Just a couple of months ago, China and America were on the brink of economic war, or so it seemed.  With the US mid-term elections are now behind us, and President Hu having made a successful trip to the US, the American government seems to have withdrawn the artillery for the moment. 

The first sign of an armistice was President Obama’s State of the Union Address.

Rather than focusing on exchange rates and global imbalances, Obama recognized that nations like China and India are competing by educating their children earlier and longer, with greater emphasis on math and science.  They’re also investing in research and new technologies.  And just recently, China became the home to the world’s largest private solar research facility, and the world’s fastest computer.

How should America respond to the rise of China and other emerging economies?  “We need to out-innovate, out-educate, and out-build the rest of the world”, according to President Obama.

Thank you President Obama, this is a very constructive message.

For Obama, this is our generation’s Sputnik moment.  Half a century ago, the Soviets beat America into space with the launch of a satellite called Sputnik.  This was a giant shock for America.  But after investing in better research and education, America didn’t just surpass the Soviets.  It unleashed a wave of innovation that created new industries and millions of new jobs.  This is what must be done again, and Obama’s administration will be promoting more research and development to this end.  America must do what it has always done, reinvent itself.

But Obama insists that if we are to produce jobs in America, we also have to win the race to educate our kids.  And America is not doing that now.  A quarter of American students aren’t even finishing high school.  The quality of our math and science education lags behind many other nations.

We all have a role to help America lift its game.  Families, communities and the classroom.  Obama has also launched a competition called Race to the Top.  To all 50 states, he said, “If you show us the most innovative plans to improve teacher quality and student achievement, we’ll show you the money.”

And thirdly Obama recognizes that we must rebuild America’s crumbling infrastructure to win the future.  Korean homes now have greater Internet access.  Europe and Russia invest more in their roads and railways.  And China is building faster trains and newer airports.

In conclusion Obama reminds us that getting things done in our democracy can be contentious and frustrating and messy because we argue about everything.  The costs.  The details.  The letter of every law. 

As he says, “Of course, some countries don’t have this problem.  If the central government wants a railroad, they build a railroad, no matter how many homes get bulldozed.  If they don’t want a bad story in the newspaper, it doesn’t get written.  And yet, as our democracy can sometimes be, I know there isn’t a person here who would trade places with any other nation on Earth.”

The second sign of an armistice was the US Treasury’s recent report which concluded that China has not manipulated its currency for the purposes of preventing effective balance of payments adjustment or gaining unfair competitive advantage in international trade.  The reasons given are the resumption of China’s exchange rate flexibility last June and the acceleration of the pace of real bilateral appreciation over the past few months (that is, China’s high domestic inflation is also having a big effect on China’s competitiveness). 

The other reasons are the commitments made during President Hu’s state visit to the US – “China will intensify efforts to expand domestic demand, to promote private investment in the service sector, and to give greater play to the fundamental role of the market in resource allocation.  China will continue to promote RMB exchange rate reform and enhance RMB exchange rate flexibility, and promote the transformation of its economic development model.”

The US Treasury is obviously not fully convinced.  “Treasury’s view, however, is that progress thus far is insufficient and that more rapid progress is needed. Treasury will continue to closely monitor the pace of appreciation of the RMB by China.”  Even Americans must save face!

So for the moment, the heat is off the exchange rate side of the US/China relationship. 

These two countries live in a state of co-dependency.  They both need each other in so many ways.  But they disagree on so many things.  There will always be ups and downs.  When things go down too far, they will self correct, because neither side has an interest in their differences becoming too big.  America needs its banker.  China needs the US market.  And nothing can make Chinese leaders feel more important than being treated like an equal by American leaders.

References:

President Obama’s State of Union Address, January 25, 2011

http://www.whitehouse.gov/the-press-office/2011/01/25/remarks-president-state-union-address  

Report to Congress on International Economic and Exchange Rate Policies.  US Department of the Treasury, Office of International Affairs.  February 2011

http://www.treasury.gov/resource-center/international/exchange-rate-policies/Documents/Foreign%20Exchange%20Report%20February%204%202011.pdf  

U.S. - China Joint Statement, January 19, 2011

http://www.whitehouse.gov/the-press-office/2011/01/19/us-china-joint-statement