Near Term-end, Paulson may not deliver in China

Near Term-end, Paulson may not deliver in China

For all high-level visits, top government officials are given advice and talking points. Ahead of US treasury secretary Henry Paulson’s trip to Beijing this week, vice-premier Wu Yi may have perused analyses that read something like this:

To: Vice-premier Wu From: Chinese ministry of finance Subject: Secretary Paulson’s visit Secretary Paulson is leading the US delegation at the third “strategic economic dialogue" at a particularly perilous time for his economy. Growth is slowing, inflation is accelerating and credit markets are in turmoil.

Paulson’s fifth visit to China as US treasury secretary can be expected to focus on familiar issues: faster yuan appreciation, opening the financial sector, our efforts to avoid overheating and the safety of our exports. Few surprises are expected.

Yet, the talks that start on Wednesday and run through Thursday are likely to avoid the three biggest issues facing US-China relations in the next 12 months: Paulson’s lameduck status, increased Chinese investment in the US and next year’s presidential election.

It has long been noted around Beijing the extent to which the Bush administration itself has descended into lame-duck territory. Its disastrous invasion of Iraq will continue to dominate President George W. Bush’s final year in office. Now, a similar dynamic is befalling Paulson’s treasury department, which is wrestling with a global credit crisis that began in the US.

When Paulson left Goldman Sachs Group Inc. in mid-2006 to join Bush’s cabinet, we assumed his tenure would be one of relentless pressure to boost our currency. It’s still a US priority; as recently as 7 December, Paulson said that while “the pace of change has accelerated," Chinese officials “need to move it more."

Even so, the yuan rose 5.4% in 2006 alone and its gains tripled in the past 15 months. Given that China is still an export-driven and developing economy, our assessment is that US claims about our inflexibility are getting less traction.

It is also worth noting that the impending end of Paulson’s term as treasury secretary is diminishing his clout. Rather than China’s currency, it now seems clear that Paulson’s legacy will be determined by how well he handles the fallout from the subprime debacle.

In the late 1990s, many were aghast to learn the US Internet-stock boom was a financial shell game aided and abetted by accounting firms. More recently, there has been shock that the US’ famed securitization model is breaking down. This time it was credit rating companies asleep at the wheel.

The level of desperation in the Bush White House can be seen in the so-called Paulson Plan to freeze some mortgages to stop a wave of foreclosures that has cut prices and demand for houses. It is reminiscent of the strategies the US scolded South-East Asian economies for employing in the 1990s. It is curious that the approach is coming from a government that preaches the gospel of unfettered capitalism.

Paulson’s past as chief executive of a major Wall Street firm during the subprime heyday also is getting attention on Capitol Hill. Bottom line, Paulson will have less and less time to fly to Beijing to pressure China for changes.

The second issue—Chinese investment in the US—is somewhat related. Many governments are taking a sceptical view of sovereign wealth funds; they’re worried about other governments buying up their assets.

And yet, recent events show Wall Street is warming up to the phenomenon. Citigroup Inc., which by late November had lost almost half of its market value amid massive losses tied to mortgage and other securities, recently received a $7.5 billion (Rs29,550 crore) cash infusion from Abu Dhabi Investment Authority.

As our $1.4 trillion of currency reserves increase and the yuan strengthens, it behoves China to look abroad for higher returns. Troubles in the US may create many distressed assets that Chinese government investment officials may want to consider buying.

Herein lies one of the ironies of pressure for a stronger yuan: A rise in our currency only makes US assets cheaper. China bidding for household-name companies may lead to even bigger political squabbles than exchange rates.

Finally, China should be looking beyond the Bush years to the next US president. In September, for example, President Hu Jintao had the good sense to invite Australia’s Kevin Rudd to next year’s Olympics in Beijing. Like many, our president felt voters were destined to elect Rudd prime minister, which they did last month. We should apply similar foresight to our ties with Washington.

While it would be indelicate to raise the issue with Paulson, our strategic dialogue should begin including senators Hillary Clinton and Barack Obama, if only indirectly. The focus should be heading off trade wars should either Democrat begin bashing China to woo voters.

China need not take too seriously any demands Paulson brings to Beijing. When one considers the risks facing the global economy, those emanating from the US are as serious as any—if not more. Still, if Paulson asserts that China is a threat to stability, we should resist the urge to hold up a mirror for our US counterpart to peer into. BLOOMBERG

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