Voice

The myth of China's financial leverage

Last week Reuters' Emily Flitter filed quite the story, entitled "China flexed its muscles using U.S. Treasuries ," about China's financial power over the United States.  Here's the opening: 

Confidential diplomatic cables from the U.S. embassies in Beijing and Hong Kong lay bare China's growing influence as America's largest creditor.

As the U.S. Federal Reserve grappled with the aftershocks of financial crisis, the Chinese, like many others, suffered huge losses from their investments in American financial firms -- from Lehman Brothers to the Primary Reserve Fund, the money market fund that broke the buck.

The cables, obtained by WikiLeaks, show that escalating Chinese pressure prompted a procession of soothing visits from the U.S.Treasury Department. In one striking instance, a top Chinese money manager directly asked U.S. Treasury Secretary Timothy Geithner for a favor.

This story generated a lot of interest across the mediasphere.  FT Alphaville called it "Diplomacy by US Treasuries."  AFP reports that the "sensitive cables show just how much influence Beijing has and how keen Washington is to address its rival's concerns." 

As someone who's published on this question, you'd think I'd be very happy at the attention this issue is receiving.  And Flitter deserves kudos for going through the cables to find clear efforts by Chinese officials to use its financial muscle to get what it wanted from the United States. 

The thing is, the reportage is framed to suggest that China not only asked for concessions, but the United States granted them.  And Flitter's own story suggests that very little in the way of concessions actually happened. 

Here are the portions of Flitter's story that discusses U.S. responses to Chinese pressure: 

On Chinese requests to halt/restrict arms sales to Taiwan:  Flitter records no response.  These concerns were voiced in late 2008 and the arms sales went ahead in early 2010, so there doesn't appear to be much influence here.  AFP suggests that this pressure led the U.S. to not sell F-16's to Taiwan, but I don't think that option was ever in the cards. 

On Chinese demands that they be provided guarantees for Chinese re-entry into the U.S. repo market:

The U.S. government does not appear to have offered the Chinese a special setup guaranteeing U.S. banks. Instead, the cables show, American diplomats reassured the Chinese by pointing out that Washington had infused banks' balance sheets with $700 billion in fresh capital, effectively propping up the banking system.

On Chinese demands for providing explicit U.S. government guarantees of Fannie Mae and Freddie Mac debt

To defuse the situation, the Treasury Department sent Undersecretary for International Affairs David McCormick to Beijing for two days in October 2008. The gesture went over well.

"All of Undersecretary McCormick's counterparts appeared to appreciate his willingness to come to Beijing in the midst of a financial crisis," Piccuta wrote in a cable dated October 29, 2008. "Interlocutors stressed that unless leaders' concerns about the viability of banks and U.S. government-sponsored enterprises (GSEs) are assuaged, lower-level officials will be constrained from taking on greater counter-party risks."

The cables show McCormick trying to reassure the Chinese. "In each meeting, Undersecretary McCormick emphasized that even though the U.S. government did not explicitly guarantee GSE debt, it effectively did so by committing to inject up to $100 billion of equity in each institution to avoid insolvency and that this contractual commitment would remain for the life of these institutions," [Deputy Chief of Mission at the U.S. Embassy in Beijing Dan] Piccuta wrote.

On Chinese protests regarding Federal Reserve purchases of Treasuries and agencies in March 2009:  Flitter has no response, though the fact that the Fed went ahead with QE2 suggersts that Chinese pressure didn't deter the Federal Reserve.

On responses to Chinese requests that CIC be allowed to participate in bidding on Morgan Stanley's new equity issuance:

There's no record in the cable of how Geithner responded, but it was only a day later, on June 3, that CIC announced plans to purchase $1.2 billion in Morgan Stanley shares.

A spokesperson for the Fed said in the instance of the June 3 CIC investment, no application for an exemption was made to the Federal Reserve Board.

On the general dynamic of Chinese financial pressure:

The cables also indicate a high level of confidence among the Americans that China can't entirely stop buying U.S. debt, a sentiment shared by most economists who describe the dynamic as a form of mutually assured financial destruction. 

So, to sum up, the Chinese maybe got a small break on being able to particupate in the Morgan Stanley auction.  Beyond that, all of these efforts led to the dilomatiic equivalent of hand-holding and not much else.  And, hey, what do you know, that's pretty much consistent with what I wrote about this back in late 2009.  So, contrary to some deep-seated fears of mine, the Wikiliaks cables appears to buttress rather than contradict prior scholarship. 

Flitter deserves credit for making explicit what had only been inferred, but I'm worried that commentators are drawing the wrong lessons from her article.  The big reveal here is not that China tried to exercise its financial muscle.  The big reveal is that these efforts generated next to nothing in the way of U.S. concessions.  China's financial might does give it the ability to deter U.S. pressure -- but to China's growing frustration, it doesn't yield much else. 

Daniel W. Drezner

Whither the Saudis?

In a lot of ways, Saudi Arabia has had a lousy six weeks.  Revolutions, protests and general unrest have spread across the region from far-away Tunisia to way-too-close-for-comfort Bahrain and Yemen.  You're starting to see mainstream meda reports suggesting that the Kingdom's influence is waning compared to Iran.  The region is clearly spooked enough to spend an extra $36 billion to forestall a massive turnout for the planned "Day of Rage" on March 11.    If that doesn't work, the king might have to fall back on The Onion's suggested strategy.

With all of this going on, however, I find this report by the Financial Times' David Blair,  Jack Farchy and Javier Blas to be veeeeerrrrryyy interesting:

Saudi Arabia is in “active talks” with European oil companies to meet the production shortfall left by Libya, the clearest indication to date that the leader of the Opec oil cartel is about to boost supplies to stop further rises in the oil price, which surged to near $120 a barrel on Thursday. 

Riyadh is asking “what quantity and what quality of oil they [the European refiners] want,” a senior Saudi oil official said on condition of anonymity....

Paolo Scaroni, Eni chief executive, on Wednesday made the most pessimistic public assessment to date of the impact of the Libyan crisis on the country’s oil output, saying the country was producing only 400,000 b/d, compared with 1.6m b/d before the violence erupted.

“The real phenomenon is there are 1.2m barrels less on the market,” Mr Scaroni told reporters in Rome, adding that the loss of Libyan production was “not a huge thing, but it is something and there is also a sense of general uncertainty in the region which can be the trigger for speculation”.

The shortfall means the world market is enduring its biggest oil crisis since hurricane Katrina in 2005 knocked out most US oil production in Gulf of Mexico.

Traders believe that Saudi Arabia has the capacity to increase production and also the oil of the right quality to meet the shortfall. The kingdom produces so-called Arab Extra Light and Arab Super Light, which through blending could be made to resemble the high-quality, light, sweet oil produced by Libya.

The Saudi move comes as oil prices reached levels that many economists believe will dramatically slow the global economy and potentially trigger a double-dip recession. Oil prices hit an all-time high of nearly $150 a barrel in mid-2008.

Here's my question:  why are the Saudis being so cooperative at this point?  There might be sound strategic reasons -- preventing a double-dip recession, assuaging longstanding allies, etc.  It could be that the Saudi leadershipis feeling secure enough to plan for long-term price stability.

Still, based on the recent reportage, I'm a little surprised that the Saudis aren't exploiting the current uncertainty to ensure the security of the current regime going forward. If I was a Saudi prince right now, I'd be blowing my fortune during a 72-hour blowout in Vegas involving Salma Hayek, Christina Hendricks, and all the shrimp I could eat making it very clear to my buyers just how important stability is in my neck of the woods. 

As an energy consumer, I'm grateful for the current Saudi behavior.  As someone who studies the global political economy, I'm surprised and puzzled by this same behavior. 

Am I missing anything?