These days U.S. Treasury Secretary Tim Geithner is visiting China. While this visit might entail less drama than then President Nixon’s first visit to China in 1972 (the topic of John Adams’ 1987 minimalist opera “Nixon in China”), the largest and the third largest economies of the world, being very differently positioned during the present crisis, have a lot to talk about. Let us consider what might be in the “rest of the world’s” best interests.
1. China’s insatiable appetite for savings during the past 10 years found its productive outlet in the U.S. consumers’ insatiable appetite for ever more consumption. It is estimated that China holds around 1.500 bill $ in U.S. treasury bonds, thus potentially exerting significant power over the future of the U.S. economy. If China decided to shift a large part of these savings into other currencies, the effects on the dollar would be disastrous. The global economy would incur another shock.
2. Recently, Chinese officials like the Governor of the Bank of China, have voiced increasing concerns over the fate of the U.S. economy, its large budget deficit and have criticized the U.S. $ role in the global economy. They made strong hints at their preference of a “more balanced” global monetary system – with a less dominant role for the dollar. This is a new development: during the past years, pressure was from the U.S. on China to relax and revalue its own currency, in order to reduce the massive current account (mainly manufacturing goods) surplus of China vis-à-vis the U.S. Now this is a two-way street.
3. It cannot be in China’s interest to weaken the dollar seriously– for two reasons: they need to maintain their competitive advantage as a net exporter with an undervalued exchange rate, and they do not want to devalue their dollar holdings and thus weaken their extremely strong reserve position.
This massive imbalance: here the U.S. absorbing Chinese savings (and many other countries’) because Americans “buy and borrow”, there the Chinese (and other, mainly Asian, countries) massive savings and export surpluses – is a severe threat to the global economy. These imbalances are not sustainable, they create volatility and extreme vulnerabilities for the whole world. They are one of the major causes for the present crisis.
4. Thus it is positive that these two giants of the global economy talk and come to some terms. However, this must not come at the expense of the “rest of the world”. Their discussions and a hopefully consensual strategy forward are a necessary, but not sufficient condition for a more sustainable global economy.
5. They will talk about their exit strategies from the crisis, but talks must go beyond. Both countries have initiated large stimulus packages: the U.S. because they are in a deep recession and have to rescue their banks and other firms, the Chinese because they have an endemic lack of private consumption, high private investment rates, but need to shift their economy from producing cheap manufacturing goods to the world to internal demand. China is still growing strongly (recent estimates are around 6% for 2009), but they are at the threshold below which China fears to incur public unrest which might endanger their very successful economic model of the past 20 years.
6. China’s consumers save around 20% of their (low) disposable income. They do not want to spend more, because they need to pay for their child’s education, for every visit to the doctor, for old age, for unemployment. China will soon incur a severe aging problem as a result of its one-child policy, thus an old-age pension system will be high priority. It is my assessment that Chinese consumers will only spend as much as they produce, once they have a basic social services sector available which takes care of their most basic existential risks. The Chinese government has started to see this and is investing in public health clinics and a beginning pension system. In addition, China still has huge infrastructure requirements and – partly as a legacy of its exorbitant growth during the past decades – huge needs in environmental damage mitigation and investments into more sustainable production methods. Thus, in the medium term, Chinese internal demand will have to come from public investment and consumption and not from private consumption.
7. An important topic of discussion will have to be China’s stronger involvement into the global economic policy/financial architecture, in short: much stronger influence in the Bretton Woods institutions and other bodies. This is important because of China’s size, but also because its newly found function as benefactor (both as investor and lender) to African and Latin American and Asian resource producers is done outside of the frail rule-book of international investors, thus endangering some of the disciplines the World Bank, IMF and other institutions have been trying to bring to some of the aid recipients. While Western countries have cancelled massive amounts of developing countries debt during the past years, China is adding new debt burdens on them. While some of these rules might be one-sidedly in the interest of the Western rich countries, Chinese influence must also be aligned with international global rules. Thus China must play a larger role in the IMF, the World Bank, the Financial Stability Board, and other institutions.
8. The global economic policy governance must be aligned in the medium term so as to minimize large global imbalances, both on the deficit and the surplus side. It must no longer give preference to one single currency, thus providing an incentive for this currency’s country to incur large external imbalances – not having to fear devaluation. The large currencies of the world need to be all represented in commensurate amounts as global currencies. This would stabilize large exchange rate fluctuations, and help especially smaller countries with weaker currencies to be wrecked by fluctuations outside their own decision-making power.
9. Both the U.S. and China are massive contributors to climate change-inducing air pollution. They must jointly agree to enter multilateral discussions for mitigation and adaptation. This is in their own and the world’s interests. Suitable mechanisms for more sustainability must be found.
10. Both the USA and China will pursue their national interests in their talks. It would be naïve to expect otherwise. However, it is to be hoped that the new spirit of multilateralism which the new US administration has revived will also extend to these discussions. We need a G-2 consensus to move the world economy and society forward on a sustainable path. G-2 is necessary, but not sufficient. The two giants must tread gingerly, in order not to tread on the still very fragile global economy. We need a new multilateral governance where all types of countries, large and small, developed and developing, surplus and deficit countries can represent their interests. The existing G-groupings cannot do this legitimately.