Coping With China's Financial Power

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China's approach to economic development has turned the country into a lopsided giant, an export juggernaut with one huge financial arm. Following the reforms launched by Deng Xiaoping in 1979, Chinese businesses began using cheap labor and cheap capital to compete on the world market, with ever-increasing effectiveness. Today, Beijing continues to subsidize exports heavily. It does so directly, through favorable loans to businesses and favorable exchange rates to foreign buyers of Chinese goods. And it does so indirectly, through what economists call "financial repression," whereby the government imposes controls on the investment of Chinese citizens that allow it to funnel capital into Chinese businesses. The People's Bank of China has gathered a good portion of the enormous trade profits and cash inflows that have resulted. At the end of 2009, it held $2.4 trillion worth of foreign exchange. This is the largest amount of foreign exchange owned by any central bank in the world -- and it does not even reflect the reserves held by China's major commercial banks. What is more, the figure is likely to grow by another $300 billion in 2010.

Never before has China had this much financial might, and it is now experimenting with how best to use it in its relations with other states. Reintegrating Taiwan is an essential goal of China's foreign policy overall, but the principal aim of China's financial foreign policy is to stimulate economic growth and job creation at home. In pursuing this goal, the government enjoys considerable legitimacy: it is supported by the pride of a nation that is finally moving to a central place in the world order. Corruption, rising inequality, restricted freedoms, and environmental damage are challenges to the Chinese Communist Party, but the CCP's hold on power is likely to remain secure so long as it can continue to develop China's economy and create jobs.