How to Deal with the Rise of China

By James Cumes, 10.7.05

Report by Australian Broadcasting Corporation

On 28 June 2005, a report from the Australian Broadcasting Corporation read as follows:

"The ABC has learned that concern about offending China prompted the Australian Government to decline an invitation from the United States to take part in secret talks on how to deal with the rise of China. Calling themselves the 'Halibut Group', the talks were to also involve the UK, Canada, New Zealand and Japan.

Officially, Australia is giving no explanation for its refusal to take part.

A spokesman for Foreign Affairs Minister Alexander Downer says 'Australia has a wide range of talks with other countries on a wide range of issues and doesn't tend to talk about them'.

But Labor's Robert McClelland wants an explanation.

ROBERT MCCLELLAND: Clearly, in terms of Australia's security and economic interests in the next half a century, issues relating to China, both as a military power and as an economic power, are fundamental to Australia's interests. You would want a clear explanation from the Foreign Minister as to why Australia didn't attend that invitation, but he hasn't provided that.

KIM LANDERS: A spokeswoman from the Chinese Embassy in Canberra says they were not aware of the secret meetings and 'first heard about it on the ABC'. Professor Stuart Harris, from the Department of International Relations at the Australian National University, is a China expert. He's not surprised the Australian Government refused to take part.

STUART HARRIS: I think it was a very sensible decision on the part of Australia. You know, I think there's been enough effort on the part of some parts of the US administration to get Australia involved in a one-sided process vis-à-vis China, and I don't think it's in our interests to go along with that.

PETER CAVE: Professor Stuart Harris from the Australian National University. Kim Landers was our reporter. "


A particular reason for fascination with this report is that the United States and Australia have arrived at their present relationship with China by much the same route and the two are joined in what Australian Governments have, for the past fifty years, regarded as one of their most fundamental security arrangements, the ANZUS Treaty.

To understand the rise of China and particularly its scale and speed, we must go back more than thirty years to the period 1969 to 1971, when post-war stability, largely based on a strong and stable United States dollar, collapsed.

The American attempt to fight inflation through fiscal and monetary measures in 1969 brought only more inflation, spreading the phenomenon of stagflation around the world. In 1971, the Nixon Administration abandoned the link between the United States dollar and gold and precipitated the collapse of the stable international currency system overseen by the International Monetary Fund since 1945. The spread of “free-floating currencies” powerfully reinforced trends towards a highly speculative world economy and diminished the role of GATT and GATT’s successor, the World Trade Organisation (WTO) in the effective regulation of world trade

After 1969, there followed more than a decade of highly visible runaway inflation punctuated, but not fundamentally caused by two major "oil shocks" in 1973 and 1979 and a roller-coaster ride for commodities.

Although the fundamental policies of the United States remained unchanged and, if anything, its reliance on interest-rate policy implemented through the Federal Reserve intensified, inflation, as measured by consumer price rises in the United States, declined to more acceptable levels from the 1980s onwards.

That decline was and continues to be attributed to the monetary policies of the United States, including especially discipline imposed by the Fed's interest-rate policy, dedication to "free" markets and small government, and free-floating exchange rates. Because of this attribution, these policies became ever more deeply embedded as time went on. The tendency was also for other countries to adopt them because they seemed to have worked for the United States – as the United States robustly claimed.

This view seemed to be reinforced by the collapse of the Soviet Union. The “market” was increasingly seen as sovereign and as the key to growth, income, competitiveness and even to employment. Privatisation became a key element in economic policy for mainstream economists and government policymakers.

Coincidentally with the fall in domestic consumer inflation and its attribution to mainstream monetary and free-market policies, a dramatic transformation began to take place in some east and south-east Asian economies. Leaving aside Japan, the smaller economies of Singapore, Hong Kong, Taiwan and South Korea were miraculously transformed over a period of a decade or so from slow growth, relatively backwater, developing economies into the Tiger economies of Asia.

During the same period, changes were occurring in the status of China, some of them highly visible, others unnoticed by most observers. In 1971, Henry Kissinger made and President Nixon foreshadowed his sensational visit to Beijing. Later that year, against at least purported and public opposition from Washington, Mainland China was admitted as the representative of China in the United Nations and took its place as one of the five permanent, veto members of the Security Council.

That elevation of Mainland China to the Security Council, though dramatic, was in fact less significant than the economic changes that had taken place over the previous two years in United States economic policies and that were to acquire much greater significance when Deng Xiaoping initiated changes in economic policy in China from 1979 onwards. Deng appeared to take the rapid development of Japan as a model for China to follow.

From that point, the stage was set for China to travel along the same path as that taken by the smaller Asian Tigers.

Compared with the Tigers - or, indeed, with any other country - China is a colossus, in population and potentially in economic power. The momentum of economic transformation and growth built up slowly during the 1980s but it built up ever more surely during the 1990s and into the new millennium. It built up partly through the initiatives embodied in its own economic and social policies; but its scale and speed derived especially from United States policies. The latter not only permitted but dramatically stimulated policies of economic growth through direct and indirect real fixed-capital investment, enhancement of productivity and rapidly expanding production in China.

In short, the United States provided an unprecedented opportunity which the Government of China grasped through its carefully managed transition from a centrally-planned economy to an economy in which private enterprise and the market were deliberately designed to occupy an increasingly important place. The transition was not and seems never to have been envisaged as a reckless plunge into total reliance on a “free market”, whether domestic or international. Rather was the transition envisaged as being from a centrally-planned to a mixed economy. It was neither to an economy in which the government was the sole master of production, distribution and exchange nor to an economy that was unequivocally “free” or overwhelmingly in the hands of “private enterprise” and the “market” in the widely accepted American sense. Nor, of course, was it contemplated that China would be a neo-liberal economy on the United States model.

As a consequence of these developments in the economies of the Asian Tigers, China and gradually India too, United States inflation appeared to be brought under control from around the mid-1980s onwards. It did so, not because domestic demand and supply were brought into some sort of balance, but because supplies were available, in ever greater quantity, especially from east and south-east Asia and, increasingly, from China. What this meant in effect was that the impact of inflation - deriving from pressure of excess demand on an inadequate supply - shifted from domestic price rises to deficits in the balance of trade and payments.

That situation of external imbalance intensified and became more “ideologically” embedded over the years. It was maintained - and intensified - not because it was understood and believed to be desirable - but because it suited the short-term interest of both sides. The supply countries were willing to hold their surplus dollars in idle reserves or in forms which did not disturb other economic situations. Investment and economic growth in the supply countries were stimulated by the assured markets in the United States; and, for its part, the United States received supplies which appeared to keep its inflation under control while satisfying the needs of its consumers. The deficits caused a decline in the value of the United States dollar through the later 1980s and earlier years of the 1990s; but this was gradual, relatively undramatic and sustainable in the light of the surplus countries' willingness to hold dollars. The United States dollar recovered to some extent during the boom years of the later 1990s, only to resume its downward trend after the collapse of the high-tech stock market boom at the turn of the century.

On the American side, there has been a pretty universal ignorance of what has been happening to the fundamentals of the American economy. This ignorance has been shared by a succession of Administrations, as well as think-tanks and academics in the United States – and indeed in most relevant academic and professional institutions worldwide.

On the side of China, it is difficult to say how completely their appreciation of the situation was in the past or how far it extends now. It may be that they not only had the “Japan model” in mind but that they saw clearly how the Tiger economies had been transformed and decided to join in. In other words, it can be postulated that they simply recognised a major economic opportunity and took advantage of it. We cannot be sure but, as time has gone on, the Chinese Government must have become increasingly aware of the monumental opportunities offered to it and the monumental changes that are under way in the world economy and in the economic relationships between major - and minor - national economies. Beyond the economic perspectives, they must be aware of the enormous political and strategic implications of those changes.

Although largely unrecognised, the United States has been, for some decades and continues now, in serious economic decline. In the final analysis, economic power confers political and strategic power. Relative rather than absolute changes in economic power transfer political and strategic power from one country to another. Traditionally, American strength derived from its unrivalled capacity to produce, a capacity that arguably won the Second World War for the Allies and that contributed critically to world reconstruction afterwards. It was that capacity that put men on the moon. It was that capacity that brought victory in the Cold War.

However, by the time the Cold War was won, the United States had already been applying policies for some twenty years which - unacknowledged – put in jeopardy its own destiny as a superpower. Economic trends suggested that its fate might be much the same, in broad terms, as the communist superpower whose overthrow it had, in large measure, contrived. That fate might be inevitable unless the policies which the United States had adopted since 1969 were fundamentally revised.

Even by the late 1980s, but especially through the "New Paradigm" years of the 1990s, and now well into the first decade of the new millennium, the United States has re-identified itself not as the great producer that it was traditionally, but as the great consumer. Its economic growth is now closely related to its insatiable consumption, rather than to its unrivalled production. From being the world's largest creditor, it has become the world's largest debtor. It has the largest external deficit the world economy has ever known. It has a huge budget deficit. Household debt is at record levels. Personal savings are at record lows. Personal equity in real assets has been drawn down to finance consumption excesses that refuse to diminish. Public investment has failed to cover depreciation of public infrastructure which now calls for massive injections of capital to restore the standards of the past. Manufacturing has been gutted. How much of American manufacturing survives is difficult to say. Estimates and “guesstimates” range from 40% to below 20%. The mode of calculation is highly suspect. However, what is clear is that, over the last thirty years, the formidable capacity of the United States to mass produce in quality, at low cost, has been seriously eroded and may perhaps have been devastated.

The apparent devastation continues and extends increasingly to the service industries through outsourcing and off-shoring. The traditional American economy seems to be disappearing over the horizon, leaving behind relatively unskilled and low-paid jobs in the distributive trades - accompanied of course by a recklessly speculative finance capitalism that creates and destroys asset bubbles and corporate and personal fortunes in predictable and destructive cycles. The frequently rosy claims of productivity gains are not sustained by real-income gains for the majority of the working population in the lower and middle income groups. Overall, rather than the “gale of creative destruction” described by Schumpeter, we continue to witness a gale of destructive destruction masterminded by the American policymakers themselves.

Against this background, the broad prognosis must be that the ills of the American economy are so many and so widespread that it can be only a matter of time before some event – possibly a relatively minor financial, political or strategic event - precipitates a major collapse.

That collapse will bring with it major instabilities in the whole political situation in the United States - instabilities which will quickly have their impact on the political and strategic situation throughout the world. What was only a relatively short time ago the assured position of the United States as the unrivalled superpower will be seen to be crumbling or to have already been destroyed. This will be so even though the “shock and awe” military power of the United States could, at least for a time, remain unrivalled. Any idea of a Pax Americana based on that power will have gone. Indeed, the signs of its passing can already be seen in the limited ability of the United States to handle the situation – largely of its own creation - in Iraq and Afghanistan.

When such a collapse does occur, there will be no other power capable of taking the place of the United States. Neither the European Union nor any of its members have demonstrated – nor do they claim - any such capacity. As it appears at the moment, the likely successor may be China but, even if that succession does eventually come to pass, there will be an extremely dangerous interregnum in which there could be not only widespread economic and social turmoil, but also a high risk of armed conflict, extending possibly to war among the great or major powers. The only way out of this potential catastrophe – if indeed there now is one - is to re-evaluate mainstream economic policies of the last thirty and especially the last twenty years, and to revert to policies nearer the American tradition. Essentially, these policies will be based on achieving economic growth and employment through domestic fixed-capital investment, high real productivity and production.

How does this suggest we should "deal with the rise of China"?

So far as Australia is concerned, we must note, first of all, that Australian economic policies have shadowed American policies in the long drift to disaster since 1969. Australia's use of interest-rate policies that stimulate or allow and then collapse asset-price inflation while intensifying consumer-price inflation, has been as typical in Australia as in the United States. Over time, those policies have been instrumental in shifting inflation from domestic price rises to the external balances. In some ways, Australian trade deficits have been even more chronic and persistent than the American and have often tended to represent an even higher proportion of the Gross National Product. The manufacturing sector has been gutted. The disappearance of so many skilled jobs has weakened the trades unions and destroyed the stable growth and full employment policies that were typical of the period from the end of the Second World War until 1969.

The Australian Government therefore needs, as much as the United States, to reform its own economic and social policies if it is not itself to experience catastrophic collapse. A corollary is that, until it brings itself to acknowledge the shortcomings of its own policies, it is unlikely to exert any pressure on the United States to confront its self-destructive policies and draw back from the political and strategic consequences that those policies entail.

That brings us to the other vital factor in the Australian position: its ANZUS treaty link with the United States. Superficially, that link would appear to have been strengthened even further through the support given by the Australian Government to United States action in Afghanistan and Iraq and the close personal relations apparently formed between President Bush and Prime Minister Howard.

If there has in fact been a proposal by the United States for a “secret” meeting on how to deal with the rise of China and if Australia has said "No", that would seem to conflict with embedded Australian policy on security through close partnership with the United States.

If indeed there has been a "No", it would seem likely that the response derives from causes other than national-security concerns. One might be the robust development of trade relations with China for some years past and the particularly dynamic market in commodities that Australia has now found in China and anticipates as growing strongly in the future. This actual and prospective dynamism follows many years in which commodity markets have been subdued and their revival therefore offers the best chance in a long time for Australia to improve its trading position, enjoy buoyant markets for its products and reduce its external trade and payments deficits. That is especially so in the light of the gutting of the Australian manufacturing sector and the growing tendency, shared with the United States, for off-shoring in the services sector.

Despite the current buoyancy in commodity markets, Australia's trade and payments deficits have persisted and tended even to increase. This has been and continues to be attributable to Australia’s strong consumer market and the encouragement that government policies continue to give to personal consumption. However, rather than weaken, that only reinforces the welcome that Australia has, in effect, been obliged to give to the improvement in demand for a wide range of commodities and for China’s special place in creating and maintaining that demand. A corollary is no doubt a reluctance to give any “offence”, deriving from national-security concerns, to the government of the economy on which we have become so crucially dependent.

Is this really so? Would an understandable trade interest override critical Australian security considerations? Would Australia rather see American capacity to ensure its own security and help guarantee that of Australia weakened than jeopardise markets for its commodity exports in China?

The decline in American capacity in terms of strategic security could introduce Australia to a new and, in many ways, terrifying world, politically and strategically. The interregnum we have referred to above could introduce a period of worldwide and chronic security crisis with special impact on the Asian and Pacific region. If that were to lead eventually to actual replacement of the United States by China as the world’s single superpower, then China would loom to the north of Australia as an economic, political and strategic colossus of a kind that has brought nightmares of many Australians for generations. Australia would be in constant fear of domination in a variety of ways by such a powerful northern neighbour. The threat would be far greater, for example, than that represented by the emergence of Japan in the years before World War Two – and because of whose possible revival, we sought the ANZUS Treaty with the United States after World War Two.

Therefore, the reasonable explanation seems likely to be that the Australian Government does not appreciate the macro trends in the world economic, political and strategic situation and believes that its link with its not completely reliable security “guarantor” will remain at least as reliable in the future as in the past. In other words, the Australian Government is firm in its conviction that the United States is not in decline but in robust growth in power through the economic, political and strategic policies that the United States –and Australia too - continue to pursue.

We cannot be sure of course that any such "secret" meeting as that described in the ABC report has ever been proposed. For the United States to propose such a meeting would be, in diplomatic terms, clumsy and unwise. The suggested participants in the meeting - Britain, Canada, New Zealand, Japan, as well as the United States and Australia - are close partners in a variety of ways and, as Foreign Minister Downer's comment suggests, they can readily consult on almost any issue without making arrangements for a "secret" meeting which, if revealed, might do more harm than good to relations with China and to ways in which the group might "deal with the rise of China."

On the other hand, the Bush Administration has been so clumsy in so many ways that the proposal for a "secret" meeting cannot be regarded as entirely implausible. Whether it is a fact or not, the United States and other countries must at last have begun to think a little more deeply about the implications of "the rise of China" and what they can and should do about it. At least that would suggest some progress in understanding, although any such progress would seem still to be small – and almost unbelievably belated given that the “rise of China” has been going on now for more than twenty years.

On the basis of what has been said above, the first thing that the United States should do in “dealing with the rise of China” is to consider the ways and the extent to which it has, through its own policies, brought about the spectacular "rise" of what looks like an increasingly formidable adversary. Those policies have been self-destructive in economic, political and strategic terms. They have enabled American business and corporate interests to thrive, in the short and medium term, at the longer-term cost of American security, prosperity and social cohesion. On that basis, there is no need for a "secret" or other meeting to "deal with the rise of China" but rather a need for a more realistic analysis by the Americans of their own economic policies over the last thirty years and the formulation of policies that will reverse the decline of American power and restore those elements which conferred such formidable power on the United States over the period up to 1969.

That will be difficult because current policies have become so deeply embedded. Moreover, new approaches cannot reverse transformations, in China and elsewhere, that have already been provoked. In many ways, those transformations are to be welcomed. They have brought growth and prosperity to large areas and huge populations in Asia and, in harmonious conditions, they promise to bring further and lasting benefits.

The challenge is now to preserve these beneficial transformations while we carry through the more difficult task of correcting the disastrous trends which their creation has brought about in the United States and in other countries which have followed, to a lesser or greater degree, the American lead.

That applies to Australia. It is difficult to see how, in the present political environment in Australia, much can be accomplished to reform and recast our economic policies. That reform and recasting must necessarily be so fundamental that it calls for a reversal of all those economic and social “certainties” with which the political, academic and other classes in Australia have burdened themselves for more than a generation. They are as fixed in their “wrongness” as their ancestors at the onset of the Great Depression were in those terrible years, especially from 1929 to 1932. Then, we were moved out of our destructive policies only by war and the gradual emergence of economic theories that showed some glimmerings of what might be called more common sense than deep intellectual understanding.

We must bear in mind too that the current Australian Opposition is committed to the policies of the last twenty years or so as deeply as the current Government. Indeed, the Labor Governments of the 1980s and 1990s directly and enthusiastically contributed to the economic and social decline that has afflicted and threatens to devastate the Australian society. Therefore, a simple change of government would likely mean only that the wrong policies will continue to be implemented perhaps more or perhaps less “effectively” by a new team.

The way through the wood in the years of the Great Depression was eventually defined not by governments but by people outside government, such as John Maynard Keynes in Britain. In Australia, they were such people as Professor L.F. Giblin and Joseph Benedict Chifley who was to become Treasurer and then Prime Minister in a wartime government. We must look to such people now, essentially perhaps outside the “political classes” and outside the mainstream academic and intellectual circles.

The challenge is not just to devise a rather better way of managing the Australian economy. It is a matter of finding a new way of managing the United States economy and those other economies around the world on whose stability and prosperity we – all of us - mutually depend. Even that however is far from all that is at stake. Not only economic stability but social, political and strategic stability, in the Asian and Pacific region and around the world, will ultimately depend on whether we can so rethink and reform our economic policies as to get safely through the years – even perhaps the months – immediately ahead.

Whether we are chatting formally or informally, at a “secret” or a public meeting, that is “How to deal with the rise of China”; and, at the same time, preserve our peaceful and cooperative relations with the United States, China and others involved in promoting peaceful change in a peaceful world.

James Cumes