On Monday and Tuesday of this week, Treasury Secretary Geithner – and Secretary of State Clinton - meet with a high-level Chinese delegation. (Could someone please update the Treasury’s schedule of events? At 7am on Monday it still shows last week’s agenda; update, 9am, this is now fixed – thanks).
According to official previews (i.e., the apparent contents of background briefings given to wire services), the economic topics are China’s concerns about the value of the dollar (i.e., their investments in the U.S.) and the amount of debt that the U.S. will issue this year.
This is absurd.
China decided to accumulate over $2trn worth of reserves, most of which they are presumed to hold in dollars. No one compelled, suggested, or was even particularly pleased by their massive current account surplus (peaked at 11% of GDP in 2007, but still projected at 9.5% of GDP for 2009). We can argue about whether this surplus - arguably the largest on modern record for a major country – was intentional or the result of various policy accidents.
Irrespective of underlying cause, any country that runs such a current account surplus is implicitly taking a great deal of currency risk – China was in effect deciding to take the biggest ever official long-dollar position. The idea that the US government should spend time reassuring them is somewhere between quaint and not good strategy.
If China decides to now shift out of dollars, what would happen? Remember that the US left the world of fixed exchange rates and associated rigidities a long time ago – back in the early 1970s. The dollar would surely depreciate and inflation would likely rise. But who cares?
A weaker dollar would help our exports. It’s not honorable for the issuer of a reserve currency to talk down its own exchange rate (hence the Rubinesque “strong dollar” rhetorical trap), but if a third party leads a big sell-off, what can we do about it?
Treasury’s concern is not really the value of the dollar – particularly as they would like a bit of inflation at this point; again, if it’s China’s fault that the real value of our debts falls, that might play (or spin) well in Peoria. Instead, Treasury’s concern is the large amount of debt that they/we are trying to issue.
If China is worried about the future value of our debt in renminbi, then Treasury will have to pay higher long term interest rates. But, as Treasury and the White House have been emphasizing, what really matters for our long-term fiscal solvency is bringing Medicare and associated costs under control. Any strategy that relies instead on indefinitely low long-term interest rates is illusory – and any investor who thinks we will be like Japan in this regard is in for some disappointment.
The real issue for discussion this week should be China’s current account surplus and the pressing actions needed to bring this under control. The US should put on the table the possibility of more assertively taking China to the World Trade Organization over its fundamentally undervalued exchange rate and associated trade policies (Arvind Subramanian’s idea). The exchange rate dimension should have been dealt with by the IMF, but unfortunately that organization has (again) ducked its responsibilities on this issue.
The Treasury apparently thinks it should be deferential and on the defensive vis-a-vis China. This is not only bad economics, this is bad geopolitical strategy.
By Simon Johnson