no fluke. It occurred not because of Tsai’s “cool” charisma or the DPP’s skill at mobilizing its supporters, although those were not trivial. It was the result of the public growing more skeptical about Ma Ying-jeou’s policy of engaging China, at least economically—a skepticism grew that throughout Ma’s second term. If Beijing can adjust its strategy and Tsai is willing to meet Chinese President Xi Jinping half way, a mutual accommodation between them is not impossible. But it will not be easy.

Cross-Strait shifts?

The open question, which only future developments can answer, is whether today’s result reflects a more fundamental shift in political attitudes than simply dissatisfaction with Ma Ying-jeou’s policies and their consequences. Such a more fundamental shift would not only change the balance of power within Taiwan but also the continued feasibility of China’s approach to reaching its goal of unification. If so, should Beijing offer more and different carrots to better “win the hearts and minds” of Taiwan people? Or would it consider greater reliance on sticks?

The open question...is whether today’s result reflects a more fundamental shift in political attitudes than simply dissatisfaction with Ma Ying-jeou’s policies and their consequences.

The implication that the U.S. government drew from the election results is captured in the statement the State Department released today: 

“We share with the Taiwan people a profound interest in the continuation of cross-Strait peace and stability. We look forward to working with Dr. Tsai and Taiwan’s leaders of all parties to advance our many common interests and further strengthen the unofficial relationship between the United States and the people on Taiwan.”

It is worth noting that Taiwan is the only ethnic Chinese society in the world in which genuinely competitive elections pick senior political leaders. The powers that be in China, Hong Kong, and Singapore all seek to preserve control over the outcomes of their leadership selection processes. Taiwan is the one system where the outcome reflects the preferences of over 12 million voters. Moreover, this is Taiwan’s third peaceful transfer of power through direct elections, and it should further consolidate Taiwan’s democracy. Finally, that Taiwan has elected its first female president signals the removal of one more significant social barrier to talented people holding the island’s highest political office.

China has provided foreign assistance since the 1950s, and is now the largest developing country to provide aid outside of the Development Assistance Committee (DAC), a forum of the world’s major donor countries under the Organization for Economic Cooperation and Development (OECD). Like its foreign policy more broadly, Chinese foreign assistance has adhered to the “Five Principles of Peaceful Coexistence” and emphasized the virtue of national self-reliance. At the same time, it has served a strategic purpose alongside other foreign policy priorities.

A slow start but a steady increase

Compared to top DAC donor countries, the scale of China’s foreign assistance is still relatively small. According to some estimates and OECD International Development Statistics, China’s gross foreign aid in 2001 was extremely limited, amounting to only about 1.8 percent of the total contribution by DAC donors. However, since launching its “Go Global” strategy in 2005, China has deepened its financial engagement with the world, and its foreign aid totals have grown at an average rate of 21.8 percent annually. In 2013, China contributed about 3.9 percent to total global development assistance, which is 6.6 percent of the total contribution by DAC countries and over 26 percent of total U.S. foreign aid. 

Millions of USD (Current)

Gross foreign aid provided by China versus major DAC donors

And the lion’s share goes to: Africa

Africa is one of China’s most emphasized areas of strategic engagement. Particularly since the establishment of the Forum on China-Africa Cooperation (FOCAC) in 2000, the relationship between China and Africa has gotten closer and closer. In 2009, African countries received 47 percent of China’s total foreign assistance. Between 2000 and 2012, China funded 1,666 official assistance projects in 51 African countries (the four countries that don’t have diplomatic relations with China—Gambia, Swaziland, Burkina Faso, and São Tomé and Príncipe—were left out), which accounted for 69 percent of all Chinese public and private projects. Among the 1,666 official projects, 1,110 qualified as Official Development Assistance (ODA)—defined by the OECD as flows of concessional, official financing administered to promote the economic development and welfare of developing countries. The remaining 556 projects could be categorized, also according to the OECD, as Other Official Flow (OOF)—transactions by the state sector that are not “development-motivated” or concessional (such as export credits, official sector equity and portfolio investment, and debt reorganization). (Note: in terms of dollar amounts, not included in the statistics here, most Chinese lending to Africa and other parts of the developing world is not concessional and is therefore not foreign aid.)

Zeroing in on infrastructure

About 61 percent of Chinese concessional loans to Africa are used for infrastructure construction, and 16 percent are for industrial development. The three areas that receive the largest allocations of Chinese concessional loans are transport and storage; energy generation and supply; and industry, mining, and construction. A small portion of the remaining allocations go to health, general budget support, and education. 

Some have interpreted these trends to mean that China is making an effort to export domestic excess capacity in manufacturing and infrastructure, especially considering the uncertainties of China’s economic transition. But the motivations are broader than that. China’s “Africa Policy”—issued in December 2015, in Johannesburg—clearly expresses the Chinese government’s belief that infrastructure construction is a crucial channel for African development. This notion could be connected to the domestic Chinese experience of having benefited from the technological diffusion of foreign aid and foreign direct investment in the construction sector. Moreover, in practice, China’s more than 20 years of experience in implementing international contract projects, as well as advanced engineering technologies and relatively low labor costs, have proved to be a comparative advantage in Chinese foreign assistance. In addition, by prioritizing the principles of non-interference and mutual benefit, China is more comfortable providing infrastructure packages (e.g., turn-key projects) than many other countries. 

Doing assistance better

Legitimate concerns have been raised about China’s tendency to facilitate authoritarianism and corruption, as well that its assistance does not always trickle down to the poor. As such, the state-to-state Chinese approach to providing assistance should be reformed. Globalization scholar Faranak Miraftab indicates that on-the-ground partnerships between communities and the private sector—mediated by the public sector—could achieve synergies to overcome certain shortcomings, creating a win-win situation. With deeper involvement by domestic assistance providers, Chinese foreign assistance could touch more people’s lives by tackling both the short- and long-term needs of the most under-resourced parts of civil society. Domestic assistance providers should exploring public-private partnerships, which among other benefits could yield increased foreign assistance services. By focusing on its comparative advantage in contributing to infrastructure projects that benefit the general public while also facilitating participation from civil society, Chinese foreign assistance could bring more concrete benefits to more individuals. 

China has already begun tackling these and other weaknesses. Although infrastructure and industry still account for the largest share of total official projects in Africa, China has intentionally strengthened its official development finance efforts in areas related to civil society. Projects have surged in the areas of social infrastructure and services, developmental food aid and food security, support to non-governmental organizations, and women in development, to name a few. Moreover, following President Xi Jinping’s promise at the United Nations summit in September 2015, an initial $2 billion has been committed as a down payment toward the China South-South Cooperation and Assistance Fund. The funding is primarily designed to improve the livelihoods of residents of recipient countries and diversify domestic aid providers (e.g., NGOs) qualified to participate or initiate assistance projects in the least-developed countries. 

In order to achieve positive results, it is critical for the Chinese government to carry out detailed management initiatives to engage civil society: for example, establishing a complete system for information reporting and disclosure (actions have already been taken in several ministries and bureaus), publishing guidelines for the private sector to develop assistance services overseas, and improving coordination and accountability among ministries and within the Ministry of Commerce. Although challenges still remain, Chinese foreign assistance is moving in a positive direction without abandoning its defining characteristics. 

Was the Iran nuclear deal, signed last summer, a prelude to proliferation across the Middle East? This is a question that Brookings Senior Fellow Robert Einhorn and Non-resident Senior Fellow Richard Nephew explore in a new report. At an event to discuss their findings—moderated by Brookings Deputy Director of Foreign Policy and Senior Fellow Suzanne Maloney and with panelists Derek Chollet and H.E. Yousef Al Otaiba—Einhorn and Nephew argued that none of the Middle East’s “likely suspects” appears both inclined and able to acquire indigenous nuclear weapons capability in the foreseeable future. They also outlined policy options for the United States and other members of the P5+1.

Einhorn described the incentives and capabilities of Egypt, Saudi Arabia, Turkey, and the United Arab Emirates for acquiring nuclear weapons. He argued that, while both Saudi Arabia and the UAE a) consider Iran a direct military threat, b) have concerns about the U.S. commitment to the security of the region, and c) have sufficient financial resources, they recognize that they have no choice but to rely on the United States for their security and are unwilling to jeopardize that relationship by seeking nuclear weapons. Einhorn also said that both Egypt and Turkey do not view Iran as a direct military threat and are more preoccupied with instability on their borders and internal security, concerns that cannot be addressed by possession of a nuclear weapons capability.

Nephew outlined policy recommendations, including measures to ensure strict implementation of the JCPOA, greater intelligence sharing and security cooperation with Middle East allies, and means of fostering IAEA-supervised regional arrangements that would encourage peaceful nuclear energy development and limit potentially destabilizing nuclear activities. Nephew also asserted that some elements of the JCPOA, such as online monitoring of nuclear facilities, could be applied to other nuclear energy programs in the region to enhance transparency. 

Derek Chollet of the German Marshall Fund argued the United States must deter Iran and reassure U.S. allies by maintaining a robust military presence in the region, planning a range of U.S. responses to destabilizing Iranian activities, and ensuring that U.S. forces have the weapons systems and personnel required for scenarios involving Iran. He suggested that the United States and its Middle East allies continue regular summit meetings on security and broader partnership issues, and possibly formalize security cooperation by establishing a dedicated regional security framework. 

Emirati Ambassador to the United States Yousef Al Otaiba emphasized that, to many of the countries in the region, Iran poses a threat wider than just its nuclear activities. He suggested that the JCPOA will be judged on the degree to which the United States and its allies address Iran’s destabilizing behavior outside of the nuclear file, such as Tehran’s support for Hezbollah and the Houthis, as well as its ballistic missile activities. Al Otaiba said that, though he has seen some efforts by the Obama administration to push Iran on its regional behavior, it has sent a mixed message overall, with senior U.S. officials also encouraging European banks to invest in Iran. The ambassador asserted that rigorous enforcement of the JCPOA will be critical to convincing Iran not to eventually proceed to build nuclear weapons.

On Saudi Arabia, Einhorn noted that although the Obama administration supported the Saudi military campaign in Yemen, there was a risk that the Kingdom would overreact to its regional security challenges. He suggested that the United States pursue a dual-track approach: counter provocative Iranian behavior and defend the security interests of its regional partners, while at the same time seeking a resolution of regional disputes and encouraging Saudi Arabia and Iran to find ways of reducing tensions between them.

On the possibility that Iran would rapidly scale up its enrichment program, Einhorn acknowledged that while Tehran can legally do so under the JCPOA in 10 to 15 years, it will not have a strong civil nuclear rationale since it will be able to acquire nuclear fuel from Russia and other suppliers. Furthermore, Iran’s progress in centrifuge research and development may not be as rapid as Iran currently anticipates. Moreover, even if Iran elects to ramp up its enrichment program down the line, the JCPOA and Nuclear Non-Proliferation Treaty (NPT) will bar it from pursuing nuclear weapons, and monitoring arrangements still in place will provide warning and enable the United States to intervene and prevent Iran from building nuclear weapons.

On reaching a regional accommodation that includes Iran, Al Otaiba indicated that the UAE would have much to gain, especially economically, from a better relationship with Tehran. He said the UAE and others in the region would like to try to engage with Iran to reduce tensions—but Iran, for its part, seems unwilling.

On prospects for a U.S.-Saudi civil nuclear cooperation agreement, Einhorn said that progress on such an agreement has stalled due to Saudi reluctance to formally renounce enrichment, something the United States has so far insisted on. He suggested that Washington should be prepared to relax the so-called “gold standard” (i.e., a formal renunciation of on enrichment and reprocessing) and instead accept an approach that would still discourage Saudi fuel cycle programs, such as giving Riyadh the right to pursue enrichment but allowing the United States to cease its nuclear cooperation if the Kingdom exercised that right. On the UAE’s civil nuclear program, Al Otaiba affirmed that the Emiratis continue to value the “gold standard” barring enrichment which is enshrined in the U.S.-UAE civil nuclear agreement, and have no plans to change their position on enrichment.

China has provided foreign assistance since the 1950s, and is now the largest developing country to provide aid outside of the Development Assistance Committee (DAC), a forum of the world’s major donor countries under the Organization for Economic Cooperation and Development (OECD). Like its foreign policy more broadly, Chinese foreign assistance has adhered to the “Five Principles of Peaceful Coexistence” and emphasized the virtue of national self-reliance. At the same time, it has served a strategic purpose alongside other foreign policy priorities.

A slow start but a steady increase

Compared to top DAC donor countries, the scale of China’s foreign assistance is still relatively small. According to some estimates and OECD International Development Statistics, China’s gross foreign aid in 2001 was extremely limited, amounting to only about 1.8 percent of the total contribution by DAC donors. However, since launching its “Go Global” strategy in 2005, China has deepened its financial engagement with the world, and its foreign aid totals have grown at an average rate of 21.8 percent annually. In 2013, China contributed about 3.9 percent to total global development assistance, which is 6.6 percent of the total contribution by DAC countries and over 26 percent of total U.S. foreign aid. 

Millions of USD (Current)

Gross foreign aid provided by China versus major DAC donors

And the lion’s share goes to: Africa

Africa is one of China’s most emphasized areas of strategic engagement. Particularly since the establishment of the Forum on China-Africa Cooperation (FOCAC) in 2000, the relationship between China and Africa has gotten closer and closer. In 2009, African countries received 47 percent of China’s total foreign assistance. Between 2000 and 2012, China funded 1,666 official assistance projects in 51 African countries (the four countries that don’t have diplomatic relations with China—Gambia, Swaziland, Burkina Faso, and São Tomé and Príncipe—were left out), which accounted for 69 percent of all Chinese public and private projects. Among the 1,666 official projects, 1,110 qualified as Official Development Assistance (ODA)—defined by the OECD as flows of concessional, official financing administered to promote the economic development and welfare of developing countries. The remaining 556 projects could be categorized, also according to the OECD, as Other Official Flow (OOF)—transactions by the state sector that are not “development-motivated” or concessional (such as export credits, official sector equity and portfolio investment, and debt reorganization). (Note: in terms of dollar amounts, not included in the statistics here, most Chinese lending to Africa and other parts of the developing world is not concessional and is therefore not foreign aid.)

Zeroing in on infrastructure

About 61 percent of Chinese concessional loans to Africa are used for infrastructure construction, and 16 percent are for industrial development. The three areas that receive the largest allocations of Chinese concessional loans are transport and storage; energy generation and supply; and industry, mining, and construction. A small portion of the remaining allocations go to health, general budget support, and education. 

Some have interpreted these trends to mean that China is making an effort to export domestic excess capacity in manufacturing and infrastructure, especially considering the uncertainties of China’s economic transition. But the motivations are broader than that. China’s “Africa Policy”—issued in December 2015, in Johannesburg—clearly expresses the Chinese government’s belief that infrastructure construction is a crucial channel for African development. This notion could be connected to the domestic Chinese experience of having benefited from the technological diffusion of foreign aid and foreign direct investment in the construction sector. Moreover, in practice, China’s more than 20 years of experience in implementing international contract projects, as well as advanced engineering technologies and relatively low labor costs, have proved to be a comparative advantage in Chinese foreign assistance. In addition, by prioritizing the principles of non-interference and mutual benefit, China is more comfortable providing infrastructure packages (e.g., turn-key projects) than many other countries. 

Doing assistance better

Legitimate concerns have been raised about China’s tendency to facilitate authoritarianism and corruption, as well that its assistance does not always trickle down to the poor. As such, the state-to-state Chinese approach to providing assistance should be reformed. Globalization scholar Faranak Miraftab indicates that on-the-ground partnerships between communities and the private sector—mediated by the public sector—could achieve synergies to overcome certain shortcomings, creating a win-win situation. With deeper involvement by domestic assistance providers, Chinese foreign assistance could touch more people’s lives by tackling both the short- and long-term needs of the most under-resourced parts of civil society. Domestic assistance providers should exploring public-private partnerships, which among other benefits could yield increased foreign assistance services. By focusing on its comparative advantage in contributing to infrastructure projects that benefit the general public while also facilitating participation from civil society, Chinese foreign assistance could bring more concrete benefits to more individuals. 

China has already begun tackling these and other weaknesses. Although infrastructure and industry still account for the largest share of total official projects in Africa, China has intentionally strengthened its official development finance efforts in areas related to civil society. Projects have surged in the areas of social infrastructure and services, developmental food aid and food security, support to non-governmental organizations, and women in development, to name a few. Moreover, following President Xi Jinping’s promise at the United Nations summit in September 2015, an initial $2 billion has been committed as a down payment toward the China South-South Cooperation and Assistance Fund. The funding is primarily designed to improve the livelihoods of residents of recipient countries and diversify domestic aid providers (e.g., NGOs) qualified to participate or initiate assistance projects in the least-developed countries. 

In order to achieve positive results, it is critical for the Chinese government to carry out detailed management initiatives to engage civil society: for example, establishing a complete system for information reporting and disclosure (actions have already been taken in several ministries and bureaus), publishing guidelines for the private sector to develop assistance services overseas, and improving coordination and accountability among ministries and within the Ministry of Commerce. Although challenges still remain, Chinese foreign assistance is moving in a positive direction without abandoning its defining characteristics. 

President Obama's announcement last month that earlier this year a “U.S. counterterrorism operation” had killed two hostages, including an American citizen, has become a fresh occasion for questioning the rationales for continuing attacks from unmanned aerial vehicles aimed at presumed, suspected, or even confirmed terrorists. This questioning is desirable, although not mainly for hostage-related reasons connected to this incident. Sometimes an incident has a sufficient element of controversy to stoke debate even though what most needs to be debated is not an issue specific to the incident itself. More fundamental issues about the entire drone program need more attention than they are getting.

The plight of hostages held by terrorists has a long and sometimes tragic history, almost all of which has had nothing to do with drones. Hostage-taking has been an attractive terrorist tool for so long partly because of the inherent advantages that the hostage-holders always will have over counterterrorist forces. Those advantages include not only the ability to conceal the location of hostages—evidently a successful concealment in the case of the hostages mentioned in the president's announcement—but also the ability of terrorists to kill the hostages themselves and to do so quickly enough to make any rescue operation extraordinarily difficult. Even states highly skilled at such operations, most notably Israel, have for this reason suffered failed rescue attempts.

It is not obvious what the net effect of operations with armed drones is likely to be on the fate of other current or future hostages. The incident in Pakistan demonstrates one of the direct negative possibilities. Possibly an offsetting consideration is that fearing aerial attack and being kept on the run may make, for some terrorists, the taking of hostages less attractive and the management of their custody more difficult. But a hostage known to be in the same location as a terrorist may have the attraction to the latter of serving as a human shield.

The drone program overall has had both pluses and minuses, as anyone who is either a confirmed supporter or opponent of the program should admit. There is no question that a significant number of certified bad guys have been removed as a direct and immediate consequence of the attacks. But offsetting, and probably more than offsetting, that result are the anger and resentment from collateral casualties and damage and the stimulus to radicalization that the anger and resentment provide. There is a good chance that the aerial strikes have created more new terrorists bent on exacting revenge on the United States than the number of old terrorists the strikes have killed.

This possibility is all the more disturbing in light of what appears to be a significant discrepancy between the official U.S. posture regarding collateral casualties and the picture that comes from nonofficial sources of reporting and expertise. The public is at a disadvantage in trying to judge this subject and to assess who is right and who is wrong, but what has been pointed out by respected specialists such as Micah Zenko is enough to raise serious doubt about official versions both of the efforts made to avoid casualties among innocents and of how many innocents have become victims of the strikes.

The geographic areas in which the drone strikes are most feasible and most common are not necessarily the same places from which future terrorist attacks against the United States are most likely to originate. The core Al-Qaeda group, which has been the primary target and concern in northwest Pakistan, is but a shadow of its former self and not the threat it once was. Defenders of the drone strikes are entitled to claim that this development is in large part due to the strikes. But that leaves the question: why keep doing it now?

The principal explanation, as recognized in the relevant government circles, for the drone program has been that it is the only way to reach terrorists who cannot be reached by other tools or methods. It has been seen as the only counterterrorist game that could be played in some places. That still leaves more fundamental questions about the motivations for playing the game.

Policy-makers do not use a counterterrorist tool just because the tool is nifty—although that may be a contributing factor regarding the drones—but rather because they feel obligated to use every available tool to strike at terrorists as long as there are any terrorists against whom to strike. In the back of their minds is the thought of the next Big One, or maybe even a not so big terrorist attack on U.S. soil, occurring on their watch after not having done everything they could to prevent it, or doing what would later be seen in hindsight as having had the chance to prevent it.

The principal driver of such thoughts is the American public's zero tolerance attitude toward terrorism, in which every terrorist attack is seen as a preventable tragedy that should have been prevented, without fully factoring in the costs and risks of prevention or of attempted prevention. Presidents and the people who work for them will continue to fire missiles from drones and to do some other risky, costly, or even counterproductive things in the cause of counterterrorism because of the prospect of getting politically pilloried for not being seen to make the maximum effort on behalf of that cause.

This piece was originally published by The National Interest.

Arthur Kroeber expands upon a recent paper, answering questions about China's monetary policy on the valuation of the renminbi and the political issues this raises.

1. The Chinese currency, or renminbi (RMB) has been a contentious issue for the past several years. What is the root of the conflict for the United States and other countries?

The root of the conflict for the United States—and other countries—is complaints that China keeps the value of the RMB artificially low, boosting its exports and trade surplus at the expense of trading partners. Although the U.S. Treasury has repeatedly stopped short of labeling China a “currency manipulator” in its twice-yearly reports to Congress, it has consistently pressured China to allow the RMB to appreciate at a faster pace, and to let the currency fluctuate more freely in line with market forces. The International Monetary Fund, the World Bank and many economists have also argued for faster appreciation and a more flexible exchange rate policy. Partly in response to these pressures, but more because of domestic considerations, China has allowed the RMB to rise by about 25% against the U.S. dollar since mid-2005. Yet the pace of appreciation remains agonizingly slow for the U.S. and other countries in Europe and Latin America whose manufacturing sectors face increasing competition from low-priced Chinese goods.

2. What impact does exchange rate control have on the economy?

According to foreign observers, consistent intervention by China to keep its exchange rate substantially below the level the market would set is a price distortion that prevents international markets from functioning as well as they could. This price distortion also affects China’s own economy, by encouraging large-scale investment in export manufacturing, and discouraging investment in the domestic consumer market. Thus, it is in the interest both of China itself and the international economy as a whole for China to allow its exchange rate to rise more rapidly. However, Chinese policy makers do not agree with this view, and believe the managed exchange rate is broadly beneficial for economic development.

3. What is the Chinese view of their policies toward exchange rate control?

Chinese officials see the exchange rate—and prices and market mechanisms in general—as tools in a broader development strategy. The goal of this development strategy is not to create a market economy but to make China a rich and powerful modern country. Market mechanisms are simply means, not ends in themselves. Chinese leaders observe that all countries that have raised themselves from poverty to wealth in the industrial era, without exception, have done so through export-led growth. Thus, they manage the exchange rate to broadly favor exports, just as they manage other markets and prices in the domestic economy in order to meet development objectives such as the creation of basic industries and infrastructure.

Since they perceive that an export-led strategy is the only proven route to rich-country status, they view with profound suspicion arguments that rapid currency appreciation and markedly slower export growth are “in China’s interest.” And because China is an independent geopolitical power, it is fully able to resist international pressure to change its exchange rate policy.

4. What are some misconceptions about China’s large-scale reserve holdings and investments in U.S. Treasury Bonds, specifically the idea that China is “America’s banker?”

Because China’s central bank is the single biggest foreign holder of U.S. government debt, it is often said that China is “America’s banker,” and that, if it wanted to, it could undermine the U.S. economy by selling all of its dollar holdings, thereby causing a collapse of the U.S. dollar and perhaps the U.S. economy. These fears are misguided. China is not in any practical sense “America’s banker.” China holds just 8% of outstanding US Treasury debt; American individuals and institutions hold 69%. China holds just 1% of all US financial assets (including corporate bonds and equities); US investors hold 87%. Chinese commercial banks lend almost nothing to American firms and consumers – the large majority of that finance comes from American banks. America’s banker is America, not China.
It is more apt to think of China as a depositor at the “Bank of the United States:” its treasury bond holdings are super-safe, liquid holdings that can be easily redeemed at short notice, just like bank deposits. Far from holding the United States hostage, China is a hostage of the United States, since it has little ability to move those deposits elsewhere (no other bank in the world is big enough).

5. What are the implications for U.S. policy and how should policymakers react?

China’s exchange-rate policy is deeply linked to long-term development goals and there is very little that the United States, or any other outside actor, can do to influence this policy. Also, the same suspicion of market forces that leads Beijing to pursue an export-led growth policy generating large foreign reserve holdings also means that Beijing is unlikely to be willing to permit the financial market opening required to make the RMB a serious rival to the dollar as an international reserve currency.

In substantive terms, there is little to be gained from high-profile pressure on China to accelerate the pace of RMB appreciation, since the United States possesses no leverage which can be plausibly brought to bear. U.S. policy should therefore de-emphasize the exchange rate, and instead focus on keeping the pressure on China to maintain and expand market access for American firms in the domestic Chinese market, which in principle is provided for under the terms of China’s accession to the World Trade Organization.