Is the U.S. losing its grip on foreign policy as China rises?

By Francesco Sisci

In recent months, the administration of U.S. President Barack Obama scored two modest international successes involving Cuba and Iran.

The first was the decision to establish diplomatic ties with Cuba after a freeze that lasted over half a century. The second was the decision to come to an agreement with Iran on its nuclear program.

In either case, the U.S. didn’t come up with ideal solutions. But it has grabbed some positive, short-term benefits that don’t exacerbate existing foreign policy worries. Washington fell short of its desired regime change in these two countries. Cuba has lasted with and without Soviet support, and the U.S. has failed to topple Castro’s government. The Iran nuke deal, while controversial, doesn’t carry many negative side effects. Nor were there feasible alternatives.

At the same time, these two initiatives are fell short of what might be considered American successes. However, they now cast the U.S. in a better light following the unfortunate events and policy mishaps going back many years. The key problems were the failures of the wars in Afghanistan and Iraq during the George W. Bush administration The succeeding Obama administration didn’t fare much better as it tried to change some Muslim countries through semi-peaceful revolutions in Tunisia, Egypt, Libya, and Syria. With the exception of Tunisia, the rest of Obama’s efforts were utter failures: Libya is barely a country, Egypt has reverted to some sort of strong-man politics, and Syria has basically dissolved into Iraq. All this is the culmination of some 14 years of U.S. foreign-policy failure.

Is the U.S. losing its grip on foreign policy as China rises? The question is huge. Perhaps it’s worth taking a small detour starting with the gigantic successes of the George Bush, Sr. presidency to explore this question. In his four short years, Bush did what for half a century seemed impossible: He managed to destroy the Soviet empire, break down the USSR itself, and also bring down the ambitions of Iraq’s Saddam Hussein, which threatened to reshape regional politics. Focusing on his last achievement, Bush managed to thwart Saddam by guiding and integrating a wide alliance. This point is extremely important as the misunderstanding of the logic behind Bush’s moves later led to chaos in the Middle East and Central Asia. In this alliance of many states (basically everybody was united against Iraq), Saddam was totally isolated – even Iran and Syria, then long-term enemies of the U.S., were brought into this alliance.

Bush applied a simple principle: To beat your enemy, you have to first isolate him. In World War II, America teamed with the USSR against the Nazis.  In Afghanistan in the 1970s, America went to bed with radical Muslims against the Soviet Union; and in the 1980s to stop its old foe the Vietnamese, Washington even backed the mass-murdering Khmer Rouge. This is no dream world – it is the strategic rationale of alliances for thousands of years. You don’t choose your best friend – you choose your lesser enemies against your worst enemy. All this in the hopes of getting your priorities right. This is how Bush easily defeated his enemies. They became isolated and without hope of support. Furthermore, it also increased American influence in two ways: By expanding its web of backers and by frightening any would-be challengers of U.S. supremacy.

After Bush’s electoral defeat in 1991, Bill Clinton went even further. He didn’t content himself with defeating his enemies. Clinton laid down the basic rules of a future political and economic order. He started the process – then christened “globalization” – that pushed for the transfer of technology and production to other countries with cheaper production costs. This was also made possible by the new spread of information technology. Computers, the Internet and later, mobile phones, made it easier for companies to manage factories many thousand of miles away, where they could built on cheaper land, pay cheaper energy bills, and offer stingier wages.

The main beneficiary of globalization, of course, was China. The U.S. thought briefly that it could spread the gospel of globalization and dominate it at the same time. It believed it could lay out the rules of the new economic and financial game. Things didn’t go exactly as America wished, however, and one consequence of that was the Asian financial crisis of 1997. It followed a precedent, set in 1992, when a similar storm broke down EMS, a monetary pact in the European Union with a system of semi-fixed exchange rates between some European currencies.

In 1992, financial speculators, mostly from Wall Street, exploited the fact that European currencies had fluctuating fixed exchange rates but very different interest rates. They cheaply bet on the German mark against the British pound or the Italian lira. Many European countries almost went bust as a result, and all European central banks lost tons of money.  In a way, the euro was born in 1992 under an failing EMS star. This is because at the time of the financial crisis, the agreement for the establishment of a united currency, the euro, was also signed in Maastricht. The new currency sought to overcome the problems of the EMS by creating one hard currency (against a system of currencies linked with fluctuating exchange rates). It also represented an edge towards a political union, something that the U.S., to put it mildly, didn’t quite appreciate.

Five years later, the wave of financial attacks resumed – this time against the emerging markets in Asia.  It all started in Thailand when the Thai baht collapsed. Financial speculators analyzed the weaknesses in local currencies and attacked them, one after the other. The mistake that Asian countries made was to borrow abroad in U.S. dollars at a cheaper rate, betting on the fixed exchange rate between their own currency and the dollar. Once the fixed exchange rate broke, dollar-denominated debt multiplied to break a country. All Asian nations suffered in the crisis. The only one that held up against all speculative assaults was China.

The financial attacks failed against China for three reasons. The factors were quite technical. But to this day, the real reasons have been surprisingly ignored by global financiers. First, as the Chinese currency, the yuan, was not freely tradeable, speculators attacked the Hong Kong dollar, which after July 1, 1997, had returned to Beijing’s rule. But the Hong Kong dollar is rigidly pegged to the U.S. dollar – that is, there are huge amounts of U.S. dollars deposited in Hong Kong banks to cover the amounts of Hong Kong dollars in circulation.  Moreover, Beijing, the ultimate target of the attacks, was protected by two sets of walls: there are administrative controls that make it very hard to have capital flights or devalue the currency without government approval. At the time, China also had large reserves that allowed it to withstand these speculative attacks. The aforementioned protections to stopped the attacks against the yuan. Many currency speculators who bet against the yuan also lost a lot of money.

Between 1998-1999, when China successfully repulsed the speculators, it won popularity and influence all over Asia. Not only did Beijing stop these attacks, it also helped to head off more currency devaluations that could have brought down the whole of Asia. While China’s actions in the crisis were ruled by self interest, for a magic moment, the interests of China and those in the rest of Asia were aligned. Such an alignment didn’t exist at the time between the U.S. and Asia. The U.S. wasn’t in favor of the devaluation of those currencies in Asia, but it also wasn’t against it. Plus, the intervention of the International Monetary Fund didn’t improve the situation. Washington back then also opposed the idea of an Asian Monetary Fund or AMF then promoted by Japan and China.

The consequences of the Asian financial crisis, plus the memory of the 1992 EMS crisis, may have helped accelerate the birth of the euro, which was effectively launched in 1999, two short years after the Asian debacle. By some lights, it looked as if U.S. global economic dominance was under threat. On the one hand, the Europeans were joining together around the euro, which in objective terms wasn’t the U.S. dollar. On the other, the Asians were holding hands around China. While China wasn’t the dominant regional economic power at the time (it was still Japan), China was nonetheless, the only country that had withstood the crisis.

Was this state of affairs key in setting up the U.S. agenda at the start of Bush Jr.’s administration? Bush began 2000 by torpedoing the Sunshine Policy pushed by South Korea that favored a dialogue with North Korea. The Sunshine Policy of then-president Kim Dae-jung was also backed by China. Soon after, on April 1, there was the notorious EP3 incident, in which an American surveillance plane landed on the southern Chinese island of Hainan after being damaged in an incident with a Chinese patrol fighter. Bilateral tensions intensified.

However, things took a different turn after 9/11. The U.S. immediately recognized that its main threat didn’t come from China, but from radical Islam.  After easily winning a war in Afghanistan, the U.S. moved to Iraq. A collateral benefit of invading Iraq may have been to secure oil production with cheap extraction costs. This would give the U.S. the ability to influence oil prices worldwide from a country at the crossroads of Asia and Europe. By controlling Afghanistan and Iraq, the U.S. was poised to control Europe and East Asia. Both wars went badly. Perhaps it came down to hubris on the U.S. side. A compromise with former Saddam Hussein generals would have made the day. Saddam’s generals were ready to surrender and work for the Americans. They were prepared to do so in a way similar to Egypt ‘s Abdel Fattah El Sisi, after the Egyptian revolution.

America in 2002 didn’t want to compromise in Iraq, leading to the situation as it exists today. The global predicament of the U.S. was exacerbated by the 2008 financial crisis. It hit the U.S., the world’s heart of financial innovation and creativity worst of all. Less affected was Europe (straitjacketed) by the euro and Asia, which bounced back on the rising importance of the yuan.

At the end of our story, the U.S. looks troubled and China is on the rise. China avoided collapse in 1997-1998 and also weathered the 2008 recession. This is not the end of history, and perhaps not even a full stop on a long story. But these key elements from the past 25 years suffice to point to a larger picture.

What’s notable is that the EMS crisis in Europe and the Asian financial crisis in Asia didn’t push back either region to some primitive economic state. They recovered fully. Meanwhile, the 2008 financial crisis dented American financial and economic leadership credibility. As Washington was preaching economic virtues abroad, it was practicing accounting indiscipline at home.

Such troubles aren’t the result of evil conspiracies hatched on Wall Street. But they do point to the fact that the whole global financial order (including that of the US) is shaky.

Moreover, the process of globalization (relocation of production in cheaper places driven by a new system of command and control via Internet and mobile phones) has sparked a new way to distribute economic wealth. Factories will migrate from country to country looking for cheap locations, just like traders in the 16th and 17th century. Through their migrations they will also spread wealth and development globally in an unstoppable process.

The spread of wealth fostered by easier communications against the backdrop of outdated financial rules are also the reasons that make China’s new Asian Infrastructure Bank interesting. This, despite some tactical mistakes that the Chinese may have made in the process.

But to return to the big picture, the bottom line for the U.S. is that China and Asia, as economic rivals, can’t be wished back to poverty. China itself, presently the engine of Asian growth, is also far more resilient than some western analysts believe. (see http://atimes.com/2015/03/sisci-chinese-states-wall-of-stability-opens-door-to-the-future/). Asians resisted and came back stronger than ever after two financial and political crisis in 1997 and in 2008. Europe, meanwhile, has been stuck for years in a paralysis about the difficulties of its southern members. China is leading the pack. After China, there is the growth of Southeast Asia,  India, Africa, and the rest of the world. For the West, all this represents a crisis as deep as the fall of Rome (see http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=video&cd=15&ved=0CE0QtwIwDg&url=http%3A%2F%2Fwww.youtube.com%2Fwatch%3Fv%3D_uum_K2CWVE&ei=iaw1Ve2rCMi2ogTut4CoCg&usg=AFQjCNFYJq9s_nyrO130doljyDeHfAN6Cg ). The West has never been challenged like this since the fall of Rome. Back then the West forced to abandon its old value system and adapt to barbaric (i.e. Germanic, Slavic, or Hungarian) customs. China faced a similar challenge with the Opium Wars and the fall of the Ching empire. It has forced, and is still forcing, its people to undergo a very stressful process of modernization/westernization.

Still, the rise of China isn’t a triumphal march. Beijing got embroiled in disputes with its neighbors over the South China Sea and the Diaoyu/Senkaku Islands with Japan. For the sake of petty border issues it squandered the strategic leadership it had gained in Asia during the 1997 and 2008 financial crises.

However, China has also become politically more agile. After being cornered in these maritime border issues, Beijing turned the table by launching its trans-Eurasian New Silk Road: One Belt, One Road project. The AIIB was similarly managed. After bungling its start by behaving arrogantly with many potential partners, China changed its tone and opened to the requests for greater transparency. The U.K. and other European countries joined in and left the U.S. behind.  Washington could have again turned the tables and scored points by claiming that Beijing had agreed to the U.S. requests, but it didn’t. China is becoming nimbler in its relations with the outside world. Perhaps the U.S. should look at it in a different light.

Recently, (see http://www.ft.com/cms/s/0/3a42d156-e288-11e4-aa1d-00144feab7de.html) Chinese Premier Li Keqiang explained that China knows it is the great beneficiary of the present world order – why should China destroy it? This awareness is extremely important because it lays the concrete basis for collaboration between China, the emerging world, and the West. After 16 centuries, it is clear that the barbarians who sacked Rome not only toppled an enemy empire. They also condemned themselves to centuries of poverty. Is China, the new “barbarian at the gates,” signaling a different  consciousness vs. the barbarians of once upon a time? The future of the world may depend on the answer to that question. But one thing is clear: The U.S. also needs to lead in a different fashion. Perhaps Obama, with his initiatives in Cuba and Iran, is attempting to do this.

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