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Former Chairman of Morgan Stanley Asia Stephen Roach: The Sino-American Codependency Trap

Stephen S. Roach 1 Increasingly reliant on each other for sustainable economic growth, the United States and China have fallen into a classic codependency trap, bristling at changes in the rules of engagement. The symptoms of this insidious pathology were on clear display during Chinese President Xi Jinping’s recent visit to America. Little was accomplished, and the path ahead remains treacherous.

Codependency between America and China was born in the late 1970s, when the US was in the grips of wrenching stagflation, and the Chinese economy was in shambles following the Cultural Revolution. Both countries needed new recipes for revival and growth, and turned to each other in a marriage of convenience. China provided cheap goods that enabled income-constrained American consumers to make ends meet, and the US provided the external demand that underpinned Deng Xiaoping’s export-led growth strategy.

Over the years, this arrangement morphed into a deeper relationship. Lacking in saving and wanting to grow, the US relied increasingly on China’s vast reservoir of surplus saving to make ends meet. Anchoring its currency to the dollar, the Chinese built up a huge stake in US Treasuries, which helped America fund record budget deficits.

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America provided China with both stability and growth anchors. China enabled the US to sidestep the mounting perils of subpar saving, reckless fiscal policy, and weak household income growth.

But economic codependency is as unstable as human codependency. One partner eventually changes, while the other is left hanging, feeling scorned.

China is now changing, and America doesn’t like it. Not only is China rebalancing its economic model from exports to consumption; it is also redefining its national character. It has adapted a more muscular foreign policy in the South China Sea, embraced the nationalistic longing of rejuvenation, framed by what Xi calls the “China Dream.” And it has started to reshape the international financial architecture with new institutions such as the Asian Infrastructure Investment Bank, the New Development Bank, and the Silk Road Fund.

The US response has put China on edge, particularly America’s so-called “Asian pivot, ” or “strategic rebalancing, ” with its subtext of containing China. The US recognizes the need to increase China’s role in the existing Bretton Woods institutions (the International Monetary Fund and the World Bank); but when it fails to deliver, it chafes at Chinese institution building. And while the US has long urged China to tilt its growth model toward private consumption, it is uncomfortable with many of the implications of this shift.

In large part, America’s unease reflects a failure to address its core economic problems – mainly a lack of domestic saving. The net national saving rate (businesses, households, and the government combined) stood at just 2.9% of national income in mid-2015, less than half the 6.3% average over the final three decades of the twentieth century. As China shifts from surplus saving to saving absorption – using its surpluses to build a safety net for the Chinese people rather than subsidize the savings of Americans – a saving-short US will find it tough to fill the void.

America’s monetary policy reveals another layer of codependency. By citing international concerns – especially China’s slowing growth – as a major reason for deferring its long-awaited interest-rate hike in September, the Federal Reserve has left little doubt concerning the key role that China plays in sustaining a still-fragile US recovery.

And with good reason: US exports, which accounted for a record 13.7% of GDP in the fourth quarter of 2013, up from 10.6% in the first quarter of 2009, slipped back to 12.7% of GDP in mid-2015. With domestic demand still weak – real consumption has grown at an anemic 1.4% pace over the past 7.5 years – the US needs export growth more than ever. So the outlook for China, America’s third-largest and most rapidly growing major export market, is crucial for a Fed that has failed to gain much traction from its unconventional post-crisis monetary policies.

This aspect of codependency is global in scope. Over the past decade, China has accounted for an average of 1.6 percentage points of world GDP growth per year – more than double the combined 0.7-percentage-point contribution of the so-called advanced economies. Even if its GDP growth slows to 6.8% this year, China would account for slightly more growth than is likely from the advanced world. Little wonder that China’s growth prospects are such a big deal for policymakers worldwide.

Speaking in Seattle on September 22, Xi stressed the need for both the US and China to deepen their “mutual understanding of strategic intentions” as a key objective for the bilateral relationship. And yet his deliberations with US President Barack Obama were lacking in precisely that respect. The agenda was shaped more by disconnected issues – cyber security, climate change, and market access – rather than by an appreciation of the strategic challenges that both countries face alone and together.

Moreover, there was little sign of meaningful progress even on the issues that Xi and Obama discussed. Both sides hailed a newfound commitment to high-level exchanges on cyber crime; but the US is about to impose sanctions on Chinese companies that have benefited from egregious hacking. Likewise, they stressed yet again the need for a “high standard” bilateral investment treaty; but there was little indication of serious movement on the industries that would be shielded from such an agreement (the “negative list.”). To its credit, China did announce an important shift in environmental policy – a nationwide cap-and-trade system for greenhouse-gas emissions, to go into effect in 2017. But, without similar actions by the US, China’s move hardly tempers the perils of global climate change.

Trapped in a web of codependency, the US-China relationship has become fraught with friction and finger pointing. In human behavior, the endgame of this pathology is usually a painful breakup. The just-concluded summit between Obama and Xi did little to dispel this possibility.

Copyright: Project Syndicate 2015 – The Sino-American Codependency Trap



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