Dollar diplomacy

There is a fascinating story in the Washington Post today about how Pakistan is looking to China for $3 billion worth of emergency assistance. Pakistan, which is on the verge of bankruptcy, desperately needs funds but knows that in the current circumstances the United States is unlikely to come through. China with $1.9 trillion in foreign reserves, and with a long-standing relationship with Pakistan—it played a crucial role in assisting the Pakistani nuclear programme, is well placed to help.

It will be well worth watching to see what other countries China assists over the coming months. However, in the long term the financial crisis could do far more harm to China than America. The Chinese Communist party’s legitimacy is dependent on producing strong economic growth something that might not be possible in the current climate; one of my smartest hedge fund friends told me the other day that Chinese growth will slow down to two or three percent in 2009 and 2010. How the Chinese political system copes with these changing circumstances will be one of the things that determines the balance of global power over the next fifty years.