The US meets the bank manager

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.

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8 Comments

  1. Posted June 1, 2009 at 6:59 am | Permalink

    Thank you for putting it so clearly.
    If the USA currency devalues, that will, of course, affect the whole world because, since the abandonment of the gold standard, the Dollar is the currency which people throughout the world depend on.
    For example, my (English) son in Bangkok is paid in Dollars and has his life savings in Dollars.
    The other thing, of course, is that the USA is the world’s policeman. And if that policeman is not paid, the world will soon become a street where the thugs rule.
    I am not at all sure that the Chinese have any intention of being the world’s policeman. At the moment, they seem to be going round making as much money as they can out of anywhere, even the world’s worst trouble spots (Sri Lanka and Zimbabwe for instance).

  2. Josh
    Posted June 1, 2009 at 7:40 am | Permalink

    America isn’t going to do anything to upset the Chinese. With the horrendous level of borrowing they are undertaking, America needs the Chinese to keep buying Treasury bonds.

  3. Posted June 1, 2009 at 8:55 am | Permalink

    Why exactly should the Chinese “spend” more other than to bail out stupid Westerners? Why should my neighbour downstairs keep her flat warmer than it need be because I have drunk all the money for my fuel bills and am feeling thirsty?

    This is a bigger and more chaotic mess than many think, and given the immediate general prospects, the Chinese would do well to to look to their own problems, of which there are all too many.

  4. Adam Collyer
    Posted June 1, 2009 at 10:38 am | Permalink

    I do think you have to factor into all this the political considerations from a Chinese point of view. They will not only be looking at what is best for them economically, but also at what will most boost their power and influence relative to that of the US, and the Chinese do play a long game. Therefore they may well not do what is in their own short term economic interest, if they think it will damage the US more. The danger is that at some point, the Chinese decide it is time to make their strike – by refusing to fund more US government debt. That would lead to a crisis in the US, a collapse in the dollar and a potential global political realignment.

  5. PayDirt
    Posted June 1, 2009 at 10:50 am | Permalink

    Chinese people to spend more? Joe China surely does not earn that much. Rather the giant Chinese business interests are already buying up the World’s resources. We’ll have to earn more to pay them for stuff we really need. Look out for a grand reversal of wealth/poverty in the next few years, US junkyards to spread across the nation. Unless of course the reviled “protectionism” gains pace, which looks more and more likely as the world dumps the socalled Anglo-Saxon model.

  6. Robert George
    Posted June 1, 2009 at 2:31 pm | Permalink

    I suspect that President Obama is still on the campaign trail. However if he doesn’t do something to rein in government spending his nation is going to blame him for the major inflation coming up in 2010 2011.

    As for the Chinese they’re in the position of having a customer owing them (the bank) too much. They won’t revalue significantly so they will have to take a 15 to 20% dollar devaluation in their bond holdings . The Chinese will learn they cannot win both ways.

  7. Citizen Responsible
    Posted June 2, 2009 at 1:35 pm | Permalink

    J R “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.”

    This is what US policymakers are saying to reassure people and I think the US government could be a little too complacent about this. I just can’t see China continuing to finance US debt at the levels that President Obama is committed to. Apart from the billion $ bailouts for banks and GM (“Government Motors”) there are billions more $ required for spending on green issues such as alternative forms of energy and universal health care.

  8. John
    Posted June 4, 2009 at 2:45 pm | Permalink

    Wow! You have encapsulated what the west needs to do. It’s a shame that no one in the American or British governments is listening.

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  • About John Redwood

    John Redwood has been the Member of Parliament for Wokingham since 1987. First attending Kent College, Canterbury, he graduated from Magdalen College, and has a DPhil from All Souls, Oxford. A businessman by background, he has been a director of NM Rothschild merchant bank and chairman of a quoted industrial PLC.
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