Editor's Note: The following is an excerpt of Arvind Subramanian's new book, Eclipse: Living in the Shadow of China's Economic Dominance, published by the Peterson Institute for International Economics.
By Arvind Subramanian - Special to CNN
February 2021. It is a cold, blustery morning in Washington. The newly inaugurated Republican president of the United States is on his way to the office of the Chinese managing director of the International Monetary Fund (IMF) to sign the agreement under which the IMF will provide $3 trillion in emergency financing (about 12 percent of GDP) to the United States and the conditionality to which the United States will have to adhere.
Over the preceding decade, the US economy has had to contend with three interconnected problems: slow growth, a fragile fiscal situation, and a beleaguered middle class. Under the weight of public and private debt accumulated after the crisis of 2008–10, high and persistent unemployment, and diminished participation in the labor force, the US economy has grown at just below 2 percent in the 2010s. As a consequence, and despite intermittent attempts to come to grips with the rising costs of entitlements, especially related to health care, public finances are not on fundamentally secure footing.
Public-sector liabilities have built up to 50 percent of GDP, as Peter Boone and Simon Johnson warned a decade ago, because the US financial system has remained as cavalier in its risk-taking and as toxic-asset-laden in its balance sheets as before the financial crisis of 2008–10. And inequality has increased even further, with income gains at the very top (.01 percent of the population) becoming even larger. Economic and social mobility have declined, giving rise to a middle class that understandably does not want to move down the skill spectrum but whose prospects of moving up, through education and skill acquisition, are increasingly limited by competition from India and China.
At the same time, China, despite the slump of 2012–13, has recovered its growth momentum and is economically dominant: Its trade and GDP are nearly 50 percent larger than those of the United States, and it remains the largest bankroller to the world with the United States still its largest bankrollee. The renminbi is increasingly in demand as a reserve currency, and the sheen has come off the dollar.
In the months preceding the 2020 US election, inflation became the primary global problem because commodity and oil prices soared due to rapid growth in the emerging markets. Growth in the United States has slowed, threatening to further expose the fiscal and financial sector vulnerabilities.
Rumors are swirling in global financial markets that China is planning to wield its financial power because it can no longer countenance substantial US naval presence on the Indian and Pacific Oceans. The dollar is under intense pressure and China has reinforced that pressure by selling some of its $4 trillion worth of reserves. The dreaded dollar collapse is imminent. Bond markets have turned on US government paper, the country has been stripped of its AAA rating, and investors are suddenly absent from US Treasury auctions.
To maintain confidence, the US Federal Reserve has raised interest rates sharply—much more than it might have had to when it enjoyed the “exorbitant privilege” of the dollar as the world’s near-exclusive reserve currency. The United States has started to face the dilemma that many developing countries faced during the Asian financial crisis of the late 1990s: While necessary to keep inflation in check and maintain confidence in the currency, higher interest rates are threatening growth and hurting the viability of the financial sector. US debt dynamics look ominous because interest rates substantially exceed growth rates. Significant economic and social costs loom. America, in short, appears like any emerging-market country.
Cheap financing is the need of the hour—especially since the loss of confidence is related to fiscal sustainability, as many advanced economies discovered years earlier (Iceland, Greece, and Ireland in 2010 and 2011 and Spain and Portugal in 2012). The oil-rich countries have refused to extend emergency financing to the United States, because the friendly autocrats of yore have all been replaced by “illiberal democrats” (to use Fareed Zakaria’s phrase) of various Islamic persuasions, moderate to extreme, with long memories of US intervention in the Middle East. The IMF seems the only option left.
The presidential motorcade reaches the plush IMF headquarters, but the leader of the free world has not arrived alone. Because the elections of 2020 resulted in divided government, the managing director has insisted that, to reassure the financial markets of the credibility of the IMF loan-cum-conditionality package, US congressional leaders of both parties be present to signal that bipartisan legislative approval for the package will be forthcoming.
(The United States, however, is able to resist pressure that the chief justice of the Supreme Court, representing the remaining branch of government, also be present.)
China—which is now the largest contributor to IMF resources and, pursuant to the reform of the IMF’s voting structure in 2018, now has veto power at the Fund—makes the removal of US naval bases from the Western Pacific introduction a precondition for the United States to receive the financing necessary to make its debt dynamics sufficiently stable to satisfy bond markets. This precondition has bite because China can easily get a majority of IMF members—beneficiaries of Chinese trade and financial largesse—to block a US financing program. The terms of the IMF program are clear, onerous, and delicately balanced between tax increases and expenditure reductions and are therefore equally distasteful to Republicans and Democrats. The US government must introduce a national value-added tax, restore the highest marginal tax rate to 40 percent, institute means testing for Medicare and Social Security benefits, and substantially reduce defense expenditures. The president grimly accepts.
Under the calm gaze of the managing director and flanked by leaders of both houses of Congress, he signs the letter of intent that elaborates the terms and conditions of IMF financing.
This scene of stark symbolism is relayed instantaneously around the globe. It is eerily reminiscent of 1998, when with arms crossed and a smug expression, West-embodying IMF Managing Director Michel Camdessus watched as Indonesian President Suharto signed off on an IMF program and, in the eyes of Asia, signed away sovereignty and self-respect. Except that the roles have been reversed. The handover of world dominance is complete.
“Is this scenario merely fantasy, or could it actually play out in the not-too-distant future?” asks economist Arvind Subramanian in his new book, Eclipse: Living in the Shadow of China's Economic Dominance. “The economic dominance of China relative to the United States is more imminent (it may already have begun), will be more broad-based (covering wealth, trade, external finance, and currency), and could be as large in magnitude in the next 20 years as that of the United Kingdom in the halcyon days of empire or the United States in the aftermath of World War II.”