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Bad Debts:
Assessing China's Financial Influence in Great Power Politics

Original Article By: Daniel W. Drezner
International Security Fall 2009 vol 34 no 2
Major Topic: Politics
Minor Topic: Economics


         It has been suggested that the US's high indebtedness to China scales back America's sovereignty especially with respect to China's foreign policy wishes. It is believed that America's dependence on Chinese inflows of capital could be used for nefarious purposes if lenders can translate their financial power into political power.

         The author's twofold theses are: 1) financial power over a powerful state is very difficult to convert into political power over that debtor but powerful state; 2) a great power can sometimes convert its financial power into political power over a small power.

         Ever since the time of Thucydides (460 BC – 395 BC) and up until World War II wise people have advised against debt. Two lines of reasoning have been presented: 1) deterrence: a creditor country can use it financial power to deter debtor countries' actions against the creditor. 2) Compellence: in which a creditor country tries to use its financial power to extract concessions from debtor countries. There is plenty of evidence that these events sometimes happen. However, the evidence is not conclusive since there are also many examples of a creditor state failing to influence a debtor state.

         The author claims that China will not be able to extort much (if any) action from America as a result of financial influence. The author gives a list of conditions in which a creditor country may influence a debtor country.

         In order for a creditor country to successfully influence (in a geo-political sense) a debtor country, the following conditions must be met: 1) the debtor country must not have access to credit from other sources or in other words, the creditor country must be able to get far ranging institutional support for carrying out the threat; 2) the debtor country must not be able to retaliate with meaningful of costly counter-sanctions; 3) the debtor country must believe that there are few or will be fewer conflicts with the creditor in the future; and 4) the debtor country must be trying to maintain a fixed exchange rate.

         It seems that China does not meet any of the conditions. 1) The U.S. has plenty of other sources of credit outside China – in fact the U.S. has monopsony power in the field of the creation of liquid financial assets. 2) The U.S. can retaliate against China in a trade war to a higher degree that any sanctions that China could create. 3) The U.S. expects more conflict with China not less in the future due to China's raising status. Some areas of increased conflict are in the realm of nonproliferation, humanitarian intervention, governance styles (democracy promotion) and security in the Pacific. 4) The U.S. does not have a fixed exchange rate rather China does.

         One case study involved sovereign wealth funds. By their nature Sovereign wealth funds function as financial arms of their governments so when the U.S. pushed for transparency and regulations the sovereign wealth funds and their governments resisted. But despite the pressure from their governments the OECD countries imposed their will. In other words debtor countries forced creditor countries to change. The author believes that the sovereign wealth funds gave in because 1) the OECD countries were the only place to invest with a meaningful return and low risk; 2) the OECD countries were working on preventing the sovereign wealth funds from further investments.

         A second case study involved China's attempts to alter U.S. policy and the international financial system during the recent financial crisis in 2008 and 2009. China demanded two things from the U.S.: 1) that the U.S. protect China's dollar-denominated assets and 2) that the U.S. guaranteed Chinese producer's access to the U.S. market for Chinese products. In the first demand China may have had some influence but they were not the only ones who wanted the U.S. government to protect Fannie Mae and Freddie Mac. The Government helped these two government corporations with a bail out but did not guarantee them or any other bonds issued by other government sponsored enterprises. In the second demand the U.S. has not changed the status quo and therefore the author claims China's efforts at enhancing its access to the U.S. market have failed.

         China's failure to influence U.S. financial policy lead the Chinese to try to remake the world financial system through the creation of a super-sovereign reserve currency. However, as of the publishing date, no one else is seriously considering challenging the U.S. currency's position as the currency of last resort.

         Financial power has been greatly exaggerated as a source of geo-political influence. This is especially true in the case of great power politics. In the mid-term China and the U.S. will continue to need each other – decoupling is not going to happen anytime soon. In the long term mutual dependence may lead to a very lopsided dependence. Therefore the author believes that China will do its utmost to decouple its economy from the West. Other countries will likely develop a more insular market in the products they specialize in in order to create a safe haven for national brand companies.

Added on: 2010-02-07 20:33:52
Précis by: James Jeff McLaren
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