Editor’s Note: U.S. Treasury Secretary Timothy Geithner’s first trip to China will feature a range of discussion about global economic issues and the U.S.-China economic relationship. Eswar Prasad outlines some of the critical agenda items and the broader challenges facing these two closely intertwined economies.
Q. What are the major agenda items for Secretary Geithner’s trip to China and what can be realistically accomplished? Is Secretary Geithner’s trip symbolic of the broader importance of the U.S.-China relationship?
Secretary Geithner and the Chinese view his trip as an important opportunity to smooth out some ruffled feathers on both sides. They want to try and sort through some issues early on so they can make the upcoming Strategic and Economic Dialogue and subsequent bilateral discussions more productive.
The interdependence between the two economies is clearly going to grow and there is a strong desire on both sides to make this a constructive and equal partnership. There will no doubt be some public posturing, but that is largely for the benefit of domestic political constituencies.
The two sides also know they will need to cooperate if there is to be any substantive progress on matters like climate change, IMF reforms and broader reform of the international monetary system. Secretary Geithner’s visit will play an important role in setting the tone for discussions on a number of complex economic and geopolitical matters later this year.
Q. What do you think is on the priority list for China’s leaders in terms of their relationship with the U.S. and what issues might they raise with Secretary Geithner?
The Chinese will be eager to hear Secretary Geithner’s views on some key issues. First, they want to be reassured that the U.S. has a strategy for bringing its budget deficit under control once the economic recovery is underway. They are concerned about losses on their holdings of U.S. treasury bills and bonds if rising deficits and the quantitative easing undertaken by the Federal Reserve lead to a surge in inflation.
Second, they want a clarification of this administration’s stance on trade policy. They are looking for signs as to whether the administration is inclined to go along with or tamp down protectionist measures from the U.S. Congress. Third, they are genuinely interested in hearing about U.S. plans for a new regulatory framework and the likely exit strategy from the banking system once the banks are firmly on their feet again.
The U.S. needs to hear from China that they will play their role in helping the global recovery and mitigating global current account imbalances. The Chinese can do this by taking measures to boost domestic consumption (which they are) and allowing for some currency appreciation (which they are not). The U.S. would also find it easier to get its IMF reform package through Congress if China and other emerging markets did contribute to an expansion of the IMF’s resource base.
Q. Do you think the issue of currency manipulation will be or should be discussed?
The key issue for Geithner and the Chinese is how to handle this major irritant in the bilateral relationship–Chinese currency policy–in a way that both sides can claim victory and appease their domestic political constituencies.
The Chinese authorities know that some currency appreciation in the future will be part of their growth rebalancing strategy. However, exports are a sorely-needed engine of job growth, so they cannot easily detach themselves from the soft dollar peg at a time when external demand is weak and their export industries are already suffering.
Q. What does the future hold for the relationship between these two economies?
The U.S. and China are getting locked into an increasingly tight embrace—not necessarily one that either side is thrilled about. In the short run, the Chinese could make things unpleasant for the U.S., which has huge and rising financing needs for its budget and current account deficits. Any precipitous actions by the Chinese to shift their investments away from U.S. dollar assets could set off some turmoil in U.S. bond and currency markets, where sentiment is already fragile as large and rising fiscal deficits loom.
On the other hand, the Chinese still need the U.S. export market and don’t have much of an alternative to continue putting a large fraction of their reserve buildup into U.S. Treasuries. They have of course already shifted markedly into short-term Treasury bills rather than longer-term Treasury bonds, signaling their concerns about medium-term inflationary risks in the U.S.
I interpret some of the recent Chinese assertiveness on international economic policy issues as reflecting their frustration at the fact that their growth model will bind them even more strongly into an uncomfortable embrace with the U.S. They know they cannot do much about this in the short term (one to two years) but are trying very hard to get away from this in the medium term, including by doing everything they can to rebalance their growth pattern and work towards reordering the international monetary system.
Q. Are there implications from this set of meetings for the broader global recovery from the financial crisis?
The world economy, which is already on its knees, simply cannot afford escalating economic tensions between China and the U.S. Trade disputes between the two countries could disrupt the world trading system, and further wreck consumer and investor confidence. The world now needs China and the U.S. to pull together rather than rattle their sabers at one another. The challenge is to bring the joint interests of the two economies to the fore in these difficult times when the tendency is to turn inward.
There is a solution—a grand bargain between China and the U.S. on macroeconomic policies and international economic affairs (see “The U.S. and China: A Grand Bargain?”). While none of these elements is particularly novel, rolling them into a package that Chinese and U.S. leaders could jointly announce would provide domestic political cover for both sides to implement policies that are ultimately in their own interests.
As part of this package, the Chinese would allow their currency to become more flexible and responsive to market forces while the U.S. would articulate a plan that commits it to taming its budget deficit once the economy begins to recover. The U.S. would also support an expanded role for China in multilateral financial institutions, including significantly greater voting rights at the IMF.
With these steps, the U.S. could show that it is willing to enter into a genuine economic partnership with China that can benefit both sides and also demonstrate true leadership by accepting China’s expanded role on the global stage. The Chinese could reaffirm to their restive citizens their commitment to restoring growth and jobs, and also be seen as getting the respect they deserve as a world power while doing their bit for global economic and financial stability.
Sentiment inside the Beltway has turned sharply against China. There are many issues where the two parties sound more or less the same. Trump and others in the administration seem heavily invested in a ‘get very tough with China’ stance. It’s possible that some Democrats might argue that a decoupling strategy borders on lunacy. But if Trump believes this will play well with his core constituencies as his reelection campaign moves into high gear, he will probably decide to stick with it, if the costs and the collateral damage seem manageable. But that’s a very big if, especially if the downsides of a protracted trade war for both American consumers and for American firms become increasingly apparent.