Behind the yuan smokescreen

PUBLISHED : Tuesday, 12 December, 2006, 12:00am
UPDATED : Tuesday, 12 December, 2006, 12:00am

US Treasury Secretary Henry Paulson kicks off his 'economic strategic dialogue' in Beijing this week, adding a new dimension to Sino-American engagement. His entourage is probably the strongest negotiating team ever thrown at Beijing, including the secretaries of commerce, trade, health and the environment.

As an investment banker with long experience in China, Mr Paulson brings fresh pragmatism to a presidential administration whose theoretical, Alice-in-Wonderland approaches to world issues have left a legacy of sad results. By creating a multi-dimensional approach to negotiating, he echoes the thinking of other China-hand business kingpins like George Fischer, former chairman of Eastman Kodak Corp. Mr Fischer used a similar approach in the 1990s to open the mainland's once tightly guarded film sector, giving America the market lead.

China clearly anticipates that the issue of the yuan's value will be raised by the visiting Americans. Beijing telegraphed its position last Wednesday, on the front page of a newspaper owned by the central bank: it explained why the yuan should be devalued rather than strengthened.

With China holding over US$1 trillion in foreign-exchange reserves, this argument seems far-fetched. China's export-engineered, hyper-growth economic model, however, could face shocks from oil prices and a lack of the management capability needed to progress to the next stage - higher-end production.

If such factors drive up costs, the mainland may become less attractive as a manufacturing base for multinationals. The Nike sportswear firm recently announced it was shifting a quarter of its production from China to Indonesia.

If that becomes a trend, it would draw into question the sustainability of an equation in which America's deficit is being financed by China's purchase of US Treasury bonds - to lock foreign-exchange reserves into a secure holding. Meanwhile, those same reserves are boosted through the sale of cheap products to Americans on the back of loans from China's insolvent banks. This dangerous situation is one of the greatest pyramid schemes in the history of financial architecture.

Mr Paulson has said clearly that even a 20 per cent yuan appreciation will do nothing to save American jobs. The future of American jobs will depend on economic adjustments and industrial restructuring. More importantly, it will require federal spending on educational and vocational programmes in urban backwaters, rather than sending undereducated Americans to war as a means of removing them from future welfare rolls.

So this round of yuan-appreciation talks amounts to a smokescreen. Mr Paulson is too smart for this: he knows all too well that China has its own specific agenda for yuan reform.

What, then, does Mr Paulson want? As a former investment banker, he would see the opening of the mainland's financial services sector as the main prize. So we can expect pressure to shift to that issue, with yuan appreciation leading the news as a chip to be traded away.

Opening the financial services sector is the last frontier of mainland business, as other sectors have already been opened, carved up and occupied by multinationals. It offers a lucrative opportunity for leading American financial institutions and services.

Mr Paulson is leveraging American interests vis-a-vis China by exposing the emerging economic superpower's rawest Achilles heel. Despite the mainland's immense foreign-exchange reserves, its banks are insolvent and its capital market is in tatters.

Mr Paulson also knows that, while China cannot be pressured, a deal can always be cut. This requires trading, not engagement. So, without a stick, what's the carrot that the US can dangle? It lies in dropping the restrictions on US technology sales to the mainland: China needs to upgrade production, and America holds the key.

So Mr Paulson's multi-faceted economic strategic dialogue may not be about who can pressure, but rather who can bargain, the hardest.

Laurence Brahm is a political economist, author, filmmaker and founder of Shambhala Foundation