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Treasury's Geithner Faces an Assertive China

One might think China's top leaders would warmly welcome Timothy Geithner in his May 31-June 2 visit to Beijing. After all, Geithner, who once studied Chinese at Peking University and speaks Mandarin, is considered something of an old China hand. So he is attuned to Beijing's financial and economic concerns, not just Washington's. It is also becoming painfully clear to both sides how mutually dependent China and the U.S. are: China still needs U.S. demand for its exports, while the U. S. needs China to buy its mounting debt. But beneath the usual diplomatic niceties, there's likely to be real friction and little substantive progress in sorting out the thorny differences between the two countries during Geithner's first visit to China as Treasury Secretary.

When Geithner meets with top officials, including Chinese President Hu Jintao, Premier Wen Jiabao, and Wang Qishan, vic-premier in charge of finance, he is likely to press for a more freely tradable yuan. (After taking a tough line on China's currency manipulation during his confirmation hearings early this year, Geithner and other U.S. officials have softened their tone in recent months but still are pressing for change.) The hope is that a strengthened yuan would help narrow the massive U.S. trade deficit with China by making Chinese exports less competitive. Equally important, of course, is that the Chinese begin to break their frugal habits, start spending more, and so pick up some of the slack left by the collapse in U.S. spending, a topic Geithner will probably raise when he speaks to students at Peking University on June 1. China must initiate "stronger domestic demand growth. It involves shifting the structure of the Chinese economy" to stimulate greater demand, a Treasury official said shortly before Geithner headed to China.

In this visit, however, Geithner will also get an earful about what Beijing wants. As China's economy shows signs of picking up and even growing 8% this year, Beijing is feeling no inclination to accept criticism from the beleaguered West. An assertive China will tell the U.S. to control the growth of its rapidly swelling budget deficit. Beijing is worried that Washington's spending policies will lead to inflation and further depreciation of the U.S. dollar. That would be bad news for China, the world's largest holder of U.S. Treasury bills, with an estimated $1.45 trillion in U.S. denominated-assets at the end of 2008.

The Chinese have already put their concerns front and center. At a nationally broadcast press conference held in Beijing's Great Hall of the People on Mar. 13, China's premier said he was worried by the situation. "We have lent a huge amount of money to the United States" Wen said. "I request the U.S. to maintain its good credit, to honor its promises, and to guarantee the safety of China's assets." Notes Chang Chun, a professor of finance and associate dean at Shanghai's China Europe International Business School: "Most of China's foreign currency reserves are in U.S. dollars—and the reserves are huge. This is not sustainable. We cannot rely on U.S. dollars for all of our trade and finance."

stepping up pressure on the dollar

China is also pushing for a larger international role for its currency, which would by necessity weaken the leading global role the U.S. dollar now plays. After central bank governor Zhou Xiaochuan called for a new "super-sovereign reserve currency" to replace the U.S. dollar in March, Geithner, as well as Federal Reserve Chairman Ben Bernanke, said they categorically opposed the change. Nonetheless, in recent months, Beijing has signed a series of currency-swap agreements with trading partners, including Malaysia, South Korea, and Argentina. Although still limited in scale, these moves allow the countries to trade in their own currencies rather than with the U.S. dollar as an intermediate currency. "This is the beginning of the end for the U.S. dollar if you look at the bigger historical trend," says Wenran Jiang, a professor of political science at the University of Alberta, who concedes that it could take years for the yuan to become fully convertible and really rival the dollar. "There will be resistance from the U.S., of course. The U.S. doesn't want to give up the special role for the dollar."

The Geithner delegation certainly expects plenty of pushback. But the U.S. argument that China must do more to encourage consumption isn't just being made for political reasons. There is widespread questioning among analysts and policymakers as to whether China is doing enough, or is serious enough, about moving away from a low-exchange-rate, export-driven model of growth that is dependent on U.S. consumption. The U.S. Treasury's China analysts believe the global economic system cannot stabilize long term unless that happens. In short, the U.S. thinks China's policies are also partly to blame for the crisis, and they want to start pushing China to address those issues more aggressively than China is probably prepared to for its own domestic reasons. "We want to begin to lay the groundwork for more balanced, more sustainable growth going forward," says a senior Treasury official. While in the U.S. that means bringing fiscal deficits down, getting the savings rate up, and making needed financial regulatory reforms, "it's important that we bring about stronger growth in domestic demand in a variety of countries outside of the U.S. It's a critical component to ensure balanced, sustainable growth in the future." Yet U.S. policymakers and analysts worry that if China does not see its policies as being part of the problem, or simply won't acknowledge that for domestic reasons—and U.S. policymakers clearly understand the domestic job pressures the Chinese are under—Beijing's top leadership may not push as strongly to make as much change as the U.S. sees as necessary.

The U.S. will also likely bring up the rising complaints from U.S. and other foreign companies in China that stimulus money and other spending there is increasingly being funneled into "Buy China" projects. "It is extremely important that we stick to G-20 commitments to avoid measures that would increase barriers to trade," said the Treasury official. "We have asked the WTO to examine and report back on the measures being put in place in other countries."

only a better safety net will open chinese wallets

Thus, Beijing and Washington have plenty to disagree about. Despite the White House's determination to cut the budget deficit over the long haul, for now the Obama Administration is very unlikely to abandon its policy of borrowing heavily to restart the U.S. economy. Already, in the last week of May, Treasury prices softened on concerns about mounting U.S. debt. And as Beijing knows all too well, seriously strengthening consumption as an economic driver—domestic consumption now makes up only some 35% of Chinese GDP—is a long-term project. China's consumers are not going to start opening their wallets until Beijing rebuilds its tattered social safety net, a process that will take years to complete, says Arthur Kroeber, managing editor of Beijing-based China Economic Quarterly.

That means helping China's hard-hit export sector—which dropped 20.5% in the first four months and has shed at least 20 million migrant-worker jobs—remains a top priority for Beijing, no matter how big the trade deficit with Washington gets. So just days before Geithner's arrival, China's State Council on May 27 announced $84 billion in new short-term export credit insurance and a rise in tax rebates for both labor-intensive and high-technology industries. At the meeting in Beijing, Premier Wen said that to support exporters, China will keep the value of the yuan "basically stable" and at a "reasonable and balanced level." (That's Chinese official-speak for no currency appreciation planned.)

Another reason why Beijing is unlikely to be conciliatory in talks with the visiting Treasury Secretary is the growing populist pressure in China to take a tougher line when it comes to the U.S. Fueled by popular new books that take a critical look at the U.S. and advocate a stronger, more assertive role for the mainland (China is Unhappy is a recent title that sold a half-million legal copies in just a few months), Chinese, particularly on the Internet, are criticizing their own government for being too pliant with the U.S. "Whoever sends money to the U.S. is betraying the Chinese people!," one Shenzhen-based netizen wrote on the popular bulletin board site on May 31. "The U.S. is a big viper. If you save it now, it will eat you up after it recovers."

Commenting on the possibility that during the visit, Geithner may pledge to control the growth of the U.S. deficit and so protect the value of Chinese investment in Treasury bills, "[this is like] a wolf telling a sheep that your babies will be safe here with me, don't worry," wrote a netizen from Zhangjiajie, Hunan—also on on May 31. "When the global economic crisis took place, in the U.S. people blamed Wall Street," explains Cheng Li, director of research and a senior fellow at the Brooking Institution's John L. Thornton China Center in Washington. "But in China, people blamed the government because it largely still controls the economy…they are often seen as too naïve or pro-U.S."

Roberts is BusinessWeek's Asia News Editor and China bureau chief. Sasseen is Washington bureau chief for BusinessWeek.

Roberts is Bloomberg Businessweek's Asia News Editor and China bureau chief. Follow him on Twitter @dtiffroberts.
Sasseen is Washington bureau chief for BusinessWeek.

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