How China deploys its reserves remains a matter of great concern, especially to the United States, since most are invested in US dollar-denominated debt. If China transferred significant amounts into other currencies — it is believed that it holds rather more than 60 per cent of its reserves in dollars (with less than 30 per cent in euros), though this is a tightly guarded secret [569] — it would have the immediate effect of depressing the value of the dollar and forcing US interest rates to rise: the larger the sum transferred, the bigger the fall in the dollar and the larger the rise in interest rates. But the government is also faced with something of a dilemma. It would certainly make good economic sense for China to transfer a large slice of its reserves out of US Treasury bonds: the dollar’s value fell steadily in 2006- 8, then recovered somewhat, but there remains the strong possibility that its price might fall even further, perhaps precipitously so. China ’s vast dollar investments in US Treasury bonds furthermore earn miserable rates of return, which makes precious little sense for what is still a poor country. [570] However, if it tries to transfer significant sums of its reserves into other currencies, thereby provoking a further fall in the value of the dollar, then the value of its own dollar reserves will also decline. China is in a catch-22 situation. The two great, but utterly unlike, economic powers of our time find themselves — at least for the time being — in a position of bizarre mutual dependence. [571] This was graphically illustrated in the darkest days of the financial meltdown in September 2008, when it is believed that the Chinese were pressing the US government to rescue Fannie Mae, Freddie Mac and subsequently AIG out of concern for its holdings in them, and the Americans were understandably afraid that China might otherwise sell off some of its dollar reserves, with dire consequences for the value of the dollar and its role as a reserve currency. [572]

Before these tumultuous events, China had already been exploring other ways of using its vast reserves. In early 2007 the government announced the formation of the China Investment Corporation, a new state agency to oversee investment of $200 billion of China ’s foreign currency reserves — similar to Temasek Holdings, the Singapore government’s successful investment agency, which manages a $108 billion global portfolio of investments. [573] To test the water, the new agency placed $3 billion of its holdings with Blackstone, the US-based private equity group, thereby signalling Beijing ’s intention to switch some of its investments from US Treasury bonds into more risky equity holdings. [574] In fact it has since emerged that the State Administration of Foreign Exchange, which oversees China ’s reserves, has itself been investing rather more widely than was previously believed. [575] These moves herald China ’s rise as a major global financial player. [576] In the second half of 2007, as the credit crunch began to bite, China Development Bank took a significant stake in the UK-based Barclays Bank [577] and Citic Securities formed a strategic alliance with the US investment bank Bear Stearns before the latter went bust. [578] Three Chinese banks were also in talks about acquiring a stake in Standard Chartered, the UK-based emerging markets lender. [579] But most of this came to nought as the Chinese increasingly realized the likely severity of the credit crunch and the potential threat it represented to any stakes in Western financial institutions that it might purchase. When the financial meltdown came in September 2008, the Chinese found themselves relatively little exposed. Nonetheless, the enormous funds enjoyed by Chinese banks, based on the fact that the average household saves more than a quarter of its income and has nowhere else to invest it, mean that Chinese banks will become an increasingly formidable global force.

The relationship between the United States and China needs to be set in a broader global and historical context. The belated acceptance of China as a member of the WTO in 2001 marked the biggest extension of the world trading system since the beginning of the contemporary phase of globalization in the late 1970s. As the largest recipient of foreign direct investment and soon to be the biggest trading nation, China ’s admission immediately transformed the nature and dynamics of the trading system. By acquiring a low-cost manufacturing base and extremely cheap imports, the developed world has been a major beneficiary of China ’s accession. But China itself has also been a big gainer, achieving wider access to overseas markets for its exports and receiving huge flows of inward investment, thereby helping it to sustain its double-digit growth rate. [580] Thus, so far, China ’s integration into the global economy has been perceived in terms of a win-win situation. Is that likely to continue?

China’s impact on the global trading system is so huge, and also in the longer term so uncertain, that this is a difficult question to answer. There are already tensions over China’s relationship with the WTO: on the one hand, there are accusations from the developed countries that China is failing to implement WTO rules as it ought to, while on the other hand, both the US and the European Union are using anti-dumping clauses (designed to prevent countries selling at unfair prices) as a pretext for deploying protectionist measures against Chinese goods. [581] There has been constant controversy around Chinese exports to the US. During 2007 these were concentrated on the safety of Chinese products, notably food and toys, as well as China’s failure to observe intellectual property rights. [582] So far these skirmishes have been at the relative margins of their trading relationships but they could be a harbinger of growing tensions in the future. Although the present era of globalization was designed by and is the creature of the West, above all the United States, the greatest beneficiary has been East Asia, especially China. [583] If the West should decide at some point that China has been the chief beneficiary — and to the West’s growing detriment — then the latter is likely to become increasingly protectionist and the present global system will be undermined. The process of globalization has already ground to a halt with the failure of the latest World Trade Organization Doha Round and is extremely unlikely to be revived. [584] But it remains to be seen whether this will be the prelude to a wider breakdown.

Hitherto, the main losers in the Western world have been those unskilled and semi-skilled workers who have been displaced by Chinese competition. But their grievances have been dwarfed by the winners — the multinationals which have used China as a cheap manufacturing base and the many consumers who have benefited from China prices. What will decisively change this political arithmetic is when China, as it rapidly moves up the value chain, starts to enter spheres of production which threaten the jobs of skilled manual workers and growing numbers of white-collar workers and professionals. The process of upgrading is already taking place in a limited way, as the example of textiles in Prato and Como in Italy illustrates, with design following manufacturing to China. [585] How quickly China upgrades its technological capacity thus lies at the heart of the likely Western response: the quicker that process proceeds, the more likely it is that the political arithmetic will change and that protectionist barriers might be erected; the slower it happens then the more likely it is that trade tensions can be managed and in some degree defused. The first scenario seems at least as likely as the second.