By Greg Robb,
WASHINGTON (MarketWatch) - Treasury Secretary Timothy Geithner is about to get on a plane and travel half-way around the world to manage what is probably the world's worst marriage-of-convenience.
Mutual mistrust, competition and rivalry complicate a U.S.-China relationship that, on the other hand, has been so lucrative for both sides and the global economy. The two sides got closer during the recent recession, but there are new strains on the horizon.
China's currency has moved lower in recent weeks, riding on the back of the dollar. Criticism is sure to follow. With one of the few economies growing in the global recession, by all rights China's currency should be on the rise. Experts said this love/hate bilateral relationship is well-established.
U.S. policy towards China constantly swerves "between marriage and a nasty divorce," said Clay Lowery, a former Treasury official during the George W. Bush administration.
Over the past two decades, China has created an export machine that provides U.S. consumers with inexpensive goods while both American and Chinese companies benefited.
This has been accomplished, in part, by China keeping its currency low relative to the dollar. The byproduct is a wide bilateral trade gap and China becoming the largest foreign holder in U.S. Treasury securities.
China now holds $1.55 trillion in dollar assets, according to Brad Setser of the Council of Foreign Relations. As a result, China can look forward to an estimated $50 billion in interest payments on the debt this year.
China needs the U.S. to survive and prosper and the U.S. needs China to buy our debt, said Timothy Adams, who also served in the Bush Treasury. Washington has never been comfortable in this relationship. A debate continues at the highest levels of government whether China's rise is peaceful or a threat.
Beijing, on the other hand, is focused on respect and is not keen to listen to lectures from a U.S. government that has had to spend over a trillion dollars rescuing its banking sector.
Recession hasn't changed things
There had been some hope that the severe recession over the last 18 months would have altered this bilateral relationship. The theory went that with the U.S. consumer tapped out, China would focus on building up its own domestic consumer market. But experts say this hasn't happened, at least to the extent required. Instead, Chinese exporters have doubled down on the return of the U.S. consumer and have increased their capacity. Exporters appear to have political muscle in China to block meaningful reform.
At the same time, the U.S. budget deficit is projected to reach record levels for the next several years.
"We've got to hope China still has an appetite for our debt," given the "ocean of red ink" coming down the road, said Adams. Given this backdrop, the Obama administration wants to "make nice" with Beijing, said Carl Weinberg, chief economist at High Frequency Economics.
Geithner wants to assuage China's concerns about U.S. monetary policy and the stability of its U.S. holdings and will not push for China to strengthen its currency versus the dollar, Weinberg said.
"Geithner has no leg to stand on to insist on more revaluation ... and he knows this," Weinberg said.
Geithner is also going to China to prepare the ground for high-level talks between the two countries to be held in Washington in the latter half of the summer. The talks are modeled after the program started by former Treasury Secretary Henry Paulson. Key Cabinet officials from both countries meet to try to rescue issues from the clutches of bureaucrats.
Geithner and Secretary of State Hillary Clinton will share the stage, with Geithner shepherding economic issues, and Clinton handling environmental and political issues.
Geithner wants to be "low key" in his dealings with China, agreed Nicholas Lardy, a top China watcher in Washington for the Peterson Institute for International Economics.
Obama officials want to move away from what they see as the "lecturing mode" of the Bush administration, Lardy said. Congress has no appetite to fight China for fear that the tension might hurt the recovery. But if the jobless rate hits double-digits, then the focus of the public's ire may shift from Wall Street back to China, Lardy said.
"The rhetoric has cooled but not disappeared. It will come back," Adams said. Setser said most recent trends in the currency market are already fanning the flames. The dollar has fallen to five-month lows in currency trading, and because China's currency is pegged to the dollar, it has come down as well.
"China's currency has been depreciating in real terms even though it is generally thought that China's economy is going to do better than the rest of the global economy," Setser said.
So we're back at square one with the yuan tightly pegged as the dollar is weakening, just like 2002 to 2005, he said. Other Asian countries are scrambling to weaken their currencies to compete with China.
Dean Baker, co-director of the liberal-leaning Center for Economic and Policy Research in Washington, said that the U.S. should go so far as to try to negotiate an appropriate bilateral currency rate with China, say 5 yuan to the dollar. If the talks are not successful, the U.S. should simply set a rate.
He said that complaints in Congress and the White House over the past decade about China's currency have amounted to "stagecraft." Not all experts are so glum. Lardy of the Peterson Institute said China's recent stimulus package "was the gold standard in terms of its response to the global economic crisis."
China put money in the hands of the population, he said. Car sales, for instance, rose dramatically. If China can continue this policy, it may offset renewed tension, Lardy added. For clues on how Geithner's meeting went, Setser suggested focusing on whether there in progress on China's making a contribution to the International Monetary Fund.
During the Group of 20 meeting in London, U.K. Prime Minister Gordon Brown announced that China planned to contribute $40 billion to the IMF but no official announcement from China has been forthcoming.
A senior Treasury official told reporters that this topic may come up in Geithner's meetings. Geithner will meet with the highest level of Chinese officials on Monday and Tuesday. But both sides of the marriage are likely to keep mum about their difficulties, at least in public. In the near term, "it looks like nothing on the horizon that is dealing with these problems," noted Desmond Lachman, an expert on global economics at the American Enterprise Institute.