Daniel W. Drezner

Bond markets react wildly to blinding glimpse of the obvious

Bond markets react wildly to blinding glimpse of the obvious

Felix Salmon reviews Tim Geithner’s written testimony and concludes that, "Geithner’s answers are highly diplomatic and content-free," 

The bond market, however, appears to disagree

Mr. Geithner’s strong words on China have resulted in a sharp selloff in Treasurys. In testimony to Congress, Geithner wrote, in response to a question from Sen. Olympia Snowe, (R-Maine), that President Obama’s administration “backed by the conclusions of a broad range of economists – believes that China is manipulating its currency.”

“He came right out and said Obama believes China is manipulating their currency,” says Maryann Hurley, bond market strategist at D.A. Davidson, who notes that China’s economy is slowing as well. “It’s very easy to pick another country to be your whipping boy. In an era where we’re looking at deficits as far as the eye can see all we don’t need is somebody starting to dump our debt.”

As the FT’s Krishna Guha and Alan Beattie write, "experts said the declaration could fuel trade tensions at a time of global recession and fast-rising unemployment."

I’m as concerned about this as the next guy, but let’s be careful here and parse things out. 

The bond market is conflating two issues here.  The first is that Geithner said out loud what everyone knows to be true.  And, to be sure, before the U.S. responds to currency manipulation, it has to say that it’s happening.  So Geithner’s statement is a quasi-first step. 

The second issue, however, is what kind of action Obama and Geithner are planning.  Beattie and Guha suggest options like, "punitive import tariffs on Chinese goods."

This is where a closer look at Geithner’s written testimony would be a good idea.  Here are the two relevant passsages:

[W]e look forward to a productive economic dialogue with the Chinese government on a number of short- and long-tem issues. The Yuan is certainly an important piece of that discussion, but given the crisis the immediate focus needs to be on the broader issue of stabilizing domestic demand in China and the US. The latest figures show that China’s growth in 2008 was 9%, a full 4 percentage points lower than in the previous year. Because China accounts for such a large fraction of the world economy, a further slowdown in China would lead to a substantial fall in world growth (and demand for US exports) and delay recovery from the crisis. Therefore, the immediate goal should be for us to convince China to adopt a more aggressive stimulus package as we do our part to try to pass a stimulus package here at home….

[T]he best approach to ensure that countries do not engage in manipulating their currencies is to demonstrate that the disadvantages of doing so outweigh the benefits. If confirmed, I look forward to a constructive dialogue with our trading partners around the world in which Treasury makes the fact-based case that market exchange rates are a central ingredient to healthy and sustained growth.

Two signals here.  First, Geithner seems more concerned about China expanding its domestidc growth than with any manipulation of the yuan right now — a conviction shared by Brad Setser, incidentally. 

Second, it seems pretty clear that Geithner’s first option on the currency issue is jaw-jaw rather than protect-protect.  In other words, the bond market should have reacted more like Felix Salmon. 

UPDATE:  Be sure to check out Salmon’s follow-up post.