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Belfer Center for Science and International Aff airs John F. Kennedy School of Government • Harvard University August 2009 U.S.-China Relations Project Policy Memo Improving U.S.-China Relations: Th e Next Steps POLICY RECOMMENDATIONS • Allow China’s currency to float freely—floating upwards on the exchanges. • Transfer Chinese-owned debt to equity in the U.S. market. • Stop the Chinese practice of sterilizing incoming foreign exchange—allowing prices to rise and incomes in Chinese consumer hands to be spent. • Reach agreement on the size, geographical distribution, and purpose of Chinese and U.S. armed forces. By Richard Rosecrance, director of the U.S.-China abroad can now be consumed by an increasingly middle Relations Project at the Belfer Center, Harvard class nation at home. Th ese steps will bring China and Kennedy School the United States closer economically and increase international stability. However, unless the military- oth China and the United States are now security relations of the two countries improve, this emerging from the slumps of the 2008–2009 will not be a suffi cient remedy for the two nations’ long B“Great Recession.” But neither country has term problems. done much to address the imbalances that helped to precipitate the crisis. China has already succeeded with In 2009, a group of faculty members at the Belfer the stimulus of its own economy. Th e United States is Center at Harvard Kennedy School joined with the continuing to provide stimulus and also very low interest Chinese Academy of Social Sciences to produce Power rates. China’s success, however, means greater infl ation, and Restraint: A Shared Vision for the U.S.-Chinese which will have to be checked by higher interest rates. Relationship (N.Y.: Public Aff airs, 2009). Th is volume If interest rates go up (and capital remains mobile), began with the premise that Great Powers too oft en the Renminbi must rise as well. Th is suggests that the fi ght, especially when the power trend of one state rises recent link between the Renminbi and the U.S. dollar to approximate that of an established leader. Britain must be attenuated or broken. A higher Renminbi will and Germany faced this diffi culty at the end of the have two advantages: for the United States, it will help 19th century, and they failed to solve it. On the other to equilibrate the past trade imbalance; for China, it will hand, America’s rise vis a vis Britain was an even more stimulate consumption (and enhance imports). It will challenging event and might have led to confl ict. It therefore help China switch from a purely exporting did not. Th is was because Britain made every eff ort to strategy to one that maintains domestic growth through admit the United States to the great power system and internal consumption. Th e goods that were to be sent to satisfy its requirements in that new role. Britain, U.S.-China Relations Project Policy Memo August 2009 however, did not make similar adjustments to the rise basket of foreign currencies. Th is would put further of German power, and that failure (and the mutual pressure on the U.S. dollar and thus depreciate China’s failure of Germany to acknowledge Britain’s concerns) current holdings. led directly to the World War I. Th e United States and China obviously do not want to repeat the errors of Perhaps China would like the United States to increase Britain and Germany: what can they do about it? interest rates, but it cannot do that now, with the U.S. economy just coming out of crisis. Another alternative One relevant historical example is relations between would be for China to consider switching some of its Britain and Germany under Otto von Bismarck, debt instruments (U.S. government bonds) for equities the German chancellor in the late 1800s. Under his in the private U.S. economy. Sovereign wealth funds are leadership, Britain and Germany aimed to diff erentiate already doing this and further purchase of U.S. equities their foreign policy functions. Britain was the primary or investment in U.S. companies could return value to sea power; Germany a predominant land power. China while limiting holdings of U.S. debt. Here China Bismarck did not seek a great navy, and Britain did not would have to be sensitive to U.S. investors and political amass a continental-style army. When Bismarck was leaders in limiting its percentage acquisition of U.S. dismissed by Emperor Wilhelm II, however, Germany fi rms. Th ese changes would not undercut the value of changed its policies and resolved to challenge Britain the U.S. dollar. Also, if China ended “sterilization” of at sea as well as perhaps on land. Th e diff erentiation incoming foreign exchange, it could both stimulate its of function was obliterated, and the naval arms race own domestic consumption and also make more likely contributed to the adverse climate of relationships that an equilibrium in the trade balance with the United led Britain to oppose Germany in the war. States. In the longer term, the Renminbi will have to fl uctuate freely, or it will not be held as a reserve currency Today, China and the United States are both spending by other countries. In the medium term, China cannot substantial amounts on armaments. Th ere is no switch dollar holdings for SDRs. Th is will only create apparent diff erentiation of function: China is aiming another dollar hoard in the coff ers of the International at an increases across the board—in air, space, as Monetary Fund (IMF) which its management will not well as land and naval forces. If these come close to accept. approximating those of the United States, there is likely to be confl ict between the two powers. Th e United Most important, however, is an agreement on the size States needs to understand the limits China places on and use of Chinese and U.S. military forces. Th e United these forces to relax on its own military preparations. States has already accommodated to British, French, Th ese understandings have not yet been reached. In and Russian intercontinental forces. If China aims to economics, the two powers are also proceeding on construct six Submarine-Launched Ballistic Missiles diverse tracks. Th e United States has become more (SLBM)s, that presents no problem. If it constructs indebted as a result of importing too much and three or four carrier battlegroups, there is no problem. exporting too little, with China as the main benefi ciary But if it were to aim at twenty SLBMs or twelve carrier of the U.S. defi cit. China has placed the funds it has battlegroups, it would start an arms race with the earned in the U.S. money market and U.S. government United States that would have unknown consequences. securities. Meanwhile the dollar has fallen, and this has Th ese must be avoided. meant that Chinese investments have deteriorated in value, so much so that China has spoken recently of Statements and views expressed in this memo are solely those of the need to diversify its holdings, perhaps shift ing part the author and do not imply endorsement by Harvard University, the John F. Kennedy School of Government, or the Belfer Center for of its funds to Special Drawing Rights (SDR)s or to a Science and International Aff airs. For more research on U.S.-CHINA RELATIONS, please visit: http://belfercenter.org/region/136 U.S.-China Relations Project Policy Memo August 2009 ABOUT THE BELFER CENTER ABOUT THE AUTHOR Th e Belfer Center is the hub of the Richard Rosecrance is an Harvard Kennedy School’s research, adjunct professor at Harvard’s teaching, and training in interna- John F. Kennedy School of tional security aff airs, environmental Government, a research and resource issues, and science and professor of political science at technology policy. the University of California, Los Angeles, and a senior fellow of the Th e Center has a dual mission: (1) International Security Program to provide leadership in advancing at the Belfer Center for Science policy-relevant knowledge about the and International Aff airs. He most important challenges of inter- was formerly a professor at the national security and other critical University of California, Berkeley, issues where science, technology, and the Walter S. Carpenter, Jr., professor of international and environmental policy, and interna- comparative politics at Cornell University. He served in the tional aff airs intersect; and (2) to pre- Policy Planning Council of the Department of State. He has pare future generations of leaders for written or edited more than a dozen books and many scholarly these arenas. Center researchers not articles. He is the principal investigator of UCLA’s Carnegie only conduct scholarly research, but Project on “Globalization and Self Determination”. He has also develop prescriptions for policy received Guggenheim, Rockefeller, Ford, Fulbright, NATO, and reform. Faculty and fellows analyze many other fellowships. He was president of the International global challenges from nuclear pro- Studies Association and served as director of UCLA’s Center for liferation and terrorism to climate International Relations from 1992 to 2000. change and energy policy. RELATED RESOURCES Zhang, Hui. “Ending North Korea’s Nuclear Ambitions: Th e Belfer Center for Science and Need for Stronger Chinese Action.” Arms Control Today, July/ International Aff airs August 2009. John F. Kennedy School of http://belfercenter.org/publication/19187 Government Kaufmann, Eric. “Th e Return of Economic Nationalism.” Th e Harvard University Providence Journal, June 20, 2009. 79 JFK St.

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