The Us Treasury Secretary has difficult meetings this week with China. Getting the US/China relationship right is crucial to world economic progress. Somehow both sides need to move. The US needs to export more and import less, to save more and borrow less. China needs to import more and export less, to save less and spend more. Neither side has its heart in the changes it needs to make. Both are wedded to their old ways of doing things.
One of the central issues is the exchange rate between the two currencies. The simplest and quickest way of sorting out the imbalance would be to devalue the dollar. At a stroke US goods would be better value in China and Chinese goods would be dearer in the USA. China’s claims on the US through all the TBs and bonds it owns would be worth less,making them more nervous about saving so much. The USA would be repaying devalued dollars to clear some of its debt.
The US seems by its actions to favour a weaker dollar at the moment. The dollar has been falling on the markets. Very low interest rates and printing more dollars are an effective way of cutting the value of the currency. The Chinese are likely to tell the USA they do not wish to see further falls in the US currency, given their large stake in US debt. The US will have to say something reassuring to the bank manager, but are unlikely to announce interest rate hikes or an end to quantitative easing, so it will not amount to very much. Maybe they will say privately they have a plan to cut the deficit in due course. They will probably explain that China has to go along with massive US reflation, as the Chinese economy still needs export markets. They will be able to point out that China is effectively locked in to her dollar investments, as her position is too big to sell without substantial damage to the value.
In the longer term the Chinese currency will have to rise against the dollar. In the not so longer term the US is going to have to cut its trade deficit more and its government deficit substantially. This week will see some shadow boxing as the two big powers adjust to the US being the supplicant and the Chinese being the stern bank manager. It’s in all our interests they find a fudge to keep the show on the road. It’s even more important that both sides grasp that they do need to change their ways. Chinese people should spend more, and the US government does have to rein in its massive spending.