US-China currency war eclipses Davos, and threatens the world

Ambrose Evans-Pritchard

Ambrose Evans-Pritchard has covered world politics and economics for 25 years, based in Europe, the US, and Latin America. He joined the Telegraph in 1991, serving as Washington correspondent and later Europe correspondent in Brussels. He is now International Business Editor in London. Read more from Ambrose Evans-Pritchard at Telegraph.co.uk



US-China currency war eclipses Davos, and threatens the world
Posted By: Ambrose Evans-Pritchard at Jan 28, 2009 at 17:46:34 [General]
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Davos, Renminbi, Tim Geithner, US Treasury secretry, Wen Jiabao, yuan

Turning a corner in the labyrinthine corridors of the Davos nerve-centre, I ran smack into Chinese premier Wen Jiabao - followed by a regiment of retainers and senior offices in full regalia.

They have not quite adapted to the "sport" dress code of capitalism in Alpine retreat. Jeroen van der Weer - a Davos stalwart - wears horrendous corduroy trousers (pink sometimes) with a 1950s-era Tyrolean woolly. I dread to think how they react to Swiss prices if they venture into the restaurants.

Mr Jiabao smiled at me benignly, but he is not in a good mood. Indeed, he is fuming over the remarks by US Treasury Secretary Tim Geithner that China was "manipulating" its currency to gain market share. Reports were circulating this afternoon in Davos that Mr Jiabao erupted into a tirade after lunch at the mere mention of Mr Geithner's name.

Mr Geithner - the first US Treasury chief who can actually speak Chinese, and Japanese, nota bene - is clearly operating under instructions from President Barack Obama. If his resolve fails, Hillary Clinton is there at Foggy Bottom (State Department) to renew the broadside against Beijing - at least judging by her Sinophobe reflexes in the campaign.

This has the makings of an almighty superpower bust-up. It is fast becoming the theme of Davos 2009. It may soon be the burning issue of our times. We will all learn how to pronounce Renminbi.

The Bush Administration -- in its day -- deflected all attempts by Congress to crack down on China's currency policy. Perhaps sagely, perhaps not.

There is no question that Beijing has pursued a mercantilist strategy of conquering US and European markets by holding down the yuan/renminbi. It has a monthly trade surplus of $40bn, the highest ever recorded by any country. Or put another way, China is exporting its surplus capacity to the rest of the world. It has become a global deflation machine.

Even so, Mr Geithner is playing with fire. Beijing has amassed reserves of $1.9 trillion. From what we know, most of this money is held in the form of US Treasuries and other bonds. Creditors exercise power. Don't be fooled by claims that China could not deploy this weapon without damaging its own interests. All kinds of things can and do happen when tempers flare, and they were flaring today.

The IMF's chief economist Olivier Blanchard said it was unwise to "obsess" over the exchange rate in this fragile climate. "It is probably not the right time to focus on the Chinese exchange rate, given that it is not a central element of the world crisis. There are many other things we should be thinking about. It is an item on the list, but it is not at the top of the list."

Stephen Roach, head of Morgan Stanley Asia, offered a harsher verdict, calling it pure folly to pick a fight with Beijing. "The Chinese economy most likely contracted in final quarter of 2008 and most likely in this quarter too. China has hit a wall," he said.

"A country that is contracting doesn't take kindly to its major trading partners saying you have to increase the value of its currency. What they are being told to do is tantamount to economic suicide," he said.

Quite. This conflict needs to be handled with extreme care. There is a battle going on within the Chinese Communist leadership over currency policy. A bloc within the central bank has long argued that China itself is the victim of a policy that fuels domestic inflation and leaves the country dangerously dependent on the goodwill of export markets.

Wen Jiabao, speaking as I write, says that China's fiscal stimulus package of $600bn will be worth 16pc of GDP over two years. If so, that is huge. China is now doing its part to shore up the global system, even if he rather annoyingly continues to blame "low-savings" countries for the crisis - skipping over the role of Asia in stoking a credit bubble (Takes two to tango).

Be that as it may, China's fiscal blitz is the beginning of a shift in strategy that should - over time - start to boost domestic demand enough to eat into the trade surplus.

Mr Jiabao said it was "imperative that China and the US step up their co-operation". He pleaded with the West not to retreat into protectionism. Washington - and above all Capitol Hill -- would be well advised to listen.

Vladimir Putin speaks next. The autocrats are lining up.