Washington Post Editorial: The currency quarrel - China won't change on command. America must retake control of its own financial destiny.

Washington Post Editorial: The currency quarrel - China won't change on command. America must retake control of its own financial destiny.
Copyright by The Washington Post
Tuesday, November 24, 2009
http://www.washingtonpost.com/wp-dyn/content/article/2009/11/23/AR2009112303039.html


BY NOW it is a cliche that the United States has no more important bilateral relationship than that with China. Yet in the wake of President Obama's sometimes awkward visit to Beijing, it is becoming clear that, in one crucial respect, Sino-American relations are dysfunctional: Though umbilically connected by trade and capital flows, the two countries are pursuing incompatible economic policies. Without a course correction, both will suffer, and so will the global economy.

China has achieved its economic miracle through exports -- producing far more than its people consume. The United States -- where consumers have driven 70 percent of the economy in recent years -- is its biggest market. The United States, in fact, consumed more than it produced, but China enabled this by accumulating $2.3 trillion in reserves and plowing much of it back into U.S. government bonds.

When the global boom went bust, the United States cut interest rates to zero and began running a fiscal deficit of 10 percent of gross domestic product. This made the dollar vastly cheaper, but China, to protect its export industries, has responded by linking its currency to the plunging buck. Thus, U.S. exports are not growing as much as they would otherwise, and neither are those of other countries in Asia. China, meanwhile, evinces anxiety about its dollar-denominated assets, and U.S. leaders try to deal with having a distant, militarily powerful and authoritarian state as their banker.

Economically, the solution is obvious. China must increasingly grow by producing to meet domestic demand; the United States must live within its means. Both sides have made some headway. China has plans to build hundreds of new hospitals; pension reforms, which would reduce the need to save for old age, are also said to be on the way. In the United States, private savings have risen from minus 2.1 percent of GDP in the last quarter before the recession to 6.2 percent now. But more action is needed: Not only must the United States seriously address its long-term budget deficits; China must also allow its currency, the yuan, to rise. This view is confirmed by the two countries' trading partners as well as the International Monetary Fund.

The problem is how to get there. In theory, the United States and China might pursue some 21st-century version of the 1985 Plaza Accord, the intergovernmental agreement that called for appreciation of the Japanese yen and the West German mark against the dollar. In practice, that's not likely: Japan and West Germany were not only trading partners but also Cold War military allies of the United States. Communist China does not exactly fit that description. Moreover, the deal's results were ultimately disappointing, and it was abandoned in 1987.

And so, the United States and China are at an impasse, with each demanding, in effect, that the other change first. For Washington, the best approach is to continue pointing out the costs and contradictions of China's policy -- while taking charge of its own destiny. Given the current fragility of the U.S. economy and the 10.2 percent unemployment rate, it would be unwise, both for the United States and China, to tighten monetary policy and slash the budget deficit immediately, as some Chinese commentators have demanded. But, by beginning work now on credible "exit strategies" for fiscal and monetary policy, the United States could undermine China's beggar-thy-neighbor currency stance and ensure the long-term stability of the dollar.