Washington / Beijing: When President Barack Obama meets China’s Hu Jintao this month, he might remind his guest of an old US proverb: owe $10,000 and you have a problem; owe $10 million and the lender has a problem.
The United States owes China at least $907 billion and needs to have a careful conversation with its largest creditor when the Chinese president visits the White House on 19 January.
Obama wants Beijing to let its yuan currency rise, helping him to cut US unemployment by lifting exports to China.
China, whose economy is pulling strongly while the United States struggles, has pushed back by criticizing Obama for aggressive US fiscal and monetary policy action it says could hurt its investment by undermining the US currency.
Obama last month crafted a government stimulus plan based on $858 billion in tax cuts, and the US central bank is pumping a further $600 billion into the economy.
But China is also caught in a dollar trap due to the size of its holdings, limiting options to diversify by dumping US bonds because this could slam the value of the portfolio.
The US president has made plain he will not apologize for temporary pro-growth measures that have riled Beijing.
Analysts say Obama must not retreat from this position when the two leaders meet, urging he go on the offensive over the yuan, which US officials say China keeps artificially cheap against the dollar to promote exports.
“You have got to ratchet up the pressure,” said Fred Bergsten, director of the Peterson Institute for International Economics, a Washington think-tank.
“My sense is that this is where the administration is headed too, largely out of frustration that the effort to persuade and use sweet reason has paid very little dividends,” said Bergsten, who argues China is a blatant cheat on trade.
The White House says the yuan issue will be on the table during Obama’s talks with Hu.
China has a different take on the problem and sees a threat from a $1.3 trillion US budget deficit and ultra-loose monetary policy being pursued by the Federal Reserve.
Beijing says the US central bank’s November decision to buy an additional $600 billion-worth of US Treasury bonds will inevitably weaken the dollar, hitting China’s US Treasury holdings and potentially destabilizing its economy.
“The US fiscal deficit and debt are both increasing, and it will be very difficult for the US government to control its finances at a sustainable level where neither inflation nor dollar depreciation occur,” said Zhang Ming at the Chinese Academy of Social Sciences, a top government think-tank.
“If the Fed is too loose, I’m afraid the probabilities of both of these will increase and will hurt Chinese financial stability,” he said.
He said Beijing would try to move away from the dollar over the medium term, but substantial core holdings of US assets were the “only feasible option.”
There was evidence last year that China stepped up the pace of foreign exchange diversification, buying record amounts of Japanese and South Korean debt and also picking up Spanish and Brazilian bonds, among others.
But this happened only at the margins; China simply has few options outside of the US market. Its holdings of US debt actually grew from $894.8 billion at the start of 2010 to $906.8 billion as of October, the most recent data shows.
The Peterson Institute’s Bergsten says official data underestimates China’s dollar holdings, which could be as high as $1.5 trillion if bonds held anonymously by third parties in the international capital markets could be accurately counted.
“By cranking up its dollar printing press, the United States also puts our country in a very awkward position,” noted a 5 January commentary in Huanqiu Renwu, a magazine published by the People’s Daily, the Communist Party’s main newspaper.
“Some of the hot money will flow into our country, disrupting our financial order and aggravating our inflation,” it said.
China said in June it would move its yuan toward more flexibility but since then has allowed little appreciation against the dollar. But the currency has only risen around 3.5% since it was depegged in June.
Patience in Washington is wearing thin.
US lawmakers are pushing legislation to punish Chinese imports for exchange rate intervention, while the US Treasury has the option of slapping China as a currency manipulator.
“If I were advising the president I’d tell him to go after China and ask why it was being so uncooperative on the world stage,” said Philip Levy, a scholar at the American Enterprise Institute in Washington.
“You are worried about inflation. You’ve got all these issues. Let’s work together on this stuff,” said Levy, who prescribed yuan revaluation as a “textbook” remedy.
China, moving in the opposite policy direction to the United States thanks to its buoyant economy, has recently tightened monetary policy to counter inflation fears.
US officials, including Fed Chairman Ben Bernanke in remarks on Friday, say allowing the Chinese exchange rate to rise would help cool an overheating economy.
They want China to boost domestic demand to encourage a shift in resources away from its export sector.
Washington says this will help it invest more money domestically that is now being spent on buying US Treasury bonds to hold down the value of the yuan and aid exports.
Over time this would help trim the massive Chinese trade surplus with the United States, which economists here fear is a destabilizing threat to world growth.
“The two countries will both gain from a shift away from an excessive focus on the Chinese exchange rate to a discussion of the actions that both can take to reduce their trade imbalances,” said Barry Bosworth, a senior fellow at The Brookings Institution in Washington.
“In this sense, the required policies of the two countries are complementary rather than opposed,” he said.