A Slow Motion Chinese Train Wreck?

All is not well with the US-China economic relationship. And sadly, heightened political friction between the US and China over Taiwan, the Dali Lama, Iran, and Google, all point to a very much more strained economic relationship over the next few months. This poses a very real risk to both the US and the global longer-run economic outlook given China's newfound importance on the global economic stage.

Since 2005, recognizing China's emerging economic importance, the US has been actively engaged with China in a strategic economic policy dialog aimed at laying the basis for better mutual understanding and for securing greater harmonization of economic policies between the two countries. However, if anything is to be learned from this dialog, it is that China and the US have very different views about their respective roles and responsibilities in the global economy. All too often, this is now resulting in periodic finger pointing and hectoring that if unchecked could lead us down the road toward mutually destructive protectionist behavior.

No longer can China be dismissed as a relatively insignificant, albeit rapidly growing, emerging market economy. Rather one now has to recognize China for what it has become through many years of consistently spectacular economic growth.

China now sees the US as a profligate country that lives way beyond its means and that expects the rest of the world to finance its excesses indefinitely. It does not miss the opportunity to lecture the US about its wayward public spending ways and its mushrooming budget deficits. Following the Great Economic Recession and the banking system crisis of 2008, China now also does not hide its disdain for the US economic model and does not miss the opportunity to embarrass the US in global economic forums on its responsibility for the global economic crisis. More menacingly yet, China periodically expresses its displeasure at US gestures towards the Dalai Lama or towards Taiwan, by boycotting US Treasury bond auctions and by publicly voicing concern about China's very large holdings of US Treasury paper. It does so to keep reminding the world of China's enormous financial leverage over the US.

For its part, the US increasingly sees China as a mercantilist country that shamelessly engages in government intervention to promote its export sector at the rest of the world's expense. The US considers that China does so by deliberately keeping its exchange rate grossly undervalued with the objective of giving its exporters an unfair competitive advantage in the global market place. In the process, China has accumulated almost US$2 ½ trillion in international reserves, which can leave little doubt that China engages in massive currency manipulation to its advantage. In recent Congressional testimony, many respected US economists testified that China's currency could be undervalued by as much as 30 percent.

The US also believes that China does not contribute its fair share to global demand and that it does little to encourage domestic consumption. In particular, the US points to China's excessive savings, which have now risen to almost 50 percent of its GDP, or to a level that has no parallel in a major country at anytime in the post-war period.

Growing impatience with China's free riding the global economy at a time of close to double digit US unemployment has been manifested in the imposition of US tariffs on selected Chinese exports like steel tubing and automobile tires. More menacing yet, has been a recent petition by 130 US Congressman to US Treasury Secretary Timothy Geithner to brand China as a currency manipulator in the US Treasury's next six-monthly foreign currency report to Congress. Were Mr. Geithner to bow to this request, a variety of protectionist bills in Congress would be triggered that would raise the risk of a slide towards the sort of trade wars that most economists think contributed to the Great Depression of the 1930s.

Underlining the consequences of any further souring in the US-Chinese economic relationship is China's meteoric emergence as a potential challenger to the US as the dominant global economic power. No longer can China be dismissed as a relatively insignificant, albeit rapidly growing, emerging market economy. Rather one now has to recognize China for what it has become through many years of consistently spectacular economic growth. China already is the world's second largest economy and on present trends it threatens to overtake the US as the world's largest economy by 2030.

Recently Mr.Geithner judiciously decided to delay the issuance of the US Treasury's currency report earlier scheduled for April 15 in order to allow cooler heads to prevail in Washington and Beijing on the Chinese currency issue. One has to hope that both for China's own sake as well as for the rest of the global economy that China takes advantage of this interval to move decisively to a more acceptable management of its currency. However, after five years of empty promises from China about understanding the need for a more flexible exchange rate system, one should not hold one's breath for China to make those policy changes that would reverse what appears to be a dangerous and inexorable drift towards protectionist trade policies.

Desmond Lachman is resident fellow at AEI.

Photo Credit: iStockphoto/Yong Hian Lim

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