Commentary Type

Clash of the Titans

Article in Newsweek, International Edition


The United States and China have been the two locomotives of the world economy for the past five years. Hence, the meeting of Presidents George W. Bush and Hu Jintao in Washington this week should be a "G2" leadership conclave, reflecting their joint responsibility to ensure continued global growth and financial stability.

Unfortunately, the summit is unlikely to reinforce confidence in that outcome. Bush administration officials and congressional leaders are deeply frustrated and impatient with a wide range of Chinese policies. For its part, China believes it is being unfairly scapegoated by the United States, much as Washington stoked fears of a rising Japan in the 1980s. The summit is unlikely to reduce those tensions-and could even erupt into open conflict between the world's economic titans.

The chief culprit is the huge imbalance in the economic relationship. US global trade and current account deficits reached annual rates of $900 billion in late 2005, about 7 percent of the total American economy. China's global current account surplus soared to $150 billion in 2005, the second largest in the world after Japan, and also about 7 percent of its GDP. Bilateral imbalances should never be the focus of policy because of the multilateral nature of world trade, but China's bilateral surplus of $200 billion with the United States in this case accurately reflects a profound disequilibrium.

This imbalance cannot continue. What's needed from China is an orderly readjustment in the value of its currency, the renminbi. In the absence of such action by China, angry US policymakers are beginning to take matters into their own hands, with protectionist trade measures. New import restrictions have already been applied to six major Chinese export sectors (apparel, color television sets, semiconductors, shrimp, textiles, and wood furniture). Senators Charles Grassley and Max Baucus, the leaders of the Senate Finance Committee, have just introduced a bill that would levy severe sanctions against China. The Chinese would probably retaliate against such unilateral action by the United States, and a trade war could result.

If this trade imbalance involved any country other than China, a currency correction would have begun long ago. Large inflows of foreign money to China have attempted to push up the value of the renminbi. But the Chinese authorities have bought $15 billion to $20 billion per month for several years to maintain their fixed rate against the dollar, generating a renminbi undervaluation against all currencies that now averages 20 to 40 percent.

China's refusal to let its currency rise has also had a profound effect on other Asian countries. Most of them have understandably been reluctant to let their currencies strengthen against the renminbi and weaken their competitive positions against China. Hence they, too, have intervened, often massively, to block appreciation against the dollar. The result is that China's currency policy has taken most of Asia-which accounts for about 40 percent of US trade and about half the global surpluses that are the counterparts of our global deficits-out of the international adjustment process.

The United States would be in a far stronger position if it took action itself to reduce its excess demand, for both foreign products and foreign capital, by sharply cutting its budget deficits. Americans will have to share in the global correction whether we initiate action or not, most likely via higher inflation and interest rates and the resultant cut in consumption that will follow from a sharply lower dollar. But the most important near-term step to launch the adjustment process is revaluation of the renminbi and other key Asian currencies by at least 20 percent, which would reduce the US global deficit by $60 billion to $80 billion per year.

No country likes to appear to capitulate to foreign pressure. However, the Chinese authorities have immediately and quietly settled all three trade cases that the United States has brought against them via the World Trade Organization. It is to be hoped that a major currency change by China will similarly accompany, or shortly follow, the upcoming summit. Otherwise, we could see a titanic clash between the world's two main economies.

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