Let us hope President Obama got his fill of rest and relaxation in Mumbai and Jakarta prior to arriving in Seoul for the G20 summit and Yokohama for the Asia-Pacific Economic Cooperation Forum. He's in for quite an earful. Notwithstanding the president's stated declaration to use this trip to expand markets in Asia for American exports, there is actually a far more important dynamic at play. From the Asian perspective, Federal Reserve Chairman Benjamin Bernanke's announcement last week of a further $600 billion injection into the monetary system represents a raising of economic stakes that will very likely result in heightened tensions between the U.S. and China.
I do not believe that last week's election results will merit more than passing mention in the discussions. Few of the major countries in attendance have been without electoral upheaval. Neither do I believe that military matters will top the agenda. The wars in Iraq and Afghanistan have ceased to be matters of grave interest to non-combatant countries. In point of fact, all matters at the G20 pale in importance next to the big tete-a-tete between the U.S. and China on one matter in particular, the dollar.
It isn't that American exports to China are an unimportant issue. Far from it. But there's no disagreement that increased American exports are mutually beneficial. And contrary to what most politicians believe, the Chinese market for American goods is actually relatively open.
Although much is written about the size of China's exports, not many people are aware that China is already the world's second largest importer. Ask any major American firm to contrast its experiences in China with those in say, Japan, and you'll hear mostly favorable comparisons. In other words, there will be little resistance to the president's stated intention to export more to Asia and to China in particular. But on the matter of the dollar, it will get quite testy.
Chairman Bernanke chose a particularly inopportune time to make his announcement about quantitative easing — the fed's decision to expand our money supply by buying Treasury bonds in the open market. Recall that Treasury Secretary Timothy Geithner and many in Congress have been up in arms over China's weak currency policy. Subsequent rejoinders by senior Chinese officials suggest that pushback has started. So China was already feeling put upon. Then comes Mr. Bernanke's move which is couched in terms of providing more cheap credit to the American consumer. That is indeed the first order effect. But there's a second order effect which is more important to China.
Remember that the Chinese yuan is essentially pegged to the U.S. dollar, which was Mr. Geithner's original problem with China. Therefore, as goes the dollar so goes the yuan. Now, with this move Mr. Bernanke floods the market with more dollars (hence an "easing" in the "quantity" of dollars that are in the system) which has the resultant effect of cheapening them.
But with the cheaper dollar goes a cheaper yuan. So you can see why China is miffed. First, Mr. Geithner harangues them for not strengthening their currency, then like yin to Mr. Geithner's yang, Mr. Bernanke comes along to pressure it in the exact opposite direction.
The economic effect is even worse than ruffled feelings among the Chinese. Admittedly, an even weaker yuan makes China still more competitive on the export markets. But few know that China must import most of its basic necessities. With much less arable land than the U.S. but 1 billion more mouths to feed, China must buy much of its food and almost all of its energy from other countries.
With its currency tied to a depreciating dollar, China must limp along with the U.S., like in a three-legged race, to spend its now cheaper paper in the marketplace. Not so terrible for a food-sufficient country like the U.S., but more than irritating for a net food importer, even a rich one.
But even this is not all. It is known that China holds well over $1 trillion dollars worth of U.S. Treasury Bonds. Mr. Bernanke's monetary surge, now going on three years, must end eventually, and when it does, interest rates can only move up, probably violently.
Only a decade ago, with Alan Greenspan at the helm, the Fed had a previous experience of rapid money expansion followed by a similarly rapid contraction. Does the Y2K fiasco ring any bells? What will happen to the value of U.S. Treasury bonds held in China's reserves when that recurs? For that matter, what will happen to the value of bonds in our own hands? Suffice to say, it won't be pretty, which adds another dimension to China's pique.
As he should, President Obama will emphasize that U.S. economic policies must place American priorities first. But his task would be a great deal easier if his subordinates wouldn't chide other countries for doing similarly. This week in Asia, I wouldn't be him for all the tea in China.
Michael Justin Lee, former financial markets expert-in-residence in the U.S. Department of Labor, teaches international finance at the University of Maryland's Robert H. Smith School of Business. His e-mail is firstname.lastname@example.org.