A string of soft pearls

It is becoming clearer that the US has been going about the job of pulling the plug on China with quiet efficiency

A week ago, the US allowed a warship to travel within 12 nautical miles of the man-made island that China had created in the South China Sea. It was supposed to send a signal that the US did not recognize the sovereignty of China’s island. China was not pleased. The Chinese naval commander told his US counterpart that a minor incident could spark a war in the South China Sea.

In the meantime, an interesting Reuters story narrated how the Pentagon was “frustrated" by the vacillation in the state department and the White House in the US government.

A Pentagon report said that China had reclaimed more than 2,900 acres of land as of June, 17 times more land than the other claimants combined over the past 40 years.

Whether the US delayed the decision on the naval patrol out of concern to avoid a possible misunderstanding or it waited until international opinion against China built up would not be known until some of the US government documents are de-archived years later. But, it is possible to discern the contours of a possible US response to China taking shape. The US is right to be cautious and gradual in confronting China. The latter’s reaction can be unpredictable and dangerous.

Around the same time as the Reuters story appeared, David Pilling of Financial Times wrote that China was caught between its old self-image as a wounded giant and its new one as a risen power able to enforce its version of events.

This description is apt and it was very much evident from an insightful book that his colleague James Kynge had written years ago (China Shakes The World). Indeed, China’s victimhood will come in the way of its ill-concealed aspiration to occupy the pole position as the sole global superpower—a position that the US has enjoyed for a quarter of a century now.

The impression that one is left with on finishing Kynge’s book is troubling. China has a strong sense of self-righteousness to its claim to be the Middle Kingdom of the earth. It believes that it has been robbed of that position by the treachery of the West and therefore, it feels that it is morally acceptable for China to adopt any means to reclaim that position.

After all, in China’s calculation, it is not seeking any change to the global political order but merely restoring the order that ought to have prevailed.

This delusion is dangerous, for it blinds China to many of its own weaknesses that caused its relative downfall. Its denial of its own role in historical events is complete and the memory is irretrievably erased. Its sense of entitlement combined with its victimhood creates a propensity for the country to react disproportionately to any perceived or real threat to its supremacy.

Hence, it is reasonable for the US to tread carefully. Perhaps it is not entirely passive but it might have deliberately allowed that impression to gain currency and circulate as it went about “encircling" China with its own string of pearls.

The Trans-Pacific Partnership agreement has been wrapped up. China is welcome to join it but on the terms that others have already negotiated and signed on to. It is unlikely that the US Congress would derail the agreement. The US agreement with Iran—assuming that it does not unravel by January—would erode the effectiveness of the Shanghai Cooperation Organisation with its anti-American undertones.

Finally, while this columnist has not been an admirer of the US Federal Reserve in a long time, he has to applaud the deft U-turn that the institution had managed to make in its October monetary policy meeting.

The Federal Reserve, after appearing to lose control over monetary policy in September citing international factors as the reason, has brought a possible rate hike in December back on the table. Whether or not the rate hike is too little, too late after six years of keeping interest rates at zero is beside the point. That is a topic for another occasion.

What it can do is reignite volatility in financial markets of vulnerable emerging economies. China is clearly one of them. Not only is its economic growth slowing, but it is trying to keep its currency from sliding even as it wishes to cut interest rates to stimulate more borrowing (as though China has not had enough of debt) and more investment.

If the Federal Reserve raises the federal funds rate in December, China’s capital outflows would resume and the currency would come under pressure. Both tendencies would reinforce each other. China has considerable short-term external debt that would become a bit costlier to service when interest rates in the US go up.

Therefore, while many were sceptical of our thesis when Pranay Kotasthane and I co-wrote a paper in August as to whether the US was ready to pull the plug on China, now I think it is becoming clearer that the US has been going about the job with quiet efficiency.

Quite how China’s newfound ally—the UK—would react to the unfolding chain of events will be interesting to watch. Geoeconomic and geopolitical developments in 2016 will not be good for the fainthearted.

V. Anantha Nageswaran is co-founder of Aavishkaar Venture Fund and Takshashila Institution.

Comments are welcome at baretalk@livemint.com

To read V. Anantha Nageswaran’sprevious columns, go to www.livemint.com/baretalk

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