Saturday, February 21, 2009

U.S.-China economic relations

Two giants, one world

The U.S. and China share the world's most important bilateral relationship. This relationship differs both in context and in style from the U.S.-Soviet relationship of the Cold War era. Washington-Moscow relations revolved around ideological competition, hard military confrontation and deep mistrust and hatred; Washington-Beijing relations are characterized by economic interdependency and shared interests in regional and global security issues. Nonetheless, the relationship is complex and is being made more so by the current global economic crisis.

We float together, we drawn together

China and the U.S. are so economical interdependent that any major economic policy shift by either country will surely affect the other. China's massive holdings of U.S. denominated assets are an increasing source of anxiety for both sides today. The Chinese media has accused the U.S. of unleashing a "financial tsunami" and a "financial WMD" on the international economy as a result of incompetent management of its financial sector. Many Americans for their part have long derided what they see as China's unfair manipulation of its currency.

Over two decades of export-led growth have dramatically improved China's economic power. The large foreign reserves that have been accumulated are a source of tremendous national pride and seen as symbolic of China's renaissance on the world stage. Beijing has assertively communicated to the U.S. that it expects its investments to be protected. The Chinese have gone so far as demanding official guarantees from the U.S. to safeguard the value of their US$ 682 billion Treasury bonds holdings.

An unsustainable situation

The reality is that the relationship between China and the U.S. is no longer sustainable for the world economy. The recycling formula whereby China would produce cheap goods for American consumers and channel the majority of its export earnings back into the U.S. economy is indirectly responsible for the abundant and cheap money supply in the U.S. that led to the housing and banking crisis.

It seems that Chinese authorities are well aware that they must put more emphasize on raising domestic demand and move away from their export-heavy strategy. In order to do this, China must strengthen the extent and quality of social service provisions to its citizenry in order to encourage more spending and less saving. China as a whole saves almost 50% of its income, which is previously unheard of during peace time.

Furthermore, China has to gradually raise the income of its people. This will need to be done by investing in more productive capital, investing heavily in education to make its population competitive in today's global economy and gradually allowing its currency to appreciate in order to strengthen the purchasing power of the Renminbi.

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