The US-China Dialogue of the Deaf

China’s rapid rise, and America’s equally rapid loss of power and influence, has created a dangerous situation. NEW YORK – In 2010, economic conflict between the United States and China became one of the most worrying global developments.

China’s rapid rise, and America’s equally rapid loss of power and influence, has created a dangerous situation.

NEW YORK – In 2010, economic conflict between the United States and China became one of the most worrying global developments. The US pressed China to revalue the renminbi, while China blamed the US Federal Reserve policy of “quantitative easing” for currency-market turmoil. The two sides are talking past each other, though both are making valid points.

The global imbalances that were at the root at the Crash of 2008 have not been corrected – indeed, some have grown larger. The US still consumes more than it produces, running a chronic trade deficit. Consumption remains too high, at nearly 70% of GDP, compared to an unsustainably low 35.6% of GDP in China. Households are over-indebted and must save more.

The US economy needs higher productivity, but US corporations, which are operating very profitably, are accumulating cash instead of investing it – with quantitative easing aimed at heading off deflation.

In China, by contrast, bank lending needs to be reigned in, but regulatory efforts have been hindered by off-balance-sheet financing and the development of an informal quasi-banking sector. The economy is showing signs of over-heating.

These imbalances could be reduced by the US using fiscal rather than monetary stimulus, and China allowing the renminbi to appreciate in an orderly manner. But domestic politics in both countries stand in the way.

In the US, the Republicans, who won the mid-term elections, were determined to extend the Bush tax cuts in their entirety. This leaves little room for fiscal stimulus, while the tax cut is more likely to be saved than invested. That is why the Fed had to resort to quantitative easing, even though it tends to stimulate asset bubbles rather than productive investments.

China interprets quantitative easing as a plot to devalue the dollar and force a revaluation of the renminbi. The US, in turn, cannot understand why China should be so reluctant to allow the renminbi to appreciate, as doing so would help to dampen inflationary pressures.

Maintaining a two-tier currency system and an undervalued currency has been the key to China’s success. It is much more efficient than taxation as a means of skimming a significant share of payments for Chinese exports, which accrue as currency reserves and can be used at the central government’s discretion. This has made the central government very powerful, attracting the best brains into its service.

China would prefer to improve the trade balance through removal of trade barriers rather than exchange-rate adjustment, because it is reluctant to put additional strain on its export industries and eager to gain access to American technology.

The US maintains restrictions on high-tech exports to China because of the latter’s lack of respect for intellectual property rights. The US prefers higher Chinese import prices to help relieve deflationary pressures – which would also eliminate the need for quantitative easing, removing a source of Chinese complaints.

As things stand now, each country is pursuing policies that do not help the other and are suboptimal for their own economies. The entire global economy would benefit if both sides listened to each other and coordinated their economic policies.

But the opposite is happening. The conflict in economic policy is spreading to the geopolitical sphere. First, China asserted a “core interest” in the South China Sea, effectively claiming its 200-mile “special economic zone” throughout the region as territorial waters. US Secretary of State Hillary Clinton countered that America also has “interests” in this area, bringing the two countries to loggerheads over a vast and critically important maritime region in Asia.

Then China became embroiled with Japan in a dispute over the Diaoyu or Senkaku Islands. Few Westerners appreciate how seriously China takes this issue. Geologically, the islands are connected to Taiwan, and Japan gained control over them by taking possession of Taiwan in 1895. This elevates these uninhabited rocks to the same level of importance as Taiwan or Tibet for the official “one China doctrine.” China greatly resented it when the US endorsed the Japanese position.

China’s rapid rise, and America’s equally rapid loss of power and influence, has created a dangerous situation. With the exception of the peaceful transition of world leadership from Britain to the US after World War I, such global power shifts have always involved armed conflict. The deterioration in US-China relations is particularly troubling because it takes place against a background of global imbalances and serious internal political divisions, which drive both countries to take intransigent positions.

The global imbalances could be cured, and conflicts avoided, only by greater international cooperation. But macroeconomic policy is not the only area that would benefit from better understanding between the two countries.

Consider Afghanistan. The country is rich in mineral resources that China needs, but it is the US that spends $10 billion a month occupying a country whose annual GDP is only $15 billion. As things stand, the US is likely to reduce its presence before Afghanistan is pacified and the mineral resources developed.

Since China is the obvious market for these minerals, it would make sense for China to encourage continued American engagement by making a significant contribution to the cost of training the Afghan army.

China was farsighted when it adopted the doctrine of harmonious development, but recently it has veered from it. Apparently, the rate of change has been too rapid for Chinese leaders to adjust to it. The leadership is preoccupied with taking care of the needs of its own people, many of whom still live in poverty. But China has become a great power, with all the obligations for maintaining world order that go with it, whether or not the leadership acknowledges it.

When US President Barack Obama visited China in November 2009, he acknowledged China’s rapid rise and offered a partnership in maintaining and improving the world order. But the Chinese leadership declined the offer, explaining that China is a developing country that can hardly meet its own people’s needs.

That rift is unfortunate, because improvement in Chinese living standards ought to go hand-in-hand with Chinese participation in building a better world order. Only if China pays closer attention to how it is perceived and accepted by the rest of the world can it continue to rise in a peaceful manner.

China’s leadership knows that it must fulfill its own people’s minimum expectations in order to maintain internal peace and stability; now it must learn to make itself acceptable to the rest of the world in order to preserve external peace and stability. That means becoming a more open society and playing a more active role in maintaining a peaceful and stable world order.

China ought to regard this not as a burdensome necessity, but as an inspiration to greatness. The best periods in Chinese history were those in which the country was most open both internally and towards the outside world.

By contrast, when it comes to military might, China will not be a match for the US for some time to come. If current trends continue, China is bound to devote an increasing proportion of its resources to the military at the expense of the general population, whose expectations the leadership will find increasingly difficult to meet.

In that case, today’s prosperity is likely to prove transient. Worried neighbors are likely to seek protection under the wings of the American eagle, reinforcing the US military budget, which is already oversized. Unless a deliberate effort is made by both sides to reach a better understanding, the world faces a turbulent time in 2011 and beyond.

George Soros is Chairman of Soros Fund Management.

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