Riptide

A story we've been returning to with some regularity, the U.S. Treasury bond market & U.S.-China economic relations, and especially currency valuation, returned to the headlines this week. And, for the first time, it was one of the top headlines both in the U.S. and in China. The proximate cause was Tim Geithner's statement to the Senate Finance Committee that President Obama thinks China has been “manipulating” its currency. Personally, I'm not sure what this means. Certainly, China has been managing the value of the RMB. Is that manipulating its value? At any rate, what's really at issue is the desire of many in the developed world for the RMB to be freely tradeable and for its relative value to be set by the market. The assumption in the West (and great swatches of the East as well, no doubt) is that the RMB will rise against the US Dollar, the Japanese Yen, the Euro, the Pound (if, indeed, the Pound could go much lower). This is desirable, from a US policy perspective, because it would make exports to China cheaper. Cheaper goods from the US means more sales to China, or so the reasoning goes. But it also means less Foreign Direct Investment (FDI) coming into China, as well as (in relative terms) cheaper investments in the US by China. In other words, The RMB, having hypothetically gone up in value against the Dollar, will buy more New York real estate, more government bonds, etc. It also means a few other things, of great concern to the Chinese: US Dollar holdings by the China Investment Corporation (China's Sovereign Wealth Fund) will go down. They've already gone down a bunch and further declines will bring more criticism from within China and, paradoxically, make further Chinese investment in the U.S. less politically attractive. In addition, current Chinese holdings of U.S. Treasuries will be cheaper in RMB terms or, stated differently but with the same essential financial meaning, interest rates will need to go up, as we've predicted, only more so. Already, since 2008 Year End, Treasury yields have risen. They bumped up a bit more this Friday after Geithner's remarks were made public. And Chinese newspapers led with the story meaning, at the very least, that China took notice.

There's nothing really new in this issue. China's friends as well as her critics in the U.S. have been warning for years -- and by that I mean at least since 1998 -- that the issue of currency values and the U.S. trade deficit with China would be an issue someday. Every year, it has seemed, those who have been doing the warning have looked like a combination of Chicken Little (of "The Sky is falling! The Sky is falling!" fame) and the Boy Who Cried Wolf. You can only warn so many times without the danger arriving before you're ignored and even perceived as a bit of a naive idiot. As the Chinese would say, if the weren't being polite, "Er Bai Wu" -- the Village Idiot! If, as the Chinese may fear, the era of the gentlemanly "Go Along to Get Along" policies of the Bush Administration are over, things will get interesting pretty quickly.

The irony for both parties is that they need each other in innumerable ways. Both China & the U.S. have serious economic problems and need to work together as allies to effectively deal with those problems. This requires both candor & practicality. The problems are real. To be genuinely and effectively dealt with, both sides will have to put sensitivities aside and grapple with the real-world issues. The Bush Administration made the "Global War on Terror" the measure of all things. This was not to the benefit of either China or the U.S. A more nuanced & honest relationship would be better for both.