With policymakers failing to make progress on the critical issue of global imbalances, America has no alternative but to put China on notice. Privately but promptly, Washington has to inform Beijing it will label it as a currency manipulator, back legislation treating the manipulation as an export subsidy, and take it to the World Trade Organization (WTO) if it does not let the renminbi rise significantly.
The renewed increases in the external imbalances of the two main economies pose major risks. China's surplus is again climbing while it tightens monetary policy because of concerns over overheating. It thus maintains its rapid expansion partly at the expense of other countries and dampens global growth. It should instead let its currency rise and limit the cutback in domestic demand. That would help contain inflation and offset the resulting decline in its trade surplus.
US output growth has been cut in half in the past six months by the renewed sharp expansion of its current account deficit. The Federal Reserve's second round of quantitative easing and the likely extension of some form of the Bush tax cuts are efforts to provide offsetting boosts to domestic demand-but they may not succeed.
So, the rebalancing strategy is moving in the wrong direction. The huge US budget deficit and the Fed's easing have replaced the US private sector as "consumer of last resort" and trade is impeding rather than leading the recovery. China's reserve hoard grew faster in the latest quarter than ever before. Its global trade surplus for the past six months is more than 50 percent above last year's. The trade imbalance between the two countries has recently hit record levels.
In the medium run, this pattern will lead to further retreat from open trade and free financial flows. In the longer term, the enlarged imbalances will sow the seeds of renewed crises. The huge capital flows from surplus to deficit countries, Germany to the eurozone periphery as well as China to America, helped create the loose monetary conditions that encouraged the irresponsible lending that brought on the Great Recession.
The most effective way for President Barack Obama to break the impasse is to start adopting a serious strategy for US budget reform as proposed by the cochairs of his Fiscal Commission, who rightly urge an ambitious program of deficit reduction. Only such an initiative will convince other countries the United States is serious about rebalancing its own economy and so persuade them to rebalance theirs. This would regain the moral high ground for America.
The policy conflict with China now plays out on three fronts. The House of Representatives has passed a bill authorizing countervailing import duties against the export subsidies created by undervalued exchange rates such as with China. The Senate needs merely to attach this language to "must" legislation, such as extension of the tax cuts, and it will land on Mr. Obama's desk for almost certain signature. Another response would be to forge a broad coalition to take China to the WTO under its rule that prohibits countries from "taking exchange action that frustrates the intent of the agreement."
A second front is the next Treasury report on foreign exchange practices, delayed from its due date of October 15 pending further evidence of China's exchange rate intentions and the Group of 20 summit. The Seoul outcome was minimal and the average value of the renminbi has weakened since China announced "greater flexibility" in June. So the Treasury must designate China (and a few others) as a manipulator, as Mr. Obama came close to doing publicly after Seoul.
Then there is the visit of Hu Jintao, China's president, to Washington in January-although it is hard to see what they can agree to that they were unable to do at the G-20 summit.
The G-20 stalemate has intensified the feud over currencies and trade rather than helped to resolve it. Mr. Obama has to notify China privately that his administration will designate it as a "manipulator," support new legislation, and take China to the WTO unless it lets the renminbi rise substantially before the Hu visit. The Chinese say they will never move under foreign pressure but have revealed they will do so only under such pressure. The world economy will fare much better under the proposed strategy.