A different pivot to the East

China President Xi Jinping's visit to the United States next week will mark an important stage in Sino-US relations, the most critical of current geostrategic relationships. It comes at a crucial time in global economics, as the US Federal Reserve debates whether to raise interest rates and the world's financial markets (and exchange rates) are already reeling from worries stirred up by China's decision to move the renminbi (RMB) rate in a more flexible direction.

Chinese historians will recall that until the 20th century, Chinese emperors almost never traveled abroad. But China's opening-up to the West has changed the Middle Kingdom's perception of its international role. With dynastic decline, China became a rule-taker, rather than a rule-maker. After more than three decades of reform and development, China has moved to the stage of rule-shaper, but the geopolitical rule-maker still remains the West.

Unfortunately, Europe has become so rules-bound by its own problems that its foreign policy and monetary policies are now on autopilot. So, whether the world enters into a period of a currency war, or more geopolitical conflict, will depend on the US and China and their delicate relationship with each other.

This is not to say the other players such as Russia, Japan, India and other countries are not important. Any of them — or even the jihadist militant group ISIS — can be major disruptors. But whether there will be some semblance of global order, especially in regard to climate change, trade, growth and finance, will depend not on the US and China individually, but the complex interaction between them in many areas.

On the military front, US hawks are now screaming for a fight — fresh from a Vietnam-sized withdrawal from Iraq and Afghanistan. On the trade front, some kind of patch-up deal is being worked out on the US-led Trans-Pacific Partnership, which excluded China.

But high on everyone's agenda is whether the world will enter into a period of secular stagnation, and whether, finally, the Fed will put the last nail in the coffin of quantitative easing (QE), the idea that monetary policy alone can regenerate growth.

If US interest rates rise, as they inevitably will, the implications for the rest of the world are profound. This is why equity markets, long-term bonds, currency and real estate markets are already quivering in anticipation.

Prior to 2007 — when the Lehman Brothers failure broke open the US subprime crisis — the international monetary system worked on the hegemony of the US dollar. Addressing global imbalances depended on US leadership — often in bullying Europe, Japan and others to address crises that were mostly in emerging markets. When the imbalance was in the US itself, the unipolar myth was shattered, and a new multi-polar Pandora's Box was opened.

Although the reserve currency countries (the US, Europe, the UK and Japan) claim that unconventional monetary policy fixed their crises, in reality it was China's 4 trillion yuan ($628 billion) stimulus package that brought out a new engine of growth — China's imports of commodities and, later, high-value consumer products such as cars.

The real choice before Presidents Barack Obama and Xi is whether the RMB will join the US dollar in continuing to sustain global financial stability. Despite comments to the contrary, it was not China that started the currency war, because both the euro and yen devalued more than 20 percent against the dollar and RMB on the pretext of monetary policy. If China opts to maintain RMB stability against the US, then it will pay the price of tougher real sector adjustment, because it cannot use the export engine as an excuse for reflation.

Obama and the Fed know that if the US dollar is the only major currency to appreciate against all others, the US will run an unsustainable current account deficit, with a possible initial upside followed by another crash. It needs to buy time for its own structural adjustments to take place, including the rejuvenation of its dilapidated infrastructure.

In other words, global financial stability hinges on the understanding between the US and China to share the burden of their global responsibilities, which will hinge on whether the US will allow the RMB to join the SDR (special drawing rights) club.

The Hong Kong dollar peg plays an important role in Sino-US relations. Hong Kong has benefited from its role as a free port and international financial center, particularly as a window for China to experiment with integration with the global economy. Through its peg to the US dollar, Hong Kong is a full rule-taker. By running a three-currency economy (RMB, HKD and Macao Patacas), China has the option of gradual integration with global finance. The US benefits from its large trade and investment positions in China, often through Hong Kong.

This is why financial and social stability are uppermost in everyone's minds. If Xi returns with a feeling that the US is not committed to a partnership for peace and mutual prosperity, expect more global turbulence.

• The author is a distinguished fellow of Asia Global Institute, Hong Kong. His comments on global and Asian issues have appeared in leading publications.

Copyright: China Daily/Asia News Network