China Teaches President Barack Obama His First Lesson on Foreign Fiscal Policy

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President Barack Obama’s choice for Treasury secretary, Tim Geithner, was playing with fire last week when he told US senators that China was “manipulating” its currency.

China took Barack Obama’s views on the yuan seriously.

So seriously that China is doing the exact OPPOSITE of what the U.S. President would like. China let the yuan FALL the most in a month on Jan. 23, right after Timothy Geithner, Obama’s pick for Treasury secretary, relayed Obama’s campaign position that China was “manipulating” its currency.

The reaction was China’s way of telling the new U.S. leader what he can do with his foreign-exchange views.

Since China abandoned its dollar peg in 2005, the renminbi has in fact gained more than 20 per cent against the greenback. No wonder, the Chinese feel slighted by Mr Geithner’s rebuke.

It’s hard to believe that Geithner hasn’t stressed the dangers of a trade war with the largest holder of U.S. government debt.

“U.S. interests lie in an economically strong China,” says Marc Chandler, head of currency strategy at Brown Brothers Harriman & Co. in New York.

“Manipulate” is a charged word, and it’s politically incorrect in financial circles. And yet it was hard to keep a straight face when a Commerce Ministry official argued on Jan. 24 that “China has never tried to gain advantage in international trade by manipulating its currency.”

Yes, China manipulates its currency. Arguably, so do Singapore, Argentina, Saudi Arabia and any nation that either pegs its currency, maintains a tight trading band or oversees a “managed float” system.

Even Hong Kong, routinely ranked as the world’s freest economy by the Heritage Foundation, manipulates its currency. It has to maintain its link to the U.S. dollar.

The currency-manipulator label is rather toothless anyway. The administration of former President George W. Bush avoided it so as not to antagonize China. Yet China didn’t let the yuan gain 21 percent between July 2005 -- when China scrapped its dollar peg -- and July 2008 because the U.S. demanded it. China did it because it was best for China.

Elected on a platform of diplomatic engagement, Mr Obama said in his inaugural address that “our power grows through its prudent use”. Mr Geithner’s opening shot could be seen as IMPRUDENT.

China and the US are both responsible for the enormous international capital flows that inflated the bubbles that have now burst: China because of excessive spending, the US because of excessive borrowing. China because of excessive spending, the US because of excessive borrowing.

Since the US is going to remain a net borrower – the retrenching private sector is simply passing the borrowing baton to the government – China must save less. China can do this by expanding domestic spending more aggressively, directing the fruits of Chinese growth towards ordinary Chinese citizens instead of American borrowers.

(But) if China starts spending at home, it could provoke China into a sudden and dramatic re­adjustment of its exchange rate and foreign reserves management – up to and including its willingness to hold US sovereign bonds.

The U.S. obsession with the yuan underlines a failure of imagination. Yes, an undervalued currency helps China, but it’s not the only reason for the nation’s export prowess.

Anyone who thinks China is about to let its currency strengthen is dreaming.

That goes for the U.S. president, too.

Related Article

Beijing Snaps Back At Obama Over the Yuan

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A top official in China's central bank, alluding to comments by Treasury Secretary nominee Timothy Geithner, said the charge that Beijing manipulates its currency was inaccurate and implied there were bigger issues to address in the global financial crisis.

While China's official comments have indicated official frustration at Mr. Geithner's remarks, they also seemed crafted to avoid appearing to overreact or further escalate the dispute.

China's Ministry of Commerce said China won't rely on they yuan's depreciation to support exports.

"Directing unsubstantiated criticism at China on the exchange-rate issue will only help U.S. protectionism and will not help toward a real solution to the issue," the ministry said in its statement.