The US and China: A grand bargain?

Timothy Geithner, in his first foray into international economic affairs as US Treasury secretary, has kicked off a public row with the Chinese by accusing them of currency manipulation. The Chinese have vehemently rebutted this accusation and flexed their own muscles, telling the US to get its own house in order before lecturing others.

The world economy, already on its knees, cannot afford escalating economic tensions between China and the US. Trade disputes between the two countries could disrupt the world trading system and further wreck consumer and investor confidence. The world needs China and the US to pull together rather than rattle their sabres at one another. How can the joint interests of the two economies be brought to the fore when the tendency is to turn inward? There is a solution: a grand bargain between China and the US on macroeconomic policies and international economic affairs. None of the elements is novel, but rolling them into a package which Chinese and US leaders could announce would provide domestic political cover for both to implement policies that are in their own interests. Cooperative action would also give a fillip to international economic confidence.

The main elements are:

First, the two countries commit to using fiscal and monetary policy to the best extent possible to stimulate domestic demand in their economies in the short run. This is to reaffirm their resolve to deliver on their stimulus packages, bolster the stimulus if necessary, and for China to signal that it will not count on exports to keep its economy and job growth from stalling.

Second, the Chinese allow their currency to become more flexible and responsive to market forces while the US articulates a plan that commits it to taming its budget deficit once the economy begins to recover. This is an opportune time for China to allow more flexibility in its currency. Now that capital is flowing out of China, it could be the case that the currency depreciates slightly in the short run. Who could blame the Chinese if market forces pushed the renminbi’s value down!

In any event, it is world demand rather than modest exchange rate changes that will affect China’s exports in the short run, so the currency issue is more symbolic than substantive. But greater currency flexibility could have long-term benefits for China by reducing its dependence on exports and re-balancing its economy towards domestic consumption. It would also ease pressure on the Chinese to revalue their currency by a large amount at one step.

The US will need to tackle its mammoth budget deficit and rising public debt, which have contributed to its current account deficit and dependence on funds flowing in from the rest of the world. A clearer commitment to lower the deficit over a reasonable period after the economy recovers would reassure financial markets that US government borrowing will not be allowed to get out of control and exacerbate global macroeconomic imbalances.

Third, the US supports an expanded role for China in multilateral financial institutions, including significantly greater voting rights at the International Monetary Fund and membership in the Financial Stability Forum. These steps would make these institutions more inclusive and effective in dealing with global challenges. They are also strongly desired by China, which feels that its role in such institutions is well beneath its economic stature.

While greater Chinese influence in international economic affairs is inevitable, the US has some leverage as it can throw a spoke in the wheels if it so chooses—at least in terms of delaying changes—given its prominent role in multilateral institutions. Tying this issue into the grand bargain would allow China to assume its rightful place on the world stage soon.

With these steps, the US could show that it is willing to enter into a genuine economic partnership with China that can benefit both sides and also demonstrate leadership by accepting China’s expanded role on the global stage. The Chinese could reaffirm to their restive citizens their commitment to restoring growth and jobs, and also be seen as getting the respect they deserve as a world power while doing their bit for global economic and financial stability.

The political leadership on both sides has to move beyond nationalistic sentiments and convince their people that, in this interconnected world, China and the US will sink or swim together. There is a way. Is there the will?


Originally published at the FT and reproduced here with the author’s permission.

5 Responses to "The US and China: A grand bargain?"

  1. Dave   January 30, 2009 at 1:15 pm

    China should increase the service sector and private property rights. Owning the roof over your head(free hold, not lease) goes a long way in job creation, GDP, and citizens standard of living.

  2. Guest   January 30, 2009 at 6:58 pm

    wishful thinking, don’t you think?

  3. Anonymous   January 31, 2009 at 1:42 pm

    Dave, would you rather have The Crown owning the land you purchased?Unless you live on a different planet then I do, you forgot Chinese citizens can buy private real estate. In fact, real estate has been the main driver of chinese gdp growth. It is true the laws says all land belongs to the country, China, but in practice it means very little.You, as a private citizen of china, own the right to use the land, and own the house etc as your private property.In strict legal terms, foreigners are not allowed to own land in china; however, foreigners can still buy house.Besides, chinese citizens do not pay property tax. Nor they pay sales tax or capital gain tax. Relative to the total population, chinese government is rather small.

  4. Guest   February 1, 2009 at 8:38 pm

    Author is a dreamer. The long term interests of Chinese have little to do with US, just as Japanese and South Korea. The Asian nations have no interest in cooperation or partnership unless they benefit more than the other party. Greed will eventually be China’s undoing. Geithner is absolutely correct that China is a currency manipulator and they should be called out on it. Why does China get a free pass from WTO?

  5. Guest   February 2, 2009 at 6:38 am

    The author had me until I read “… while the US articulates a plan that commits it to taming its budget deficit once the economy begins to recover.”Made me think of the Supertramp song “Dreamer, he’s nothing but a dreamer ….”