china mortgaging america helen thompson

I began this book in the last months of 2008, as the financial crisis appeared to risk pushing the world economy into a crisis not seen since the inter-war years. I started from the sense that there was something not quite right in much that I was reading about the crisis and its causes, and that the political atmosphere of those months was obscuring some important truths about what had happened. Some of that distortion came from a failure to see or comprehend what the place of the two state-supported American mortgage corporations, Fannie Mae and Freddie Mac, had been in what had transpired over the previous 18 months. It was in what happened to these hugely indebted two corporations that the mortgage boom, the wider financial bubble, and the international flows of capital from China to the United States had come together most sharply and consequentially. And it was in a crisis in September 2008 generated for the American government by the inability of these two corporations to meet their debt obligations to the east Asian central banks that the whole effective structure of the international economy over the past decade had stood in most jeopardy from the financial crisis that had been brewing since the previous summer. This book is an attempt to explain how that crisis came about, what its implications were, and what these things say about the nature of economic interdependence today. I have incurred several of my own debts in writing this book. My thanks go to Steven Kennedy, Alexandra Webster, and Renée Takken at Palgrave for their efficiency and encouragement, and Timothy Shaw, the editor of the International Political Economy series, for his enthusiasm for the project. Two anonymous reviewers gave some very helpful suggestions. Brad Setser kindly helped me with the data on Russia’s official dollar holdings. Bear McCreary’s extraordinary music was a constant companion. David Runciman and Geoffrey Hawthorn encouraged me to write this book when in various ways I was all too readily going in less productive directions. Geoffrey Hawthorn also quite rightly forced me to get to grips with some problems in the last chapter. As always, I am deeply grateful to them both.

In late August 2008, two congressionally-chartered American mortgage corporations, Fannie Mae and Freddie Mac, were facing imminent debt repayments that they could not meet. Between them they owned or guaranteed around 50 per cent of all American mortgages and they had $5.4 trillion of liabilities in securities and bonds. Their primary creditors included the Chinese and Japanese central banks. These two central banks had purchased the two corporations’ debt and securities because they believed that in the final instance the American government would take responsibility for these liabilities. But, in the summer of 2008, the Chinese and Japanese central banks, and many of Fannie Mae and Freddie Mac’s other creditors, were not willing to expose that faith any further and were selling a significant amount of their holdings of the corporations’ bonds and securities. With the two corporations unable to raise new capital, the American mortgage market, which since the middle of 2007 had come to rest largely on them, was frozen. And with foreign creditors selling significant quantities of one set of dollar assets, the prevailing international economy that had sustained ever-rising western living standards and taken millions of people in developing countries out of poverty over the past two decades stood on the precipice of collapse. The crisis around Fannie Mae and Freddie Mac in the summer of 2008 was the first serious test of the economic relationship that had developed between the United States and east Asia since the turn of the century. Either the American government acted to guarantee the corporations’ debt, or the Japanese and Chinese central banks would 1 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 have unwound large swathes of their overall dollar holdings and plunged the whole international economy into an immense crisis. On 7 September 2008, the Bush administration accepted what the Chinese and Japanese governments had hoped was always the inevitable outcome of this crisis and put the two corporations into conservatorship whilst guaranteeing full payments to bond and security holders. In saving Fannie Mae and Freddie Mac, the Bush administration took onto the Treasury’s liabilities a sum equal to the entire federal debt of the United States and assumed de facto direct responsibility for trying to resurrect new lending in the American mortgage market. Yet the conservatorship was not sufficient to restore the confidence of the Asian central banks, and after the Treasury’s September announcement, they continued to sell. With private investors and foreign central banks unwilling to offer any new credit, the Federal Reserve Board was left to promise to buy more of the bonds issued and securities guaranteed by Fannie Mae and Freddie Mac. In practice, this meant that the American central bank was printing money to rescue a mortgage market that could no longer be sustained by foreign credit. Ten years previously such a crisis could not have happened because the financial aspects of the economic relationship between the United States and east Asia were almost entirely otherwise. Indeed in the summer of 1998 the prevailing economic relationship between east Asia and the United States had been defined by a thoroughly different kind of crisis, one shaped by a huge exit of foreign capital out of east Asia and the terms that the United States had demanded, via the International Monetary Fund (IMF), for bailing out several of the east Asian states. Then the problems of corporations servicing debt owed abroad and the domestic and international economic and political problems that generated belonged to east Asia not the United States. The 2008 crisis, however, was far from a straight reversal of the one of 1997–98. Many east Asian corporations had borrowed in a foreign currency and their debt problems had begun with a currency crisis. Since the turn of the century, by contrast, the United States had become the debtor and the east Asian states creditors in the financial relationship between them without the east Asian states assuming the political strength that accrues to states that can lend in their own currency. In becoming large-scale creditors the east Asian states created new economic and 2 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 political problems for themselves, just as the United States confronted problems it had not encountered in its previous experiences as a debtor. The events of summer 2008, and the escalation of the financial crisis that followed, significantly changed, once again, the economic relationship between the United States and the east Asian states, and China in particular. Although the American government acted to avoid the meltdown that would have ensued if it had refused to guarantee Fannie Mae and Freddie Mac’s debts, it could not reestablish the old status quo in the relationship that had made it possible for the Asian central banks to finance much of the American mortgage boom. Whilst the short-term economic interests of the east Asian states continued to bind them to the financial relationship, the Chinese government, in particular, now had considerable reasons to fear the consequences of maintaining that relationship. For its part, the American state was left, by the end, of 2008, carrying the burden of a huge amount of peacetime debt. The scale of that debt and the fiscal problems it would generate could only give the Chinese government even more reason to fear what lay economically ahead. The crisis also reshaped the domestic political space in which each government had to manage the economic relationship with the other, and in doing so, made the relationship even more fraught and vulnerable to future crisis. The economic relationship between the United States and East Asia from the 1990s to the summer of 2008: An overview The broad contours of the international economy during the 1990s were shaped by the conjunction of deepening trade and capital flows, and the post-cold war reach of American power. For different states the consequences of this particular kind of international economy in this particular geo-political setting played out differently. For the east Asian states, they proved both very advantageous and a burden. The expansion of international trade, the proliferation of regional trade agreements, and the surge in foreign direct investment during the 1990s, created strong incentives for governments to pursue particular kinds of economic policies. In this sense the international economy was a severe constraint on states. Governments that wished to regulate Introduction 3 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 labour markets, or levy comparatively high rates of corporate taxation, or finance welfare and health programmes with significant employer contributions risked making their economies unattractive to long-term investors. However, the expansion of international trade and capital flows were also an opportunity, and one that many of the east Asian states grabbed more successfully than any other states. They expanded trade with each other, drew large quantities of foreign direct investment, and exported manufactured goods into western markets, in particular to the United States. Although, after its spectacular success in earlier decades, the Japanese economy slumped through the 1990s, most east Asian states enjoyed high levels of growth through the first two-thirds of the decade. However, even for the most economically successful, like the east Asian, the vast movements of short-term capital flows that had come to characterise the post-Bretton Woods international economy and the primacy of the dollar as a de facto international currency created a structural problem around exchange rates, which both imposed a serious constraint on macro-economic policy options and risked wrecking export-led growth strategies. Whilst governments could decide to make decisions about monetary and fiscal policy independently of the position of their currency, to do so risked deleterious economic outcomes either in terms of inflation or growth and employment. Different states had tried different approaches to try to establish some autonomy from the day-to-day volatility of fastmoving foreign exchange markets. The European Union (EU) states had run in the European Exchange Rate Mechanism a collective pegged exchange rate system that allowed each individual currency to float against the dollar. Others, like Argentina, had adopted a currency board, which effectively stripped the state of any monetary autonomy. Japan aside, the east Asian states had run various forms of pegs against the dollar and directed their monetary policy to try to maintain at least some measure of exchange rate stability. For its part, the Japanese government had struggled to find any solution to the problem since the second half of the 1980s. The experience of the Japanese government showed just what an economic liability the exchange rate problem could be when it could not be managed to achieve an end a government and central bank had set for themselves. With persistent upward market pressure on the yen, the export competitiveness of the Japanese economy deteriorated and under 4 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 American political pressure to loosen monetary policy, the Japanese government was left fuelling a domestic bubble that needed to be checked. In the wake of the Japanese government’s inability to solve these exchange rate generated problems, the Japanese economy spent most of the 1990s mired between modest growth and recession and eventually fell into a period, extending into the next decade, of sustained deflation.1 The capacity of the United States to exercise power in the international economy of the 1990s, especially in the monetary and financial sphere, was significantly greater than it had been over the previous few decades. The post-Bretton Woods international economy had long given the United States considerable structural financial power. It held the pre-eminent international currency, it was free to pursue whatever dollar policy it wished without the constraint of any multilateral agreements of the kind that had constricted American macroeconomic policy during the 1950s and 1960s, and it could use the IMF to determine the terms of credit to states suffering from balance of payments problems. During the 1990s the demise of the Soviet Union and the superiority of the United States’ economic performance over Japan and Germany gave American Presidents the opportunity to demand more from other states for the economic benefits that the United States provided in the form of access to its domestic market and to capital of one kind or another. They used that power to open other states’ financial markets, to attach more stringent conditionality attached to credit whether in bilateral arrangements, like with Mexico in 1995, or via the IMF, as with Russia in 1998–1999. In the case of Mexico, the terms of the loan, not least the rate of interest which Washington charged, were so tough that the Mexican government used only a tiny part of the loan granted and repaid at the first opportunity.2 Perhaps nowhere in the world was the revamped reach of America power more apparent than in east Asia.3 In 1993, the Clinton administration imposed a trade agreement on the Japanese government that required it to make structural reforms to several sectors of the Japanese economy. A year later, the Clinton administration pushed the members of the Asian Pacific Economic Co-operation (APEC) into a commitment to create a free trade and investment area. In 1996 it insisted to the South Korean government that a timetable for financial liberalisation was a necessary condition of membership of the OECD. During Introduction 5 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 the Asian financial crisis, Clinton administration officials were involved in an unprecedented manner in the negotiations between the IMF and the three states that turned to the Fund for large loans. In the case of South Korea, Washington pushed the IMF to demand more foreign ownership, external access to domestic banks, reforms to the central bank, western practices of accounting, a restructuring of the country’s largest companies, new labour laws, and a tacit promise that nobody should run for the impending presidential elections who did not support the IMF loan.4 Although, Indonesia aside, the east Asian states recovered relatively quickly from the Asian financial crisis, the economies of those that did so on the back of IMF support had, in doing so, become significantly more open to American capital and goods and with it more constrained by the various problems wrought by economic interdependence. In the aftermath of the crisis, the Clinton administration then procured the acquiescence of the Chinese government to an extraordinarily tough set of conditions for membership of the World Trade Organisation (WTO).5 By contrast, during the first few years of the 21st century, there was a set of developments that in their cumulative impact diminished the United States’ capacity to exercise power in the international economy. In part the problems that American monetary and financial dominance of the international economy had produced for other states during the 1980s and 1990s pushed other states to try to increase their autonomy in relation to the United States. For much of the EU, the formation of the euro reduced the problems of exchange rate management caused by the dollar for the operation of the Exchange Rate Mechanism. More importantly for others, it created a possible long-term alternative to the dollar as the world’s premier reserve currency.6 Although there was little reason to suppose that the euro constituted any immediate threat to the dollar, it increased the options open to other states in accumulating portfolios of foreign exchange reserves.7 Meanwhile various states turned away from the IMF to escape American strictures on their domestic decision-making. Many of those states that took large loans from the IMF between 1990 and 2001 repaid them early, such that the amount of loans outstanding to the IMF fell dramatically between the end of 2002 and the end of 2006. With the exception of Turkey, none of the larger emerging-market states has taken a new loan from the IMF since Brazil did in 2002.8 6 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 However, in part the changes in the power dynamics of the international economy since the Asian financial crisis were also driven by the spectacular growth of the Chinese economy, particularly between 2003 and 2008. That economic success was primarily based on trade, with China enjoying a rate of growth in exports frequently double its overall annual rate of growth. The consequences for other states of China’s economic rise were profound in a range of spheres. China’s demand for energy helped to produce a large increase in the price of oil after 2002, which put pressure on the balance of payments of energy-importing states and gave energy-rich states a financial windfall and the opportunity to assert themselves externally against the United States. Cheap Chinese imports mitigated against the inflationary pressures created by the rise in the price of oil, but they also threatened domestic producers in other states that could not compete on cost. The speed at which Chinese exports grew created new protectionist demands in the EU and, in particular, the United States. Meanwhile, the Chinese government proved an alternative source of credit for developing-country states, especially in Africa. Whilst the international financial institutions and the United States had in the post-cold war era made borrowing dependent on human rights performance, the Chinese government was willing to eschew political conditionality in its search for secure energy and mineral supplies.9 These developments impacted to varying degrees on east Asia. In some ways, they tightened the constraints of economic interdependence. Monetarily and trade-wise, the east Asian economies were bound to the dollar and had to absorb the fallout of whatever relationship between the dollar and the euro in the foreign exchange markets ensued. For its parts, China’s rise created a new set of interdependencies between China and the other east Asian economies. By the middle of the decade, China had become the hub of the Asian regional economy. The Japanese and Chinese economies had become particularly dependent on each other, with China providing Japan with new exports markets, which proved crucial to Japan’s post-2004 economic recovery, and Japan acting as the largest single foreign investor in China. Politically, the east Asian states were themselves part of the reaction against the way the United States had exercised its monetary and financial power during the 1990s. Thailand and South Korea repaid the loans they had taken during the financial crisis Introduction 7 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 early and Indonesia declined further credit when its 2000–3 deal expired. During the Asian financial crisis, the three large north-east Asian states – China, Japan and South Korea – had agreed to form an organisation with the members of ASEAN known as ASEAN plus Three (APT). In 2000, the ATP states moved to create a fledging currency swap system. This was nowhere the radical move that the Japanese government had wished to make during the financial crisis itself, when it had proposed establishing an autonomous Asian Monetary Fund. Nonetheless, it did demonstrate that the east Asian states had found a new will to collective co-operation, which crucially included China, in the face of the financial and exchange rate risks inherent both to the prevailing terms of economic interdependence and the capacity of the United States to use its power against other states’ economic interests. In this changing international economy, a particular relationship emerged between the United States and east Asia in which the American consumer market underpinned the east Asian states, especially China’s pursuit of export-led growth and east Asia acted as a large-scale creditor to the United States. The trade part of this relationship followed an existing historical pattern, which dated back to first Japan and then South Korea’s post-war development and which had operated in much the same way for the later industrialising states during the late 1980s and 1990s. The east Asian states used access to the American market as part of a drive for export-led rapid growth. In China’s case, in sharp contrast to the policies pursued by the Japanese government during the post-war period, this trade strategy was complemented by an openness to American direct investment, much of which went into the export-oriented sectors of the economy. The financial and monetary relationship that emerged between the United States and the east Asian states in the early years of the 21st century was born out of the conjunction of the Asian experience of the Asian financial crisis, the Chinese government’s development strategy, and the borrowing requirements of the United States. The fallout of the capital flight out of east Asia in the second half of 1997 and 1998 was traumatic. It had wrought severe recession across the region, wrecked most of the dollar pegs that in different ways the east Asian states had tried to maintain since the beginning of the 1990s, and produced the political humiliation of the IMF 8 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 experience. Although capital controls had ensured that the Chinese economy had suffered far less than others, the Chinese government drew much the same conclusions as their east Asian counterparts about what avoiding a repetition of the crisis required. First and foremost, the east Asian governments decided to protect their currencies from future speculative attack by accumulating large-scale foreign exchange reserves and none did so more determinedly than China. In practice this meant that from 2002 the east Asian central banks, and the Chinese and Japanese in particular, bought an enormous amount of American Treasury bonds and the bonds and securities issued by Fannie Mae and Freddie Mac. In the year prior to the Asian financial crisis, China was estimated to have held around $100 billion worth of foreign exchange reserves. By the end of 2008, that figure was in excess of $2 trillion, a more than 20-fold increase. Second, the east Asian states moved to create current account surpluses in the belief that states with current account deficits were more prone to currency speculation. Third, they sought to establish what Ronald McKinnon has described as an East Asian dollar standard. For most states this meant, in his words, ‘informal dollar pegging’.10 This remained most difficult for Japan. For China, which had been able to maintain its formal peg during the financial crisis, it meant retaining that peg whilst accumulating what would become a large current account surplus. This east Asian dollar standard backed by large-scale foreign exchange reserves had a direct trade benefit because it allowed the east Asian states both to keep their currencies at levels against the dollar that enhanced their export competitiveness in dollar-denominated external markets even as they earned sizeable current account surpluses and to maintain regional exchange rate stability to encourage rapidly expanding intra-east Asian trade, most of which was denominated in dollars.11 However strong the east Asian desire to save so much of their export earnings and invest them in short-term dollar assets, the opportunity to execute this foreign economic strategy depended on a parallel need for capital in the United States. This American demand for capital arose on two fronts. The United States has been continuously dependent on foreign capital in one form or another since the early 1980s when it had begun running a persistent current account deficit. At times that need for capital has been accentuated by the decision of Presidents and Congress to run significant Introduction 9 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 budget deficits in the absence of significant domestic savings. From the mid-1990s, the American current account deficit steadily deteriorated, rising to more than 6 per cent of Gross Domestic Product (GDP) in 2006. Meanwhile, the American federal budget moved from a surplus in 1998–2000 to a deficit of nearly 5 per cent in 2003. The financial side of the economic relationship with east Asia was a boon to the United States. After 2000, the United States was able to procure a vast amount of cheap capital. Whilst the United States has enjoyed privileges as a debtor since its ascendancy to monetary power after the First World War, the terms on which it could finance these twin deficits from east Asia were exceptional. In 2003, the Federal Reserve Board was able to hold interest rates at between 1 and 1.25 per cent, a level not seen since the immediate years after the Second World War. By contrast, the financial and monetary side of the relationship with the United States left the east Asian states with some severe problems. They had turned themselves into being large-scale creditor states that could not lend in their own currencies to recycle their export earnings. This is what McKinnon has called ‘the syndrome of conflicted virtue’.12 Since the widening size of the American current account deficit suggested that the dollar would depreciate over time and their lending facilitated very low American interest rates, in lending in dollars the east Asian states were both securing a very small return on their savings and incurring a significant risk that the local currency value of their assets would depreciate over time. Meanwhile, since they earned large current account surpluses, they invited pressure from deficit states, not least the United States itself. In terms of financial incentives alone the east Asian states were doing something that was perverse, and in terms of the trade benefits that made the financial relationship rational they were doing something that risked its own destruction. For these reasons, some scholars and commentators saw the economic relationship that had emerged by the middle of the decade as fraught, whatever the short-term trade benefits to east Asia or the need for capital of the United States. Lawrence Summers memorably described it as ‘a balance of financial terror’13 because each side had the capacity to inflict huge damage on the other. The Asian states could stop lending or sell their dollar assets should they fear that the dollar was weakening beyond their ability to reverse that weakness. The United States could allow the dollar to depreciate 10 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 substantially over time to repay its foreign debt and improve its balance of payments, or default on some part of its debt, and erect new tariffs against Asian exports to stem domestic anger about Asia’s trade surpluses. That either side had not hitherto acted in any of these ways was because each understood the depth of their exposure to the other. Others countered that the crucial fact about this economic relationship between the United States and east Asia was that it gave each side something that was materially critical. If the economic relationship rested on a structure of shared interests and mutual gain in a world of economic interdependence, then, the optimists argued, it was inherently stable.14 As the next chapter will argue, each of these perspectives captured something of the nature of the new economic relationship between east Asia and the United States although the pessimists were undoubtedly correct that it contained significant structural fault-lines. However, even among those who were most pessimistic, none quite foresaw the shape of the crisis of the relationship that developed over Fannie Mae and Freddie Mac in the summer of 2008. Neither had they dwelled on the specific features of domestic American politics out of which the crisis grew. Whilst since the onset of the general financial crisis in the autumn of 2008, many have recognised that the financial flows out of east Asian were the basis of the American subprime boom, what has received far less attention is the degree to which the American state’s involvement in the American mortgage market made this specific aspect of east Asian lending to the United States possible and how it produced the consequences that have followed from that one. In crucial ways, the American mortgage market is a political, not financial creation that has long depended on the American state. The American federal state has involved itself in expanding and maintaining home ownership since the early 1930s. By the mid-1970s, the federal government was directly involved in the mortgage market through the Federal Housing Administration (FHA), which provided mortgage insurance to lenders, and indirectly through Fannie Mae and Freddie Mac, which, although private corporations, had to meet policy goals set by the Department of Housing and Urban Development. Since the late 1960s, the American federal government has also made a series of moves to address the legacy of segregation and discrimination against minorities in the mortgage market and expand home ownership among African-American and Introduction 11 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 Latino households. In providing both direct and indirect material support to lower-income groups mortgage holders, the American government has, in Leonard Seabrooke’s words, ‘permitted unprecedented levels of state-empowered credit in pursuit of [these households’] lifechances’,15 and in the first decade of this century it encouraged vast international capital flows to that end. It was the engagement of the American state in the American mortgage market, which meant that other states’ central banks were willing to lend directly to Fannie Mae and Freddie Mac even though they were privately-owned corporations. As investors believed that the two corporations were ultimately backed by the American state, whatever official rhetoric to the contrary, Fannie Mae and Freddie Mac were able to issue debt and mortgage-based securities at below market rates of interest. After the fallout of the Asian financial crisis, the Asian central banks proved willing to hold large quantities of the two corporations’ bonds and securities as foreign exchange reserves. However, whilst there were good reasons for the east Asian central bank to suppose that any American government would have no choice but to guarantee the corporations’ debt, especially once they, as major purchasers of dollar assets, held so much of it, the precise nature of the American state’s support for Fannie Mae and Freddie Mac was politically uncertain. As a consequence of the state’s involvement in the mortgage market, the finance of home ownership is more politically contested in the United States than it is in any other rich economy. For much of the past ten years that political contest primarily took place over Fannie Mae and Freddie Mac. From the late 1990s, these corporations grew into huge, highly leveraged entities that dominated the American mortgage market. Their indebtedness, combined with the size of the investment portfolios they accumulated, caused some, including the then Chair of the Federal Reserve Board, Alan Greenspan, to worry that their practices posed a significant risk to the entire American financial system. These concerns were magnified by revelations in 2003 by the Office of Federal Housing Enterprise Oversight (OFHEO), the then federal authority with regulatory responsible for the corporations, that they had systematically engaged in irregular and illegal accounting practices in part to award large executive bonuses. From 2003, the Bush administration, supported by a section of the Republican party in Congress, pushed repeatedly for legislation to put 12 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 Fannie Mae and Freddie Mac under a much tighter regulatory regime. The reformers argued that the two corporations were running significant financial risks and that these mattered as much for the future of the American economy as the housing goals Fannie Mae and Freddie Mac were supposedly pursuing. Their opponents wanted to protect the corporations’ borrowing, investment portfolios, and corporate reputation in the name of expanding home ownership and affordable housing to minorities. They denied that the two companies were creating a risk either for themselves or the financial system, and attacked those who wanted new regulation as unsympathetic to widening mortgage opportunities to lower-income groups. In lending to Fannie Mae and Freddie Mac because they believed that their debt was guaranteed by the American state, the east Asian states tied their financial relationship with the United States to the complex domestic politics of home ownership in the United States. Whilst the Bush administration’s rescue of Fannie Mae and Freddie Mac in September 2008 did not produce dissent within Congress, the very fact that the rescue was necessary only led credence to the arguments of those who had argued for much of the previous decade that the American state had over-burdened itself in supporting mortgage corporations that precisely because of the institutional political framework in which they operated lacked the incentives to pursue prudent business strategies. Even though the American government had guaranteed the debt held by the east Asian central banks, those central banks were nonetheless left holding the bonds and securities of two mortgage corporations with politically uncertain futures and because of that uncertainty they still wished to rid themselves of their existing assets and refused to resume lending. This part of the economic relationship between the United States and east Asia drew to a close because the political conditions that underpinned it changed, and any analysis of the changes in that the economic relationship wrought by the financial crisis must recognise that. Interdependence and its consequences The nature of the economic relationship between the United States and China that has developed over the past decade, the way it played out through the rescue of Fannie Mae and Freddie Mac and the financial crisis of 2008 raises some important questions about the nature of Introduction 13 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 interdependence in the world today. Scholars have used the term interdependence to capture a range of rather different recent economic, social and political phenomena. Several of these phenomena have frequently been bundled together under the term ‘globalisation’. Since the 1990s it has become something of an academic commonplace that globalisation has created an era of interdependence. In this new world, these scholars argued the economic, social and political realms are interdependent and the spatial relations within, and between, each of these realms are not demarcated by state boundaries. What matters for understanding the economic relationship between the United States and China is the way in which actors on each side across the different realms impact on others such that none on either side has autonomy. Put differently, seen in this way, the United States and China exist within a global, or at least heavily internationalised, economic, political and social space beyond the control of either. Within that global space, the ties of interdependence between the two countries are particularly strong because their economic interconnectedness has penetrated so deeply. From this perspective, there is a clear explanation both of the manner in which the loss of confidence of China’s central bank and other state agencies in their American investments in the summer of 2008 helped to precipitate the crisis at Fannie Mae and Freddie Mac and of the response of the American government to that crisis. China’s economy was too exposed to the American for the Chinese political leadership not to worry about the fallout of the collapse of the American sub-prime sector and the United States’ economy was too dependent on Chinese lending to do anything but assume responsibility for the two mortgage corporations’ debts. Economic interdependence determined the outcome and it did so by creating realities that were stronger than any independent political will that could be manifested in either state. The argument that globalisation has created a new world of interdependence has some important implications. It tends decisively to disconnect the world today from the economic and political past and it tends to diminish the role of the state.16 The implicit contrast in the thesis that globalisation has created a new world of interdependence, or at least a new kind of interdependence, is with a world in which states mattered more as sites of political agency and identity. The argument takes different forms. Some have argued that 14 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 states are just able to do less because under conditions of interdependence they have less power than they did and fewer policy options.17 In a world in which states could do less, new forms of governance, which were more fragmented than anything seen since the creation of modern states, emerged.18 Others claimed that states are becoming disaggregated. Anne-Marie Slaughter, for example, has argued that different parts of the state have to form their own relations with their counterparts in other states and international agencies and these are more significant to that sub-part of the state than internal state relations.19 These kinds of approach to interdependence reduced the importance of the political realm. Analytically, they made it less distinctive from the economic, social and cultural realms, and substantively reduced practical and imaginative political possibilities. As Colin Hay has suggested, if the argument that globalisation has created a new kind of interdependence is correct then it is ‘more difficult to govern’ and ‘more difficult for citizens to hold those that would claim to govern to account’.20 Casting the economic relationship between the United States and China in such terms, we can construct an argument about the particular consequences of the complexities of interdependence in this instance. First, this is a relationship for which it is hard to find a historical parallel. No other state of any size has developed its economy as rapidly as China by pursuing growth simultaneously through huge export sales into another market and opening up its own domestic markets to large-scale foreign investment. The corollary is that no other developed-country state has, as the United States has done over the past decade, tied so much of its own economy on both the trade and capital side to a particular developing-country economy. There is also not an obvious historical parallel for the interdependencies created by the global market for mortgage-backed securities and the connection this created between domestic housing sectors, matters of international financial regulation, the fiscal soundness of local government operations and pension funds, and growth and recession in economies on the other side of the world. A world in which the American mortgage market was fuelled directly and indirectly more by east Asian foreign exchange reserves than domestic savings deposited in local financial associations was transformative of the material prospects and expectations of many American citizens, the kind of economic choices open to governments on both Introduction 15 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 sides of the Pacific, and the business viability of American and Chinese corporations dependent on cheap short-term credit. Second, this perspective would suggest that as a consequence of the kind and scale of economic interdependence that has emerged, the United States and China have less policy autonomy than they did and that the component parts of each state, particularly the two central banks and Treasuries, have had to work out a relationship with each other that is more significant outcome wise than any they might have with the rest of the policy-making apparatus in Washington and Beijing respectively. Third, this perspective would indicate that the interdependence of the two economies is likely to act as a decisive constraint on the potential for political conflict between the United States and China. Finally, and more broadly, it would stress that the economic relationship between the United States and China is in itself an agent of interdependence. The financial crisis of 2008 that this interdependence helped to precipitate created a huge set of economic and political difficulties for a very large number of states, banks, corporations and public sectors simultaneously. The responses of these actors to the crisis then had direct consequences for others across the world, and the way these actors responded let loose complex distributional issues between states about burden-sharing in dealing with common predicaments. Nonetheless, the argument that globalisation created a new world of interdependence which has transformed the political world is problematic in several respects. Economic interdependence is simply not a new phenomenon and neither are its political consequences.21 For example, many of the political problems created by open capital flows between states, for example, played out during the inter-war years in ways that were far more dramatic than the problems generated by the financial liberalisation of the past 30 years.22 If there is something new in today’s world, it has to be that interdependence now takes a different economic form because of the intensity of the mutual relationships and, as a result of that intensity, has sharper political consequences. There are some good reasons to think that the first claim is true. Most fundamentally, there is now far more mobile capital in the world economy and it can be moved far more rapidly between economies than has ever been the case hitherto in periods of significant international economic interdependence.23 The question is whether the political consequences of 16 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 this new kind of economic interdependence are a genuinely new phenomenon. Here the argument that globalisation changed the nature of interdependence turns on the present nature of the state: what it does and does not have the autonomy to do and its internal coherence. In terms of substantive policy-making, the state was rather more robust than the globalisation thesis about interdependence has suggested. Despite financial liberalisation, the growth of enormous foreign exchange markets, the expansion of international trade, the spread of production processes across national economies, and the proliferation of foreign direct investment, states retained considerable power.24 They were able to use that power to maintain politically distinct national economies.25 And, it was states themselves that drove financial liberalisation after the end of the Bretton Woods regime.26 Crucially, much of the comparative empirical evidence about the policies actually pursued by developed- and developing-country states does not support the claim that interdependence had rendered states relatively impotent or condemned them to a narrow range of economic possibilities.27 Some developing-country states were even able to control short-term capital flows when these were taken by some globalisation scholars to be the juggernaut most weakening the state. Studies of economic decision-making in particular states over the last 30 years strongly suggest that the contingent political judgements of those in government at any particular time matter causally and they have to be understood within domestic political contexts.28 Even where economic interdependence creates genuine constraints that reduce economic discretion, unless politicians are willing to choose self-destructively, how those politicians themselves perceive interdependence matters. On the one hand, policy-makers can misunderstand it and consequently make misjudgements, either failing to see, or being unwilling to acknowledge constraints that are in fact there. Alternatively, politicians in office can find it useful to present constraints that do not exist to reduce expectations from within their party and their constituents about what they can do with power.29 In part those who stressed the state’s weakness under the recent form of economic interdependence mistook the nature of the state itself. In doing so they assumed that if the state did not do all those things that western governments had politically chosen to do in the 1930s and 1940s that the state itself was a weaker political actor Introduction 17 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 than hitherto. Yet the state is first and foremost a political entity and cannot be defined by its economic purposes, or indeed any particular set of policy commitments at a given historical moment. As Max Weber explained, the modern state is a site of exclusive authoritative rule by human beings over human beings in a strictly demarcated territorial area, which rests on the application of law and in the final instance the legitimate use of violence.30 When the state is understood as such a political entity, the question of the relations of parts of the state to sites of international agency or parts of other states appears in a different light. Parts of any state designated to deal with particular policy matters can develop deeper relations with actors beyond that state without the state changing its character. For interdependence to have changed the state it would have to be the case that under the impact of economic integration either political consent to states had diminished and citizens were looking to alternative political associations, or states were unable to exercise coercive power when necessary to sustain their rule, or that international institutions and international organisations had enforceable legal claims within the territory of hitherto sovereign states.31 Although there are good arguments to be made that some such developments might have occurred in various poor states, not least in Africa,32 it is difficult to see where any of these phenomenon has occurred in a rich state beyond the purchase of EU law on the EU’s member-states and the rules about qualified-majority voting in several policy areas in the EU’s Council of Ministers. Looking at the development of the economic relationship between the United States and China over time, we can see that the state has mattered as a political entity as have the political judgements of those in government. The move by the Nixon administration to open relations with China, without which it would never have been possible for China to pursue export-led growth through American markets and investments, was driven by a geo-political judgement about the balance of power in the cold war and not economic or social forces. When the Chinese government choose to embark on a new approach to development in the late 1970s by opening up the Chinese economy, the Chinese state remained a crucial economic actor, particularly in directing credit towards export sectors. After the Asian financial crisis, the Chinese government took the decision to accumulate large-scale foreign exchange reserves and used them to maintain 18 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 an extremely tight exchange rate policy designed to prevent the outcomes markets would have produced. Politically, the capacity of the Chinese Communist party to maintain its grip over the Chinese state and the rule of that state over a huge, heterogeneous population spread over a large territory has so far been undimmed either by a deep economic relationship with a state with a very different form of government or the penetration of Chinese society by international social, cultural and technological influences. The fact that a Communist Chinese state has endured has been an important part of what American policy-makers have been responding to in dealing with the economic relationship, just has the fact that China is integrating itself into an international economy and set of international institutions dominated by the United States been a significant part of what Chinese policy-makers have had to deal. Consequently, the economic relationship between the states has at times been politically contested. The Chinese government was internally extremely divided in 1999 about whether to accept the increased economic interdependence that WTO accession brought, and the Clinton administration had to fight Congress to pursue its preferred trade policy towards China. Meanwhile both the United States and China have ferociously guarded their legal sovereignty from various international organisations and the crucial negotiations on China’s accession to the WTO were the bilateral ones between the United States and China over permanent normal trade relations between the two states rather than those that produced the final multilateral agreement. Both the state and politics matter in their own terms in understanding how economic interdependence produced the crisis in the summer of 2008. Interdependence and its consequences have also been much debated over the past few decades by scholars in international relations. Liberals have argued that interdependence, and economic interdependence in particular, reduces the likelihood of conflict between states because it creates shared interests.33 It also generates strong incentives for them to co-operate. In Robert Keohane’s, words: ‘As interdependence rises the opportunity costs of not co-ordinating policy increase, compared with the costs of sacrificing autonomy as a consequence of making binding agreements.’34 According to liberals even the United States cannot escape the reality of interdependence. For John Ikenberry: ‘What the dominant state Introduction 19 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 wants from other states grows along with its economic size and degree of interdependence … It will be necessary for the dominant state to reduce its policy autonomy – and do so in a way that other states find credible.’35 From this perspective, the economic relationship between the United States and China leaves each state unable to make policy decisions without regard for the other and puts a premium on using international forums to mediate their policy responses to shared problems. The problem with the liberal argument is that it assumes a natural convergence between the facts of economic interdependence and politics, as if politics falls into whatever shape international economic flows require or would be optimal to sustain interdependence. Yet in reality, interdependence has to be politically managed and domestic politics is an important constraint on the way governments can respond to the policy dilemmas they do indeed, as liberals insist, share with other states. Whatever the overall universal benefits of international trade, and however much nationalist actions against foreign producers can be economically self-defeating, politicians competing for votes can face considerable incentives to respond to the grievances of those producers who are the immediate losers of international economic competition. There is no a priori reason to suppose that any set of politicians will put what is economically advantageous, or what makes co-operation with other states easier, above what in domestic politics is electorally necessary or even simply useful. State debt creates another version of the same problem for governments. Under conditions of economic interdependence money can be borrowed internationally, but the taxes that eventually have to pay for it can only be collected domestically. Increasing taxes or interest rates to pay for debt owed to foreigners can at times prove extremely politically difficult, as the political struggles of various indebted developing-country governments, especially in Latin America, have illustrated. Whatever the financial fallout of putting domestic politics before the constraints of interdependence, politicians will sometimes choose to do it. American domestic politics has frequently been beset by protectionist passions, especially in the Congress, and these have made international trade a serious domestic political problem at one time or other for every American President since Nixon. Both President Clinton and President Bush jnr failed in important parts of their 20 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 push for more trade liberalisation either because they could not procure fast-track authority from Congress or because Congress refused to ratify the agreements that they did negotiate. The question of trade for American Presidents has long gone beyond the immediate economic question of whether to protect inefficient domestic producers. For example, when, in 2008, Congress rejected the free trade treaty negotiated by the Bush jnr administration with Colombia it was repudiating an agreement that, in opening up previously closed Colombian markets to American exports whilst 90 per cent of Columbian exports already enjoyed free access to the United States, was of significantly more immediate economic benefit to the United States than its trading partner. Trade matters in American domestic politics not just because some of those who lose from it have been politically well organised but in what it appears to represent about the United States’ power and general relationships with other states. Many Americans have politically seen the protracted American trade deficit as a symbol of American weakness and the parallel trade surpluses of first Japan and then China as threats to American wealth and power. They have been quick to charge that other states, particularly those in east Asia, have engaged in unfair competition, and they have wanted to tie trade relations with other states to human rights and labour and environmental standards issues. Just as importantly, policy autonomy can be a domestic political good in itself whatever the international economic rationale for compromising it. Put differently, governments can attach considerable importance for domestic political reasons to creating the perception of policy autonomy for its own sake. Clearly, analytically autonomy and sovereignty are very different concepts. But the fact that politicians in nation-states have long used a language of national independence and self-determination in ways that have run roughshod over the distinction, especially perhaps when it has come to economic matters, has meant that policies which clearly show a government’s decision-making to be constrained by external forces, whether those be markets, other states, or international organisations, are often a domestic political risk. During the years of the Bretton Woods international monetary and exchange rate order the levels of economic interdependence between the United States and the western Europe and Japanese economies deepened. Yet as they did Introduction 21 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 so did the constraints on monetary and fiscal policy imposed on American decision-makers by maintaining dollar-gold convertibility. When sustaining that convertibility would have required the Nixon administration to accept a tighter fiscal policy and the American Federal Reserve Board to push interest rates higher, the President and his advisors chose simply to dismantle the foundations of the entire Bretton Woods system. They did so without the semblance of co-operation with other states whose economies would be hurt and who were members of the IMF, which had supposed authority over exchange rates. Asked at the meeting that took the decision to end dollar-gold convertibility about the consequences for the United States’ relations with other states for acting unilaterally in the face of what were shared economic difficulties, the then American Treasury Secretary, John Connolly, replied: ‘We’ll go broke getting their good will. … Why do we have to be reasonable?.’36 Forced to choose between the imperatives created on the one side by economic interdependence and multilateral rules and on the other by those generated by economic uncertainty, the desire to avoid macro-economic choices that would hurt the American electorate, and growing protectionist demands in the run-up to the presidential election of 1971, the Nixon administration put domestic politics first. American Presidents have to manage economic interdependence with China within such domestic political constraints. In several respects, any deep economic relationship with China was always going to create particularly awkward domestic political difficulties for American politicians. China is a Communist regime with which the United States has only had diplomatic relations since 1979 and after Tian’anmen the American government suspended all high-level official meetings and imposed economic sanctions. Prior to China’s membership of the WTO, China’s most-favoured nation status for trade was subject to annual renewal and Congress tried in the aftermath of Tian’anmen to end it by tying it to China’s human rights performance. The sheer speed of China’s economic rise after the Asian financial crisis created considerable fear among some Americans. In a very short period of time, China accumulated a large trade surplus with the United States of a kind, and on a scale, that had engendered the Japanese-bashing rhetoric of American politics in the second half of the 1980s. In these circumstances, any American President seen to 22 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 accept a reduction in policy autonomy for maintaining the economic relationship would run a domestic political risk. In assuming that economic interdependence reduces the likelihood of conflict between states, liberals also risk paying insufficient to power relations between states in the face of interdependence. In its most basic sense interdependence means that different entities depend on each other. Colin Hay has recently argued that this dependence is best conceived as ‘reciprocal causation’ such that ‘any change in one [entity] will result in a change in all the others’.37 However, this in itself does not tell us anything about the size of the impact a change in one entity will have on another and whether the impact of a change in one entity will be as significant for the others as for itself or vice versa. Neither does it tell us anything about whether one entity has a greater capacity to withstand change than the others, or whether one entity has the ability to push any of the costs of the interdependence onto others. In the present economic and political world, sharp power relations still exist between states in a situation of economic interdependence. Where there are power relations there is also dependence. The way that dependence shapes the way governments respond to economic interdependence cannot be separated from power relations between states in other realms, especially the security sphere. As noted earlier, in the second half of 1980s the Reagan administration was able to push successive governments in Japan towards macro-economic policies more conducive to American monetary and exchange rates interests than Japanese. It was able to do so in good part because Japan was dependent on the United States for its security. Whatever the mutual ties created by economic interdependence, the United States and China are very far from being equals in any of the economic, diplomatic or military realms. The United States is the dominant power in the world. Its GDP is more than three times than China, its GDP per capita is nearly eight times higher, and its military expenditure is more than seven times greater. The sheer difference in wealth and power between the two states is part of the context in which each deals with interdependence. The Clinton administration was able to impose upon the Chinese terms to accede to the WTO that allow until 2013 any other state to impose unilateral restrictions on any Chinese import if it can show that ‘material damage’ is being done to its domestic producers. The administration also forced China to Introduction 23 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 reduce tariffs on some agricultural imports into China to virtually zero whilst the Americans, Europeans and Japanese maintain a fiercely protectionist stance on agricultural goods. Power is inherent to the ways in which states deal with their interdependence. Nowhere is this clearer than in the realm of monetary and exchange rate matters. The United States possesses the premier international currency whilst China maintains restrictions on the convertibility of the yuan on its capital account. Like all other states, except the United States itself, China lives in an economic world in which it needs to earn and to hold large quantities of dollars for various purposes and in which the monetary actions of the American central bank can have a huge impact on its domestic economy. There is no symmetrical dependence of the United States on China, however much the United States borrows from China, because the dollar’s position as the dominant currency in international trade, the currency in which oil is transacted, and the primary international reserve currency is unique. Whatever the mutual constraints created by economic interdependence, there are simply ways in which China is acutely constrained by the United States that are not reciprocal, and American Presidents have been willing to use them to American advantage. Realist international relations’ scholars have long believed that the relationship between the interdependence of international economic life and international politics is not as benign as liberals suppose. They argue both that powerful states can engage in conflict, and even war, against a single rival without inflicting significant economic damage on themselves,38 and that international economic flows create genuine conflicts of interests between states.39 They also insist that what they see as the anarchic nature of international politics generates specific security problems that exist independently of economic forces, however much what happens in one economy impacts on another.40 Empirically, they point to the First World War as proof that deep economic interdependence is entirely compatible with intense military conflict between states.41 For realists, as summarised by Kenneth Waltz, ‘interdependence promotes war as well as peace’.42 Looking at the world today, Waltz has argued that since economic interdependence today co-exists with growing inequality between states, it has actually made international politics more, not less, fraught.43 24 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 Seen in realist terms, the economic relationship between the United States and China is inherently vexed and the general conflictual relationship between the United States as the world’s dominant power and China as the world’s rising power will shape the nature of the economic relationship more than the facts of interdependence. Put differently, the American and Chinese governments do not have the incentive to co-operate in the face of their economic interdependence, nor can they afford to put more premium on their shared economic interests than long-term security prospects. For an American realist like John Mearsheimer, the United States faces a threat to its interests in Asia from China’s economic rise because that growing wealth will eventually strengthen China’s military power. Accordingly, for Mearsheimer, ‘the United States has a profound interest in seeing Chinese economic growth slow considerably’.44 Whilst realists are correct that there is no necessary relationship between economic interdependence and co-operation, or reduced conflict, between states, they tend to ignore the contingent and specific ways in which interdependence constrains policy choices for states and assume too strict a separation between security matters, international economic issues and domestic politics. The analytical disassociation that realists make neglects even in their own terms the question of how states finance their security policies. In an age of open financial flows, it is very easy for states to borrow money to pay among other things for increased military expenditure not just in private international capital markets but also from other states’ central banks. This reality has particular significance in the case of the present interdependence between the United States and China. The American state did borrow significant sums of money from the Chinese state after 2000 and it did so in significant part to finance the war in Iraq. Procuring cheap credit from China allowed the United States to exercise power in part of the world long-considered central to its geo-political and economic interests without asking its own citizens to make an immediate material sacrifice either via increased taxes or higher interest rates to pay for that strategic move. From the American perspective, the safety-check for security on this financial arrangement had to be that China could only end its lending, and thereby require the United States to absorb the financial cost of the war in the short term, by hurting its own economy. Seeing that states still matter as individual actors under conditions of interdependence, Introduction 25 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 as realists do, is not a reason to simplify the complex political conditions under which they act. Since states are first and foremost sites of domestic rule, since they have to legitimate that rule and have come to do so in good part by economic means, and since their ability to deliver prosperity is shaped by the contours of interdependence, they cannot deal with other states without significant regard for the economic relations between them. That economic interdependence does not, and cannot, determine relations between states does not mean that it is not a crucial component of the context in which they interact. For all their serious differences most approaches to interdependence tend to depoliticise things that are inherently political, including the state itself, and put insufficient weight on domestic politics. By contrast, this book starts from the premise that the political and the contingencies generated by politics matter both domestically and internationally. In placing significant analytical weight on the political, the book argues that the domestic politics of states will change the contours of economic interdependence over time. Economic interdependence is not a natural fact but requires political support, the existence of which is contingent on matters beyond the material realities of interdependence itself. In this case, whilst interdependence was a stabilising dynamic within the relationship between the United States and east Asia, and China in particular, it co-existed with more destabilising political dynamics, leaving the relationship prone to change over time and vulnerable to crisis. Whilst much of the analysis of consequences of interdependence has been shaped by the academic division between international political economy, international relations, and comparative domestic politics, the nature of the economic relationship between the United States and China as it played out after 2000 demonstrates acutely just how far the facts of economic interdependence, the reality of power relations between states, and the contingencies of domestic politics need to be analysed together. It also demonstrates the importance of looking at the specifics of each of these things before postulating any kind of general claims about economic interdependence or its relationship to international power relations. Whilst much scholarly work about the risks inherent in the economic relationship between east Asia and the United States had focused on the dollar, the actual vulnerability in the relationship that played out in the summer of 26 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 2008 arose in significant part out of long-standing political commitments in the United States to the spread of home ownership. Just as potently, the development of the economic relationship between the United States and China and its ramifications shows the importance of in-time analysis. The responses of the east Asian governments to the specific problems of economic interdependence at particular moments changed the economic and political consequences of that interdependence over time and created new power relations in doing so. Aims and organisation of the book This book seeks to explain the origins of the crisis in the economic relationship between the United States and east Asia, and China in particular, in the summer of 2008 around Fannie Mae and Freddie Mac, and to analyse the significance of that crisis in terms of interdependence. It argues that those origins lay in the interaction of some specific features of the international economy that emerged after 2000 and the domestic politics of home ownership in the United States.45 It examines from a historical perspective the specific features of each that brought the crisis about. What the book does not do is examine the domestic politics behind China’s, or any of the other east Asian states’, strategic financial decisions during the years leading up to the crisis of summer 2008. Whilst the complexity of this politics explains some of the strategic decisions made by the Chinese leadership about holding dollar assets after the Asian financial crisis, it is not in itself part of the explanation of the specific crisis that developed around Fannie Mae and Freddie Mac. The book begins by explaining in detail the origins of the post1998 economic relationship between the United States and east Asia. The first chapter examines the ways in which the east Asian states responded to the Asian financial crisis and how China, in particular, sought to hold the savings from its current account surplus in dollar assets that were either issued, or believed to be guaranteed, by the American government. It proceeds to explain the demand in the United States for Asian capital. It considers the opportunities and risks of this economic relationship from the perspective of both sides and the way those were constructed in the scholarly debate around the relationship. Introduction 27 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 Chapter 2 examines the politics of home ownership in the United States from the 1930s to the end of the 20th century as the backdrop to the political development of the American mortgage market after 2002. It explains why the American state became so involved in the mortgage market through various federal agencies and Fannie Mae and Freddie Mac. It considers how from the 1960s the American state’s involvement with the mortgage market became fused with politically fraught issues around the legacy of segregation, discrimination against African-Americans and minority poverty. Against this backdrop, it explains how the Clinton administration sought to expand home ownership in particular amongst African-Americans and Hispanics, and the consequences of the interaction of this political development with the financial securitisation of mortgages to lowincome earners that began in the second half of the 1990s. Chapter 3 considers the mortgage and financial boom in the United States from 2002 to 2007, the part played in that boom by Fannie Mae and Freddie Mac, and the political battle within Congress over the regulation of these two corporations. It explains why the Bush administration was unable to construct a congressional coalition to pass legislation to establish a new and tougher financial regulator for the two corporations, and it situates that failure in the context of the domestic politics of home ownership in the United States. Chapter 4 analyses the development of events from the crash of the sub-prime financial bubble in the summer of 2007 through the Federal Reserve Board and Treasury’s moves to rescue Fannie Mae and Freddie Mac in 2008 and early 2009. It examines how for the first months after the bubble burst, the east Asian states, and in particular China, provided large sums of capital in the form of bond and equity purchases to various American financial firms, and allowed the two corporations to continue to pump money into the American mortgage market. It explains the implications for China of this continuing transfer of capital to the United States in light of the predicaments it now faced in its economic relationship with the United States and why the Chinese state-investment vehicles became increasingly unwilling through 2008 either to take new stakes in American financial firms or eventually to lend to Fannie Mae and Freddie Mac. The chapter then considers the choices that the conjunction of diminishing benefits of the financial relationship with the east Asian states and the domestic deflation of the mortgage market created for American policy-makers. 28 China and the Mortgaging of America 10.1057/9780230283305 - China and the Mortgaging of America, Helen Thompson Copyright material from www.palgraveconnect.com - licensed to Yale University - PalgraveConnect - 2011-05-02 The final chapter draws some conclusions. It considers the future of the economic relationship between the United States and China and explains how the interdependencies of the relationship have created fear and the possible implications of this state of affairs. It draws out the importance of politics to understanding the nature of economic interdependence and considers the implications of this for the way we conceptualise and analyse interdependence and international power relations in the present world.