How the US is pushing back China
A fragile capital account, and the economic self-doubt it can create, are hardly strong foundations for aggressive Chinese foreign policy.
By David Lubin (Wide Angle)
Published: Wed 16 Jan 2019, 8:33 PM
Last updated: Wed 16 Jan 2019, 10:45 PM
Chinese leaders do like their slogans, and where foreign policy is concerned, two have reflected Beijing's thinking in recent times. The first is the cautious principle of tao guang yang hui, usually rendered in English as "hide your light and bide your time," which guided Chinese policy for decades after Deng Xiaoping established it in the 1980s. In late 2013, though, President Xi Jinping coined a new slogan to define a more assertive, muscular approach: fen fa you wei, or "strive for achievement."
The drift toward a more assertive foreign policy under Xi has been evident everywhere, from China's declaration of an air defense identification zone over the East China Sea in late 2013, to the creation of "facts on the ground" in the South China Sea, to the development of the Belt and Road Initiative.
But recently there have been signs that China might be having second thoughts about its ability to keep striving for achievement. Xi's government seems clearly to have entered concession-making mode in its relations with the United States, and some prominent Chinese academics have begun questioning whether China has been guilty of strategic overstretch. For example, Yan Xuetong, a doyen of Chinese foreign-policy scholarship, has recently argued that Xi has gone too far, and that China should limit its ambitions to a narrower, regional sphere. Another Beijing-based expert, Shi Yinhong, calls for "strategic retrenchment" in Chinese foreign policy.
An easy explanation for this Chinese shift toward retrenchment is US President Donald Trump, who has applied his own brand of assertiveness to the US-China relationship, with the apparent support of the entire American political class and much of Europe's, too. Confronted by pushback from the West, China is unsurprisingly warier of pushing forward.
But China's current caution also owes much to the fragility of its economic performance. As anyone who has recently traveled to Beijing will tell you, the sense of economic pessimism there has rarely been as tangible as it is now.
To a degree, sagging Chinese growth is a self-induced problem. Since Xi's declaration in 2017 that financial stability is a national-security concern, risk-taking by local governments and the financial sector has generally been frowned upon. Because these actors have been the two main engines of China's growth in the past ten years has naturally sapped energy from the economy.
Yet there is another, under-noticed, source of China's economic fragility: the capital account of its balance of payments. Since 2014, when China's foreign reserves began to fall from their $4 trillion peak (to $3 trillion level today), the authorities have been nervous about the damage excessive capital outflows might inflict on China's economic self-confidence and global role.
In any emerging economy, there is an important connection between the health of the capital account and that of the domestic economy. If money is voting with its feet, how can anyone expect domestic confidence to be strong?
Conversely, the progressive tightening of US monetary conditions over the past five years has undeniably helped to suck dollars away from China, causing the country to lose reserves and self-confidence. This is partly because Chinese companies tend to repay debt when the dollar is strengthening and the cost of servicing dollar liabilities goes up. In addition, foreign portfolio investors are less willing to buy Chinese government bonds when the China-US interest differential narrows, as it has in recent months.
A fragile capital account, and the economic self-doubt it can create, are hardly strong foundations for aggressive Chinese foreign policy. The next time Trump feels like excoriating Fed Chairman Jerome Powell for tightening monetary policy too quickly, he might pause to consider the role that higher US rates and a stronger dollar have played in taming China's self-confidence. A dovish Fed is a gift to Beijing.
David Lubin is Head of Emerging Markets Economics at Citi and an associate fellow at Chatham House