G2 is a powerful but insufficient solution

PUBLISHED : Wednesday, 03 June, 2009, 12:00am
UPDATED : Wednesday, 03 June, 2009, 12:00am

Some Chinese see United States Treasury Secretary Timothy Geithner as a repentant debtor humbly visiting his bank manager; influential Americans see the visit as the start of a beautiful friendship, perhaps even a tipping point in global finance - the overture to the establishment of a Group of Two economic giants that will make a better job directing the global economy than the current G7 or the ambitiously unwieldy G20.

There is a compelling logic in the idea of economic partnership between the US and China, now the third-biggest economy. The fact that China, in defiance of hitherto-accepted norms of international economics of a developing country, is the biggest creditor to the US adds certain piquancy.

Coincidentally, Brad Setser of the Council on Foreign Relations calculates that China's foreign assets may be almost US$2.5 trillion or US$500 billion more than usual estimates. Besides formal reserves of US$1.946 trillion, there is US$252 billion in portfolio debt, held mainly by the state banks, plus another US$186 billion 'in a mysterious line item that corresponds with the banks' dollar reserve requirements and the [People's Bank of China's] other foreign assets'. China Investment Corp also holds up to US$100 billion.

Within the portfolio, China has increased its holdings of US treasuries, the safest and most liquid of US securities which allow China to switch easily to other assets when the moment is ripe. Indeed, China is pursuing a twin-track policy of buying treasuries for flexibility and commodities for security.

China seems to have woken up to the thought, variously attributed to John Maynard Keynes and John Paul Getty, that if you owe your bank $100, that's a problem for you, but if you owe your bank $1 million, that's a problem for the bank.

A slightly confused article on Sunday by Xinhua - because in the English version it switched without distinction between 'bonds' and 'equities' - cited a poll of '23 famous Chinese economists', of whom 17 said the country's US holdings 'pose great risks to China's economy'. But the critics did not advocate selling out.

Mr Geithner's flacks have worked hard to present him as a Putongua-speaking friend of China, not the man who asserted in writing during his Senate confirmation hearings that US President Barack Obama 'believes that China is manipulating its currency'. Unnamed officials claim the sentence was 'a mistake', a phrase inserted by a 'junior' official.

The problem for Mr Geithner and for China is that the issues remain the same. If you remove the gloss: China cannot sell its US treasuries without taking huge losses and leading to an appreciation in the yuan; with its massive US$1.85 trillion budget deficit this year, the US needs to continue to offload treasuries on the world.

China continues to count the cost. Bond vigilantes have helped send US government securities down 4.3 per cent this year, while Mr Geithner's 'strong dollar' fell 4.9 per cent in May, and even the sickly pound rose nearly 10 per cent.

Their mutual interests lead some prominent figures to argue that formation of G2 will create a better world. The original idea had political roots when Zbigniew Brzezinski, national security adviser under US president Jimmy Carter, suggested it.

But an economic and financial G2 gained traction when a prominent American and a Chinese joined forces. Robert Zoellick and Justin Lin Yifu, the president and the chief economist of the World Bank respectively, argued in the Washington Post that: 'For the world's economy to recover, these two economic powerhouses must co-operate and become the engine for the G20. Without a strong G2, the G20 will disappoint.'

In obvious ways the US and China are mirror images of each other: the US is China's biggest export market, and China buys most US government debt; unless both sides address the imbalances together, the risk is of repeating the mistakes that created the crisis.

But it would be dangerous to suggest that G2 holds all the answers to the world's woes.

It is unthinkable to imagine solutions to the global problems from recession to creating a greener, cleaner world without involving Europe, Japan, India, Latin America, the major oil producers and sub-Saharan Africa. That said, it is depressing that none of the above players has made a contribution to a global vision.

There is also a political minefield to navigate. Beijing-controlled Outlook magazine suggested that a G2 'would do more harm than good', not least because, it claimed, that America would never cede control of the world order and China, heeding chairman Mao Zedong's dictum, would never seek to exert hegemony. Quite.

Economic symbiosis

China, the third-largest economy, is the biggest creditor to the US

According to one calculation, China's foreign assets may be almost, in US$: $2.5tr