Uncle Sam takes the woo-Dragon trail

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By Colin Speakman (China Daily)
Updated: 2009-06-04 08:09

The Hillary Clinton, Nancy Pelosi and the just concluded Timothy Geithner visits to China, and the appointment of "China savvy" Jon Huntsman as Washington's ambassador to Beijing have been described "as important because the US will best be able to deal effectively with global challenges by working in concert with China".

That importance was reflected when US President Barack Obama met with President Hu Jintao on the sidelines of the G20 summit in London, which was described as "G2".

It has been a period of rapid progress in US-China dialogue. I doubt whether China, reflective of its traditional modesty would publicly acknowledge a G2 concept, making it and the US the two most important economic entities. After all, the European Union (EU) is China's biggest trading partner, China has important well-developed ties with the other BRIC members in G20 and knows its emerging economic and financial leadership role in Asia. China now operates on many economic fronts and has been wise to engage itself deeply with all interests.

But there is no doubt that the US Treasury Secretary Geithner's charm offensive shows the US regards its ties with China as its most important relationship, one that Obama will seek to take forward during his first China visit as US president in the second half of the year. The economic linkages are many, but the ones concerning the value of China's huge dollar-denominated foreign exchange reserves and its equally huge holdings of US Treasury debt have drawn special attention after Beijing voiced concern over the stability of their value.

The laughter from part of the audience at Peking University that greeted Geithner's assertion that China's assets were safe in US hands was a natural reaction to a statement at odds with evidence from no less an authority than the Congressional Budget Office. If the budget deficit that has risen to $455 billion was cause for concern in 2008, how does a projected deficit of $1.75 trillion sound for 2009?

The problem Geithner faces is that the events that created the debt burden are not within his control. Next year is likely to be a difficult one for the US because unemployment is still rising, and thus the tax base is falling and mandatory expenditures increasing. Further economic stimulus may be needed to counter these problems.

The recovery of GDP growth is expected to be modest, and its impact may be outweighed by more pressure on the administration to bail out problem kids. Some auto industry experts fear that GM could be Obama's "Vietnam" - a term used for a project that becomes a continuous drain on government resources with no clear results. Perhaps AIG is heading into that camp, too? Add the continuing difficulties in housing finance and state budgets, the impact that rapidly rising debt has on the proportion of government revenues prior-committed to debt servicing and we see the problem.

Sure, Geithner can say the administration has plans to examine all government spending and has made it clear that taxes will have to rise at some point when recovery is underway, but there's a big difference between plans to lower the fiscal deficit as a percentage of GDP and outcomes, and even that is quite some way off. It requires a leap of faith.

Equally, the US cannot claim to be able to control the value of the dollar and the commitment to a strong dollar policy lacks effective tools. Does anyone think that the US dare raise interest rates to boost the dollar any time soon given its reliance on a low interest-rate policy to help households through mortgage refinancing? Does anyone doubt that the US trade deficit will deteriorate once recovery is underway and the flood of US imports resumes? Not much structurally will have changed there. And can anyone ignore the serious inflationary risks from US monetary expansion?

China is in a better position to manage its currency value for the general good in these uncertain times, and Geithner heeded earlier warnings not to make that an issue.

So should China be wary of taking on more US debt (to add to $768 billion of US treasuries held in March) and continuing to hold such a high proportion of US dollar reserves (2/3 of about $2 trillion of foreign reserves)? The short-term answer is that China should be wary, but continue to do so.

There are two main practical reasons for that. First, the support for US financing at a time of counter-cyclical budgetary policy is necessary to help Washington on the road to recovery and that recovery benefits Beijing. While the significant drops in exports and foreign direct investment have prompted China to continue with important restructuring within its own economy, there is no doubt that export growth from a US-led Western recovery would be welcome.

Second, we come to the much-recognized issue that there are few options that do not bring with them other risks. It is true that all currencies don't all go down together and one currency's depreciation is another's appreciation. But the economic fundamentals are not strong in the euro zone and Western European governments have to grapple with their own economic downturn and help new EU members in Eastern Europe too.

China has already seen the potential for euro's depreciation against the yuan. In Asia there surely will be a regional currency at some point, but that still is a long way off. The irony is that by the time more options are clear, the US administration may well have begun to get finances under control and the dollar may well re-emerge as a safer bet.

So Geithner's assertion that China is likely to continue to hold US dollars for a long time is likely to prove true. In the meantime, the US looks at China for its continued willingness to hold dollar-denominated assets, and it does no harm for China to leverage that support while addressing other goals in the US-China relationship. That is probably the safest bet to come out of recent events.

The author is an economist and director of China Programs at the American Institute for Foreign Study.

(China Daily 06/04/2009 page9)