Courcy’s Intelligence Brief

That the world is facing a prolonged period of quite extraordinary instability can no longer be denied.  Just consider what the last few weeks have produced: a credit-rating downgrade for the US along with an acceleration of the eurozone crisis, each adding fuel to financial-market turmoil; a mass killing in Norway, riots in London, and mass demonstrations in Israel all suggesting that even long-established democracies are finding it hard to contain disillusion with the political elite; continuing unrest throughout the Arab world; further evidence of the Taleban’s resurgence in Afghanistan; and ill-considered ‘noises-off’ from China.  All the while, neither the American nor the European political elite seem up to the task of resolving crises that they were in no small measure responsible for creating.

On 9 August, the head of the European Central Bank (ECB), Jean-Claude Trichet, told the French radio station, Europe 1: "It is the worst crisis since World War II and it could have been the worst crisis since World War I if leaders hadn't taken the important decisions."   He was right about the scale of the crisis but wrong in his proposition that the decisions taken so far are sufficient to head off a further deterioration.  And, in any case, he was talking just about the eurozone crisis, not about the wider public dissatisfaction with the European political elite, the American debt crisis, turmoil in the Middle East, the drift towards defeat in Afghanistan, or China’s growing unpredictability.

There is not a great deal we can add to the vast coverage of the American and European economic crises.  What we would like to do this week, however, is to focus on the worrying signs of unpredictability continuing to emerge from China, including its initial response to the US debt crisis.

Last week we highlighted the increasingly fractious nature of China’s relationship with Japan and its neighbours further to the south, and in particular we drew attention to the volatility of its statements and actions.  Much of the time Beijing seems to want to calm things down and to emphasize its long-proclaimed policy of peace and good-neighbourliness, then it spoils everything with an intemperate outburst.

Last week, for example, on 1 August, China appeared to be trying to calm down tensions over disputed claims in the South China Sea by issuing guidelines for avoiding escalations, but on the same day the ruling Communist Party’s People’s Daily newspaper warned neighbours about “nibbling away” at Chinese territories, adding that “any serious misjudgement will inevitably pay a necessary price”.

This is not, as we said last week, language that will reassure China’s neighbours - as the simultaneous publication of Japan’s latest white paper on defence demonstrated.  During the past week, Japan has gone further still, saying on 5 August that it is launching a study into conducting joint military exercises with the US and South Korea and looking at ways of stepping up its ability to respond to attacks on remote islands to the southwest of Japan.

China, it will be recalled, has been warning Japan about widening the scope of its bilateral defence pact with the US to include other countries, fearing the development of a ‘contain-China’ alliance of pro-US democracies from India round to South Korea.  On 23 June, China’s foreign ministry issued a statement saying: “The Japan-US alliance is a bilateral arrangement created under special historical conditions and should not go beyond its bilateral scope.”  In July, China complained about a small-scale joint US-Japan-Australia naval exercise in the South China Sea, calling it “inappropriate”.

Now China’s reactions to the US credit downgrading have displayed many of the same elements of unpredictability, swinging within a matter of hours from sensible moderation to intemperate anti-US rantings.
Officially, Beijing has been silent, but it has voiced its views through the official news agency Xinhua.  On 6 August, Xinhua demanded that the US should “re-establish the common sense principle that one should live within its means”.  It said: “China, the largest creditor of the world’s sole superpower, has every right now to demand the United States to address its structural debt problems and ensure the safety of China’s dollar assets.”  And it added that the US must slash its “gigantic military expenditure and bloated welfare costs” and accept international supervision of US dollar issues.

The Global Times, a popular tabloid linked to the People’s Daily, went further in demanding that Beijing should use its financial hold over the US “to slap Washington” over arms sales to Taiwan.

Just two days later, Beijing was clearly having second thoughts about Xinhua’s officially sanctioned diatribes against the US.  On 8 August, Xinhua was calling for “the whole world to pick up the ‘in-the-same-boat’ spirit again and ride out the current crises together”.

It went on to argue that “an economically health and fiscally sound United States and Europe serve the fundamental interests of the entire international community, including China”.  And it even pointed out that “the United States, with its traditional expertise in science, technology, and innovation, still boasts one of the most competitive economies in the world.

This was some turnaround, and was no doubt in large part based upon the realization that China, through the massive and persistent undervaluing of its currency, is just as complicit as the US in the dangerous imbalances that have been created.  China undervalues its currency so that it can export to the US, but then it lends back its surplus dollars to the US in order to prevent the appreciation of its currency so that it can continue to export.

The fact that this arrangement has suited China as much as it has suited the US was admitted recently by China’s Premier Wen Jiabao when he told EU officials in Brussels: “If we increase the renminbi (RMB) by 20% or 40%...many of our factories will shut down and society will be in turmoil.”  In an earlier speech he had warned: “We cannot imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs, and how many migrant workers will return to the countryside” if China were to revalue the renminbi.

This is precisely why China, between 6 August and 8 August, so dramatically modified its response to the US downgrading.  But two concerns remain.  The first, of course, is that the imbalances are unsustainable and do have to be unravelled, but doing so entails huge difficulties and dangers.  The political difficulties that the US has in reining in its fiscal deficit have been highlighted dramatically in the past weeks, and they are based on a full understanding of the economic suffering retrenchment will cause.  The difficulties that China would face with its mirror-image adjustment are exactly as described by Premier Wen above.

The second concern is even greater (not least because of the extreme difficulties ahead that our first concern highlights) and it is that China’s leadership has once again demonstrated its lack of maturity and its propensity to relapse into intemperate populism.  It has been showing this tendency over its maritime territorial claims, and now it has displayed it during what the ECB’s Jean-Clause Trichet has accurately described as the biggest crisis since World War II.

This is a deeply worrying trend and it probably reflects, as much as anything, China’s own fears about its internal stability.  The Arab Spring has spooked China greatly, and it will not have escaped Beijing’s notice that this week’s burning and looting in London has once again demonstrated how the advent of social media is changing the relationship between ruler and ruled. JdeC.