When the Chinese recently announced the new Asian Infrastructure Investment Bank, or AIIB, the immediate international response was to blame this new development on Washington's failure to grant China greater presence at the International Monetary Fund. There is a lot of truth to this charge. In his cover article, William Overholt brilliantly identifies the failings of both the Bush and Obama administrations in effectively developing with China a joint economic agenda.
There is, however, a counterintuitive view of China's intentions, a view out of the mainstream of global thinking, that is worth examining. After all, those who correctly worried about the global banking system's highly leveraged toxic paper assets back in 2007 were also out of the mainstream.
The counterintuitive view holds that the AIIB may be less a brilliant move on the global chessboard and more a defensive ploy, or even desperate effort. The Chinese economy, the argument goes, is in a precarious position. Most Chinese manufacturing industries have experienced huge growth in oversupply capacity. In the last dozen or so years, China has experienced a domestic investment explosion equivalent in terms of urban infrastructure, residential, and commercial real estate to the building of 320 Manhattans. Yet the economy has still weakened, which is why the Beijing leadership took the unexpected step recently of devaluing its currency.
Today, half of China's debt may now be unserviceable. Several years ago, China's debt could still be financed by domestic savings. Not anymore. China's private sector borrowing in part to finance such investment has skyrocketed to between $2-$3 trillion. Because a lot of that debt is dollar-denominated, it is easy to see why IMF head Christine Lagarde is so nervous about the Federal Reserve raising short-term interest rates. The Fed is the central bank to the world. And a stronger dollar as a result of Fed tightenings, combined with Beijing's efforts to weaken the yuan, could risk some form of default, or disguised default, of dollar-denominated debt.
The AIIB is an attempt to resolve China's huge oversupply capacity problem. In cement, steel, and other elements of infrastructure improvement and expansion, China may be sitting on half the world's supplies at a time when the global economy has weakened and China's trade in both dollar and volume terms is shrinking. Such mind-boggling excess capacity, critics charge, is far larger than China can use...