Can Timmy Tackle China?

They're America's biggest investor and our best chance at quelling Kim Jong Il. Why Secretary Geithner's trip to China could define our place in an increasingly tight global economy.

Even on a weekend largely devoid of news, save for the trials of Judge Sonia Sotomayor and pretend war dances on the Korean peninsula, the story that will largely determine the fate of the American and global economies goes strikingly unattended: Treasury Secretary Timothy Geithner is in China. He’s there to meet with its leaders to begin figuring out policy puzzles whose resolution will shape the future far more than the mesmerizing crises of Korea, Afghanistan, Pakistan, Iraq, and Iran. He’s there to talk about the value of the dollar and the yuan, trade and investment decisions, and how best to pump life into a listless world economy. By these eye-crossing threads does our future hang. And don't be surprised to hear reports of Geither talking up the American economy. The reports are true, and the tactic is necessary. Otherwise, he'd have to listen to long Chinese lectures about Wall St. profligacy and play the weaker hand.

Once deadly Cold War enemies, the economies of China and America have become inseparable. The United States is China’s biggest export market by far. China is America’s biggest investor by far. If one sneezes, the other catches a cold. Their markets are so intertwined that if one side tries to gain advantage over the other, it hurts itself as well. The United States remains the biggest economy in the world by far, and China has been the fastest-growing one by far for decades now. One of America’s leading international economists, C. Fred Bergsten, recently called for downplaying the G-20 group of industrial powers and focusing instead on what he termed the “G-2,” namely China and the United States.

Once deadly Cold War enemies, the economies of China and America have become inseparable.

Here’s the agenda for the Geithner talks, the policy puzzles, and the stakes.

On economic stimulus, both countries are basically on the same page and accepting of their responsibilities for the global economy. Depending on how it’s counted, the U.S. stimulus and salvation package ranges somewhere around $2 trillion. China’s reaches almost $600 billion. But for this, Beijing gets much more bang for its buck. The Chinese, for example, have more infrastructure projects under way in Beijing than the Obama administration does in all of the United States. Low labor costs give Beijing a tremendous advantage here, which will continue to give it a big competitive advantage.

Nonetheless, the Obama team wants Beijing to spend much more to stimulate its own internal economy. The Chinese economic miracle has been built mainly on exports, especially to America. This has resulted in enormous trade surpluses for China and deficits for the United States. Washington wants to export more to China, far more than its already upward trend in recent years. But that’s a hard decision for Beijing. To begin with, the Chinese people are savers, including for things like medical costs that are scanted by the Chinese government. Also, that conservative-minded government is loathe to pump out yuan even to its own economy if the result is deficit spending.

The trade relationship hangs in good part on the relative value of the dollar against China’s reminbi or yuan. Washington has long accused Beijing of keeping the value of the yuan artificially low against the dollar in order to make its exports cheaper to the United States. Beijing says the situation is more complicated than that. In any event, if Beijing were to let the yuan fall against the dollar by about one-third, the figure often bandied about in Washington, its losses would be catastrophic. China holds about $1.5 trillion in Treasury bonds, equities and the like. A one-third decline would mean the loss of $500 billion.

On the other hand (and there’s always another hand in these subjects), Washington can’t afford to let the value of the dollar drop in America’s interests. In the first place, if its value falls, American securities will become less attractive to investors, especially foreign ones, especially China, which already has such large investments. And without those foreign investments, especially from China, the Obama administration has no hope of financing its vast deficit-spending stimulus package. Less investment money from China, more printing of depreciated money in America, more inflation, and more undercutting of Obama’s stimulus package.

Declining investments from China would also mean a jump in interest rates in America in order to attract more Chinese and other foreign investors. But the higher the interest rates, the slower the economic recovery in America because more expensive loans would further slow growth as well. Mortgages for the housing markets, in particular, would fly skyward and grind down the recovery of the housing market. And of course if all these bad things came to pass, China itself would be the second biggest loser after America, given its investment in dollars.

All of these cold calculations revolve around cash and the money balance sheets. But the talks between Geithner and the top Chinese leaders have another, still more confounding dimension—the economic power relationship. The vast majority of international economic transactions are denominated in dollars. In other words, the American economy is the touchstone that all nations have to honor and its currency is the one that requires the most protecting in the common interest. Now feeling its power oats after decades of economic growth and diplomatic deference by others, Beijing wants more of a say in the global economy and the prestige aspects of currencies. Some of its leaders have been talking about replacing the dollar with a new “international reserve currency,” over which Beijing would have its rightful influence.

But as with so many dimensions of its new great power role, Chinese leaders have not thought through what they want and what they’re demanding. Who would take the weaker dollars China would unload onto this reserve currency? How happy would they be holding onto these devalued dollars, while China profited? Global leadership requires sacrifices on the part of the leader, a fact not yet chewed, let alone digested by Beijing’s bosses. With prestige comes costs and responsibilities, which the United States alone among great powers remains willing to shoulder.

As if all this weren’t complicated enough, the Geithner visit in the next days takes place against the backdrop of North Korea’s flexing of its nuclear and missile power. Secretary of State Hillary Clinton will be looking to China for help in taming this latest outburst by Pyongyang. China is North Korea’s lifeline for food and fuel and China has more influence over Pyongyang than any other country. It has resisted pressure for fear of a collapse of the North Korean government, causing a flood of refugees and instability on China’s border.

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Geithner is charged with sorting out the economic layers of the new Chinese-American relationship. But until he and his Chinese counterparts figure out how the pieces of the puzzle fit together, and how critically interlocked common interests can be advanced without damaging separate interests, they should observe the central maxim of international medical practice: Do no harm.

Leslie H. Gelb, a former New York Times columnist and senior government official, is author of Power Rules: How Common Sense Can Rescue American Foreign Policy (HarperCollins 2009), a book that shows how to think about and use power in the 21st century. He is president emeritus of the Council on Foreign Relations.