U.S. officials and their counterparts from the country’s largest creditor, China, will take place next week in the latest of a summer full of key bilateral and multilateral meetings. In the run up to the G20 meeting in April, speculation about a “G2” consisting of the U.S. and China alone attracted a lot of attention, with many analysts noting that cooperation and compromise from the U.S. and China was needed for global progress on trade, climate change, global imbalances and a range of strategic issues. While a formal partnership between China and the U.S. along the lines of a G2 is unlikely, the two countries are expanding the topics on the agenda of their formal dialogue.
The first meeting of the a new bilateral dialogue, the Strategic and Economic Dialogue (S&ED) will be held next week in Washington, DC, bringing together both countries’ top economic and geostrategic leaders. What is on the agenda says a lot about the priorities of each government, but what’s not included may say more. As usual, the countries will focus on some of the areas on which they agree (short-term responses, big-picture ideas) with some thorny issues kept for the future. By formalizing these discussions, disagreements can be pushed through back channels, raising the prospect that some agreements may be reached before or as Obama visits Hu in China later this year. At the same time, one key goal of the S&ED under Obama is to make the dialogue less about deliverables and more about the ongoing contact between officials and their aides.
During the Bush administration, U.S. and Chinese economic officials met twice annually for the Strategic Economic Dialogue (SED) to discuss a range of issues. Initially, expectations for these meetings were high, though they faded over time. Secretary Paulson hoped to broaden the dialogue rather than fixate solely on the level of the RMB. The cooperation delivered some victories, including cooperation on food safety and small steps towards a bilateral investment treaty. The new grouping between the U.S. and China will meet annually and will take on a new set of issues – geostrategic as well as economic.
President Obama will address the meeting on Monday morning, before a session on cross-cutting issues commences. Climate change is expected to be the main topic of the first session, a move supported by the U.S. Senate Foreign Relations Committee. Climate change was an issue that was slightly out of the remit of the more economically-focused SED, but outcomes may be limited here given the diverging priorities . While both sides have agreed to a $15 billion joint-research project on clean coal earlier this month, progress on climate change may be limited.
After this, the strategic dialogue, to be led by Secretary of State Clinton and State Councilor Dai, will part ways from the economic dialogue, which will be led by Treasury Secretary Geithner and Vice Premier Wang. While there is broad agreement on many of the issues that will discussed in these meetings (such as China needs to boost consumption and the U.S. needs to save more), the mismatch in priorities on each side is likely to limit any substantial progress. Moreover, even if the U.S. and China are “roughly in agreement” over economic issues, as the Economist optimistically puts it, their accord stems from short-term and very long-term issues. China and the U.S. have engaged in some of the most aggressive economic stimulus policies since the global meltdown, but they may differ in their positions on exit strategies. Moreover, there is not too much agreement on how the two countries will navigate in a world where China consumes more and the U.S. becomes a bigger saver.
Among China’s key worries is the safety of its U.S. assets. China now holds more than $2.1 trillion in foreign exchange reserves, about 2/3 in U.S. dollar denominated assets. Official U.S. data indicates that China held over $800 billion in U.S. treasury securities as of May 2009, making China by far the largest U.S. foreign creditor with its holdings equivalent to the levels of Japan and Russia combined. No wonder China (along with other U.S. creditors) is concerned about the U.S. deficit being monetized.
Zhu Guangyao, assistant finance minister, told Chinese state media that Wang will ask the U.S. to pledge to maintain the stability of the U.S. dollar. Such a pledge seems very unlikely, but Geithner is expected to deliver the strong dollar pledge he used last week in the Middle East (another region with a lot of dollar assets). Beyond that, both countries will limit what they say in public about the dollar, since too much attention to its value helps neither. Dollar weakness would mean China will be adding to, not subtracting from, its U.S. dollar holdings. The Chinese will also seek further details on how the U.S. will try to navigate its way back to fiscal sustainability. A slower than expected economic recovery could defer that adjustment, especially given the health care and other legislation wending its way through congress.
China will also likely bring up IMF reform, as it seeks a greater role in the institution’s management. China plans to buy up to $50 billion of notes to be issued by the IMF later this year. A relatively under-the-radar milestone occurred this month as the executive board of the IMF discussed the results of China’s first Article IV consultation since 2006. A semantic but significant standoff was resolved: The IMF will no longer label member currencies as “fundamentally misaligned,” a term that would require multilateral changes to bring currencies in line. But IMF reform is really an issue for the G20, whose next meeting will take place in Pittsburg. Yet, providing more funds to the IMF to loan out to emerging market economies is something they can agree on.
On the strategic side, China can be expected to bring up North Korea, but its priorities here are different that those of the U.S. While non-proliferation tops U.S. concerns on the Korean peninsula, stability is the bottom line for China. Although Beijing might not like the prospect of a nuclear armed state on its border, Beijing is more concerned about the collapse of the North Korean regime, which would unleash a flood of refugees across the Chinese border and the loss of a buffer between the U.S. forces in South Korea. Still, there has been some agreement in recent weeks on this issue, with China agreeing to sanctions on some North Korean officials, and marginal improvements toward consensus are possible.
The primary U.S. economic goal remains economic stabilization and establishing a path for both the U.S. and global economy that will avoid a renewed weakness of growth now that the economy is getting closer to bottoming out. As a result, officials will likely talk about exit strategies to unwind the fiscal and monetary stimulus, a c
onversation to be continued with the G20. China will likely have to start withdrawing some of the new liquidity extended through the credit channel sooner than the U.S., but clarity about how all countries will coordinate these strategies will be key. The U.S. will likely also want to get Chinese officials on board with proposed regulatory reform. How China and other emerging market economies integrate into global regulatory institutions will influence the likelihood of future crises.
The U.S. will also likely want Chinese support not only on sanctions on North Korea but more broadly on anti-money laundering and anti-terrorist financing regulations. In particular, Chinese compromises on the treatment of tax havens like Macao were important in coming to G20 agreements.
In the long-term, both sides agree that increasing Chinese consumption is a mutual goal, even if they differ on thoughts on how to increase and nurture it. As Geithner did in Beijing last month, he will suggest that his Chinese counterparts to adopt policies that will shift China away from investment- and export-led growth and toward domestic consumption. As noted by the U.S. Treasury in its annual report on exchange rates, last issued in April 2009, the Chinese fiscal stimulus is a good start but more significant policy steps are needed to reduce structural incentives to save in order to reallocate funds across the economy from state owned enterprises to households.
New healthcare measures in China are a good sign (though who will pay for them is not clear) but expanding China’s social-safety patchwork is needed for consumption driven growth. For now consumption incentives have supported retail and auto sales, but the bulk of Chinese government spending has gone to infrastructure projects. The desire to limit unemployment have contributed to export rebate extensions and policies which add to production overcapacity. The U.S. is likely to push for faster reforms, but the China looks prepared to go slowly. Everyone will agree that these changes take time. Despite the fact that China’s underlying domestic demand may be stronger than many anticipated, the Chinese consumer (and those in other emerging economies) are not ready to take up the baton from U.S. consumers any time soon.
While the U.S. would like a stronger and more flexible exchange rate policy from China, that might conflict with the other item on the agenda: keeping China from reducing its U.S. dollar purchases. The increase in China’s reserves (a whopping $140 billion adjusted for valuation in Q2) and U.S. dollar holdings, suggests that moving away from U.S. assets is an issue for the next few years. China’s shift to the short end of the treasury curve is a key vulnerability for China, however. Focusing on the most liquid of U.S. assets means that China could more easily swap among U.S. assets should markets improve or, when demand requires, use such assets to buy stakes in resource companies as premier Wen suggested this week. Yet the Chinese desire for a stable currency will limit diversification as it has done in 2009 so far. Chinese steps towards internationalizing the renminbi seem to be an issue for the next decade rather than the next year. Use of the RMB in trade is still very limited.
Climate change, a major policy agenda for the Obama administration, will be high on the U.S. agenda. While both the U.S. and China, as the world’s largest carbon emitters, have made some meaningful steps in the recent past on this issue, both accuse the other of trade protectionism. The U.S. believes that China is trying to protect its renewable-energy industry and China worries that the climate change bill that recently passed the U.S. House will lead to onerous import taxes on carbon-intensive goods. China, India and other emerging markets are wary of committing to long-term emissions-reductions targets, arguing that advanced economies that had the luxury of polluting in their mid-stages of development should bear the highest cost. Thus any bilateral and multilateral agreements on this issue may be watered-down. But the U.S. and China are likely to avoid the sort of public rift exposed between the U.S. and India on the issue last week. One area of possible cooperation is technology transfer, though this, too, may be an issue for the future. More green technology production could create jobs in both the U.S. and China.
On the strategic side, cooperation on Iran and Afghanistan/Pakistan will be U.S. priorities. On Iran, China is unlikely to offer much help for U.S. priorities (Russia could be more of a help or hindrance there) but there may be room for further agreement on Afghanistan/Pakistan issues, as China fears instability in Pakistan. As Secretary Clinton did during her February trip to China, U.S. officials are unlikely to make human rights a focus of debate. While the recent Xinjiang riots will almost certainly have to be addressed, U.S. officials are likely to try to sidestep them.
What’s Not on the Agenda?
Most notably missing is trade. Both sides have indicated that a discussion of trade policies will largely be delayed until the fall meeting of the Joint Commission on Commerce and Trade. Both the U.S. and China have pointed to what they see as trade protectionism from their counterparts in recent months. Trade tensions have risen in the economic downturn, with the U.S. filing new complaints at the WTO and both sides including protectionist measures in their stimulus bills. Deferring this issue given the disagreements is a way to make time for discussions with more potential. However, such meetings have been provided a platform to launch trade steps like improved food-security screening in the past. This delay would also suggest that hopes for a revived Doha multilateral trade round may be overly optimistic.
Development assistance policies may also be left to a future date. Chinese foreign aid to Africa, Central Asia and Latin America has been on the rise, often as part of larger loan and investment packages. It also increasingly plays a key role in UN peacekeeping missions. The U.S. is about to kick off discussions of a new foreign assistance act that may boost the size of US AID, but the institution remains without a director. Greater cooperation may be in the future though, and could be an area where the U.S. and China, along with other donors, cooperate. The U.S. also has concerns about growing Chinese resource investment in developing economies.
Military issues are also off the table. Although China’s growing military power has sparked U.S. allies in Asia (especially Australia) to adjust their strategic policies, both sides prefer to keep this discussion limited to professional military personnel (and out of the hands of politicians) for now. In June, high level military-to-military talks resumed for the first time since last October, when Beijing suspended talks to protest U.S. arms sales to Taiwan. The easing in ties between Taiwan and China may provide an opening. There have been frequent naval skirmishes between China and
the U.S. in 2009, but neither side wants to escalate the issue.