China will struggle to undo US dominance

By Daniel Moss

The hottest thing in global economics is an oldie but a goodie. This market darling is enjoying enviable growth and sucking in capital from around the world. It possesses a vibrant labor market and a currency that's not just a store of value, but increasingly seen as an ascendant strategic asset. And it’s not the China of yesteryear.

The lucky country is the US, a place so often said to have been on the verge of eclipse for various reasons such as big deficits, the euro and China's seemingly inexorable climb to economic supremacy. Numerous threats have fizzled or have been proven exaggerated. There's little denying that the past few years have seen a major shift in how the relative strengths and weaknesses of the two are assessed. For now, the US economy is in a good place, as a couple of new reports indicate. Perhaps the biggest threat comes not from outside, but has its origins in domestic strains.

The term de-dollarization has been fashionable in recent years. It's a pithy way of describing disillusionment with the greenback, in part because of sanctions against Washington's antagonists. Viewed cynically, this is a successor to dollar debasement, a conservative rally cry in the years immediately after the collapse of Lehman Brothers Holdings Inc., when the Federal Reserve embarked on massive easing. The dollar collapse didn't happen then and isn't occurring now, according to figures from International Monetary Fund sent to Bloomberg News.

The US attracted almost one-third of investment that flowed across borders since the pandemic erupted, a marked increase from the pre-Covid average of 18 per cent, the IMF numbers showed. China's slice dipped to 3 per cent, a bit less than half what is was in the decade through 2019. That jives with data from Beijing: Foreign investment slowed for a fourth month in April and is down 36 per cent from the same period a year earlier.

The once-thriving industry that churned out timetables for when China would overtake the US has gone quiet. In a major global review, Capital Economics projects America will be dominant for some time. This judgement rests on the dollar’s premier role, the size and scope of US capital markets, an abundance of natural resources and, at a time of doomsaying about dwindling fertility, a sound expansion in the labor force. Could this conclusion have been reached at any time? Quite possibly, but vital ingredients are a lead in artificial intelligence and a re-affirmation of financial prowess. “If you just look at pure economic dominance, China hasn't come anywhere close to the US and we don't think it ever will,” Jennifer McKeown, the firm’s chief global economist, told me. “There has been a major shift in thinking around this. Economists have been coming around to the view that China’s model just isn’t sustainable.”

If China's catch-up to the US has stalled, then what could undo this monetary version of Pax Americana? Leadership isn't just about whether shortcomings ultimately become so great that they trip an incumbent up. A potent rival has to arrive at just the right moment and offer all the advantages and less of the negatives. That isn't China, the euro zone or the collective might — on paper — of the BRICS bloc.

The dollar is a huge geopolitical asset, but that reflects nothing God given nor set in stone. If the US loses interest in leadership or its internal divisions prove so deep that fiscal policy truly runs off the rails, the country will ultimately lose authority over the financial system. Chipping away at the Fed’s independence and driving the greenback down for the purposes of gaining a trade advantage would be a deeply troublesome approach. “If the US doesn't keep its house in order, dollar dominance would be the least of our worries,” Steven B. Kamin and Mark Sobel, prominent former US officials, wrote in the Financial Times last week, reprising their work for the American Enterprise Institute.

The US has sometimes favored what amounts to devaluation, though it’s rarely been expressed in quite those terms. The Plaza Accord of 1985, signed by the-then Group of Five, subsequently to become the G7, urged a big appreciation of the yen and deutschemark. After the dollar fell too far, officials tried to reverse the pact. And the policymakers who sank the Bretton Woods system of fixed exchange rates in 1971 predicted, and possibly desired, a weaker greenback. Yet here we are. Next time someone asserts the US is in decline, ask them how. If they blather about economic foundering, ask them where they have been the past few years.