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February 23, 2009

Barack Obama said last month that Americans should get used to “trillion-dollar deficits for years to come”. Then he sent Hillary Clinton to Beijing to see if the Chinese could get used to it. She may be the US Secretary of State, but Clinton was in China in the past few days as a high-powered bond saleswoman.

China is America’s biggest creditor. While the US banks and car companies go to Washington cap in hand to plead for emergency funds from Uncle Sam, Washington goes to Beijing cap in hand to ask China to provide Uncle Sam’s emergency funds.

That’s why Clinton pushed human rights aside, much to the outrage of activists around the world. The issue “cannot interfere” with economic and diplomatic priorities, she said in China at the weekend.

That’s why she asked China’s leaders to keep buying US Treasury bonds. After meeting her Chinese counterpart, the Foreign Minister, Yang Jiechi, she said: “I greatly appreciate China’s continued confidence in US Treasuries.”

And that’s why she went on a popular Chinese TV show and told the host, Yang Lan: “It’s a good investment, it’s a safe investment.” Pressing her case, she said: “By continuing to support American Treasury instruments, the Chinese are recognising our interconnection. We are truly going to rise or fall together.”

Clinton’s three days in China provided an explicit acknowledgment of the power shift between the two nations. And that shift has been all one-way.

China has the world’s biggest foreign exchange reserves, at $US2.3 trillion ($3500 billion), said the leading expert on this rather opaque subject, Brad Setser of the Council on Foreign Relations in New York. Of that, $US1.7 trillion is invested in US debt of various types.

To finance his $US787 billion economic stimulus package, Obama wants China’s money. To manageably fund the US budget deficit this year, which the Congressional Budget Office estimates to be $US1.2 trillion, more than double last year’s, Obama wants China’s support. And to continue its annual military spending of $651 billion, Obama wants China’s goodwill.

Will he get it?

A debate is raging among China’s policymaking elite. Should the Chinese Government really be lending America the money to build missiles which may be later aimed at Beijing?

Should the Chinese be expected to continue taking losses like the $5.6 billion in the collapse of Morgan Stanley or the $5.4 billion at risk in the stricken Reserve Primary Fund?

Influential voices argue not. An editorial in a government mouthpiece, the China Daily, said in December that Washington “should not expect continuous inflow of more cheap foreign capital to fund its one-after-another massive bail-outs”.

A former member of the policy board of China’s central bank, Yu Yongding, urged a sell-off: “China should sell some of its US Government bonds and increase its euro and yen assets” to diversify risk, he wrote for a newspaper last month. And Beijing should seek guarantees that its holdings would not be eroded by “reckless policies” in Washington.

Chinese confidence in the US was not helped by the new US Treasury Secretary, Tim Geithner, who, seeking to win popularity on Capitol Hill, accused China of “currency manipulation”. US trade law mandates retaliatory action if there is a formal finding of currency manipulation; the Obama Administration immediately tried to play down the remarks by Geithner, a walking liability for the new President.

The Chinese Premier, Wen Jiabao, has been uncharacteristically critical of the US, blaming it, accurately, for the global economic crisis. Last month he attacked America’s “unsustainable model of development” – with low savings and high consumption.

It is that gap that Clinton was asking China to pay for. Did she succeed? Clinton claimed to have won assurances that Beijing would keep financing the US deficit. But publicly China’s leaders gave no commitment.

The two countries are in a symbiosis. Citigroup economists estimate that for every 1 per cent that US growth rates slow, China’s economy slows 1.3 per cent. China depends on US export markets. For this reason, China will not make any sudden moves against the US.

But it will most certainly use its fiscal leverage to influence US policy. Top officials asked for, and received, an assurance from Clinton that the US would reject protectionism. Tellingly, China’s senior officials will travel to Washington next month to craft a joint US-China position for the key Group of 20 meeting in London in April, a meeting to recast global financial systems.

As Clinton said: “We are truly going to rise or fall together.”

Her husband, Bill Clinton, had a moment of revelation about US government finances in his earliest days as US president, and it came with a shock: “You mean to tell me that the success of the program and my re-election hinges on the Federal Reserve and a bunch of f—ing bond traders?” His cabinet colleagues said “yes”. So, with utmost reluctance, he cut his government’s spending plans and announced a timetable to cut the federal deficit.

Barack Obama has evidently had his moment of revelation, too. A future account of Obama’s first 100 days may well record him saying something like: “You mean to tell me that the success of the program and my re-election hinges on the Federal Reserve and a bunch of f—ing communists?”

Peter Hartcher is the Herald’s international editor.


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