Saturday, January 24, 2009

Redux: Why Geithner's Words Don't Matter (Yet)

After much more weeping and gnashing of teeth in yesterday's press -- including an official reaction from China -- I think it's important to reiterate why Geithner's comments on the renminbi should be taken with a grain of salt.

First, a bit of (recent) history. Many economic observers seem to have forgotten the early days of the Clinton administration, perhaps because such history does not show up in their quantitative models. However, I am betting that the one person who really matters, Barack Obama, has already taken to heart some hard-learned lessons from the Clinton days.

Early in his administration, Bill Clinton attempted to link trade relations with improvements in China's human rights. China was given a deadline by which it would have to demonstrate tangible improvements or risk having its vital trade with the United States halted. To make a long story short, when push came to shove, Clinton ultimately had to back down from his threat. Beyond releasing a handful of dissidents from prison, the Chinese made no efforts to accommodate America on human rights.

President Clinton finally learned something that the Chinese already knew: our two economies were already becoming so intertwined, so interdependent, that neither side could afford the inevitable recession that would result in an interruption of that relationship. (Lampton's Same Bed Different Dreams and Mann's About Face both contain excellent in-depth descriptions of this episode.)

Fast-forward to the present. This week's Economist contains a terrific briefing entitled "Global Economic Imbalances" that sets out to explain the deeper underlying causes of the current financial crisis. It details just how much further intertwined national economies have become. These nice pictures help to illustrate the issue very well.






Michael Pettis, a finance professor at Beijing University, also explains the issue very clearly in terms of just the United States and China in this article at YaleGlobal Online.

So what does this have to do with Geithner's testimony? A lot.

In addition to my previous assertion that we should not place too much stock in the words of people who desperately wants jobs they do not yet have, I am counting on a few other realities to help tame the potential for upsetting the Sino-US relationship.

Barack Obama, regardless of what individuals may think of him as a potential leader, is one incredibly intelligent person. Without a doubt, the smart economists who are advising President Obama have made certain that he is aware of the interconnectedness of the Chinese and American economies. Furthermore, we can be certain that he is also well aware of the loss of credibility that resulted from Clinton's withdrawn threat.

Regardless of what may be said in confirmation hearings, and regardless of the inevitable angry words toward China that will emanate from the Pelosi-led Congress, Barack Obama and Tim Geithner will not countenance major economic sanctions toward China during a time when our cooperation is of utmost importance. To do so would lead to a trade war that would bring about an even longer and deeper world recession.

Of course, all of this assumes that President Obama wants to be reelected in 2012.

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