Saturday, January 24, 2009

War of words

From TECHNICALLY, he is not yet treasury secretary, but Tim Geithner has already made waves in financial markets. In a written response to questions from senators debating his confirmation, Mr Geithner accused China of “manipulating” its currency and promised that the Obama team would push “aggressively” for Beijing to change its policies. The sharp tone and use of the legally-loaded term “currency manipulation” ricocheted through financial markets as investors shuddered at the prospect of a Sino-American spat in the midst of a global slump. Clearly this was not a slip of the tongue. Conceivably it was a bureaucratic snafu. The tough language came in a 102-page document answering numerous questions from senators—an odd place from which to lob a bombshell at Beijing. If so, it speaks poorly of a man who is already in trouble for failing to pay attention to his taxes. Most likely, therefore, Mr Geithner’s language suggests a change in Washington’s tactics towards China. American policymakers have long pushed Beijing to accelerate the appreciation of the yuan, arguing that China’s exchange-rate policy played a big role in creating the global imbalances and that—both for the sake of China’s economy and the rest of the world—the currency needs to strengthen. But Hank Paulson’s Treasury studiously avoided accusing Beijing of “currency manipulation”, a term that carries legal implications. Every six months America’s Treasury must publish a list of countries which it deems to be currency manipulators. Once a country appears on that list, formal negotiations to end the manipulation must begin. The Treasury under George Bush, particularly in recent years, preferred a softer behind-the-scenes approach and refused to brand China a manipulator. Although Mr Geithner did not commit himself to any specific action, the use of the m-word suggests Team Obama will take a tougher line. Exactly what it means is uncertain. It is not even clear who will manage America’s economic strategy with China (there is some speculation, for instance, that Hillary Clinton wants the State Department to take the lead). But there is no doubt that Barack Obama’s economic team includes a number of people who are frustrated with the world’s failure to convince Beijing to strengthen the yuan. Mr Obama himself supported legislation in the Senate to get tougher on China. More important, his advisers see tough words now as a prophylactic—a warning that Beijing must not be tempted to prop up its staggering economy by weakening the yuan. Domestic politics is also playing a big role. China’s bilateral trade surplus with America has long been a lightning rod in Congress, and with unemployment up the protectionist pressure is sure to rise. The $800 billion stimulus package making its way through Congress already has dubious “Buy American” measures that demand government spending should be on American goods. By sounding tough up front, the logic goes, the Obama team will be better able to diffuse the more extreme protectionist sentiment. Unfortunately, this strategy is dangerous on a number of counts. The basic economic analysis—that a stronger yuan, on a trade-weighted basis, is necessary to rebalance China’s economy away from exports—is surely right. But the world’s immediate problem is a dramatic shortfall in demand across the globe and that will not be righted by exchange-rate shifts. Currency movements switch demand between countries; they do not create it. In the short-term, therefore, the outlook for the world economy depends on whether governments’ stimulus packages are successful and, right now, team Obama would do better to focus on the scale, nature and speed of Beijing’s stimulus measures than rant about the currency. What’s more, the evidence for currency manipulation is weakening. Although China still runs a huge current-account surplus, it is no longer accumulating foreign-exchange reserves at a rapid clip, as capital is flowing out of the country. More important, the political calculus could easily misfire. Domestically, Mr Geithner’s comments may simply fan congressional flames for tougher action on China. Lindsey Graham, a senator who first pushed for a 27.5% tariff against China in 2005, called the comments “music to my ears”. And Sino-American economic tensions are already rising as Chinese officials hotly dispute the idea that their savings surplus had anything to do with the current global mess. (An official at China’s central bank recently called the idea “ridiculous” and an example of “gangster logic”). Traditionally, Chinese officials do not respond well to public admonition and, given the scale of China’s economic woes, they are likely to be pricklier now. The stakes are extremely high. Everyone knows that protectionism and beggar-thy-neighbour policies exacerbated the Depression. With the global economy in its most dangerous circumstances since the 1930s, rising Sino-American tensions is the last thing anyone needs.

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