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Tom Holland

Anyone who fears that Washington's "pivot" towards the Pacific increases the risk of conflict between the United States and China is behind the times.
America and China are already at war. Only the battle ground isn't the East China Sea. It's money.
In his latest book Paper Promises author and Economist columnist Philip Coggan describes economic history as an endless struggle between borrowers and lenders over the irreconcilable difference in their interests.
Today that difference pitches the US, as the world's largest debtor, into conflict with China, the planet's biggest creditor.
Coggan explains that creditors are always trying to defend the soundness of money as a store of value, in order to ensure they get paid what they are owed.
Debtors, on the other hand, have a powerful incentive to debase the value of money, which effectively lets them off the repayment hook.
For the last 40 years, ever since the US government severed the link between the US dollar and gold, creditors have had the upper hand.
Gold as a monetary anchor had many problems, but its great virtue was that it prevented governments from printing money at will.
With the anchor cast loose, the US financial system embarked on a credit creation binge that saw total debt, both public and private, explode from 150 per cent of gross domestic product to almost 400 per cent in 2009 (see the first chart).
In Europe, too, debt levels soared, assisted by the continent's monetary union (see the second chart).
It couldn't last, says Coggan. "They created more claims on wealth than they created wealth itself."
The result was that both US households and the governments of Europe's periphery ran into problems servicing their debts, precipitating the collapse in confidence which has beset Western economies for the last five years.
Left with mountains of debt to get rid of, Western governments have few choices.
The ideal way to deal with debt is through growth, which reduces the size of your debts relative to your economy.
But with labour forces static or shrinking and few obvious productivity gains in sight, real growth will be hard to come by.
In the long run, that leaves governments just two options. They can default outright, or they can attempt to inflate their way out of the problem, which would cut the size of their debts relative to the nominal (but not the real) size of their economies.
Right now central banks are desperately trying to stoke inflation, or at least to avoid deflation, by printing money. But with households and the financial sector deleveraging, it's proving a tough job.
Eventually Coggan thinks a combination of inflation and default is likely, with Western governments forced to renege on long-term healthcare and pension obligations to their citizens while doing what they can to devalue their currencies.
This is where the US and China come into conflict. An effective US default on its debts through inflation and devaluation will leave China, as America's biggest foreign creditor with an estimated US$2 trillion of US dollar debt, severely out of pocket.
But even after defaulting, the US and other Western debtor countries will still need financing.
The result, believes Coggan, will be a major overhaul of the international financial system, with China, as the biggest creditor, writing the rules to suit itself, just as in 1944 the US wrote the rules for the post-second world war monetary system.
Naturally this new system will be created in China's image, with exchange rates confined to narrow trading bands, controls on the free flow of capital across international borders, and debtor economies obliged to accept strict limits on the size of their fiscal deficits.
In short, this is a war China will win.
tom.holland@scmp.com


What 'pivot'? Real US-China war will be over money

Business

Opinion

Comment

Any default on America's debts will result in an overhaul of the financial system and leave the biggest creditor writing the rules to suit itself


Expresses the views, ideas and conclusions of the author. (Eg. Enough of Crazy Rich Asians, think of crazy poor Hongkongers.)


Column

Monitor

Monitor | What 'pivot'? Real US-China war will be over money

Any default on America's debts will result in an overhaul of the financial system and leave the biggest creditor writing the rules to suit itself