Shadow Government

An economic storm with China is still coming for Obama

By Phil Levy Secretary of State Clinton has drawn some flak for reading her stage directions out loud on her recent visit to China — Make pro forma mention of human rights, but don’t expect the Chinese to do anything. Given the looming difficulties between the United States and China, however, she should be lauded ...

By Phil Levy

Secretary of State Clinton has drawn some flak for reading her stage directions out loud on her recent visit to China — Make pro forma mention of human rights, but don’t expect the Chinese to do anything. Given the looming difficulties between the United States and China, however, she should be lauded for at least getting off to a cordial start. The impending conflicts between the countries stretch across the many understaffed departments in the U.S. government. A major challenge for the Obama administration will be whether it can develop a coherent approach.

My colleagues Aaron Friedberg and Dan Twining have recently addressed the important questions of Chinese military power and broader U.S. strategy in Asia. I’ll confine myself to economics. While Secretary Clinton advocated broadening the dialogue beyond economics, I expect she will find that this focus was not just an artifact of the Treasury’s lead role. It reflected genuine Chinese concerns.

China entered the current global economic crisis with ample savings, but also with some critical economic weaknesses. Its undervalued exchange rate has encouraged overinvestment in the export sector. That has made it particularly vulnerable to a slumping world economy. It is a still-poor economy in which public support has come more from prospects of a bright future than from present-day consumption. When jobs disappear and hopes dim, the resulting public discontent has no healthy outlet through peaceful elections.

Meanwhile, the Chinese government is sitting on a growing mountain of international reserves whose value is increasingly tenuous. The massive Chinese dollar holdings — estimated at over $1 trillion — will be fine, so long as the dollar doesn’t weaken and U.S. interest rates don’t rise. Yet both are real risks. A weakening dollar would be the flip side of RMB appreciation. An interest rate increase could accompany increased U.S. borrowing needs or inflation fears.

The Chinese have noticed this. In one strikingly candid comment before Clinton’s visit, a Chinese official said in New York: "We hate you guys… Once you start issuing $1-$2 trillion (in debt) … we know the dollar is going to depreciate, so we hate you guys, but there is nothing much we can do."

On her visit to Beijing, Clinton played the unusual role of Treasury bond saleswoman. Not only is it typically the secretary of the Treasury, not State, who focuses on such matters, but the heavy Chinese purchases of U.S. Treasuries that she encouraged are sometimes known as "currency manipulation." If you want to hold down the value of the RMB, you do so by buying up foreign currency debt.

This will leave the Treasury in an interesting position come April. That’s when it owes the Congress a report on whether China has been manipulating its currency. If the Obama administration finds that it has, it will lead to some very tense discussions between the two countries. If it finds that China has not, it will lead to some very tense discussions with unions and Congressional Democrats, who harshly criticized the Bush administration for similarly refraining. Either way, very tense discussions seem likely.

If this were the extent of difficulties on the economic front, our diplomats would have their hands full. But this is just part. The recent Buy America provision in the stimulus bill was scaled back so it would not violate U.S. global trade commitments. However, since China is one of the few major economies that is not part of the World Trade Organization’s Government Procurement Agreement, the provision’s impact will not be pro-American so much as anti-Chinese. China pointedly refrained from including a "Buy China" provision in its stimulus.

The Buy America provisions apply only to government, not private, purchases of products like steel. However, U.S. steelmakers are preparing anti-dumping complaints for the Commerce Department that would slap tariffs on private imports of Chinese steel as well. The Chinese have long complained of Commerce procedures that allow for particularly high tariffs on their products (since China is considered a non-market economy). The rationale that China intervenes heavily in its economy and distorts prices may ring somewhat hollow at a time when the United States is investing heavily in its own banks and auto companies.

Elsewhere on the trade front, the United States has long argued that China has failed to enforce intellectual property rights. In 2007, the U.S. Trade Representative filed dispute cases against Chinese intellectual property rights (IPR) practices at the WTO, annoying the Chinese to the point that they suspended IPR discussions with the United States. At the end of last month, a WTO panel ruled against the key U.S. enforcement claim. The United States claimed victory because of other rulings, but the failure comes at a time when Congress has been eager to step up enforcement actions.

A pervasive challenge to the relationship will be managing the signals the U.S. government sends. U.S. economic policy toward China emerges out of a tangle of agencies and branches — Treasury, State, Commerce, USTR, the White House, and the Congress. In some cases, notably anti-dumping, there is not even an opportunity for the president to avoid unintentional provocations. Packaging this amalgam into a clear and consistent economic policy toward China will put top administration officials to the test, if and when the administration manages to appoint them.

Phil Levy is Senior Fellow on the Global Economy, The Chicago Council on Global Affairs, and teaches strategy at Northwestern University’s Kellogg Schoool of Management.

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