Geithner’s Folly

If he can make it through the Senate, Timothy Geithner will be our nation’s next Treasury Secretary. If you’ve forgotten exactly what a Treasury Secretary does, it’s recently become a ridiculously powerful position. Essentially, he will become the “Economy Czar.”

Unfortunately, during his Senate confirmation hearing, Geithner made a monumental error in judgment. He accused the Chinese of manipulating their currency to gain a favorable trade advantage against the United States. Worse still, his statement implied that he was speaking on behalf of President Obama.

Now, while being a completely accurate statement, it also shows that someone needs to give Geithner a quick lesson in International Diplomacy 101. Although the Bush Administration occasionally complained about Chinese “currency policies”, they never accused the Chinese of manipulation – even they weren’t that stupid.

More distressingly, it shows that Geithner – the man who will soon be imbued with almost god-like powers over the American economy – doesn’t even understand how the economy works.

So how does the world work? For the Chinese economy to grow (and the Chinese government desperately wants it to) they need to export goods to the West – especially to the United States. In order to export more goods, they need us to be able to afford them. This is accomplished by keeping pressure on their currency so that it doesn’t take as many dollars to buy Chinese imports. Simultaneously, the United States claims on its surface to be pursuing “strong dollar policies” while it systematically undercuts its value. The only way we can ever hope to get out of debt, is by continually eroding the value of the debt that we owe.

This is where the symbiotic relationship developed. China needed to make a lot of junk – almost anything – to employ its huge population and it needed to sell it to people who wanted to buy vast quantities of low-quality goods. American consumers were happy to do so. The United States needed to devalue its currency and was addicted to low interest rates anyway – but at the same time needed to prevent inflation in consumer goods. Almost an impossible task, but with American stores flooded with cheap Chinese goods, the “Goldilocks Economy” seemed to be working just fine.

The second prong of the relationship was money. The US has absolutely no money and can’t raise taxes significantly higher (and generate more income). It must borrow money to continue its spending spree (if we can’t borrow it, we need to print it) – and so the unofficial pact was born. We borrow money from them to buy their junk. The cheap junk keeps prices down in the US, and hundreds of millions of Chinese come into modern civilization. Meanwhile, the Chinese take the money they made from selling us junk (and the interest we pay them on the money they loaned us), and they turn around and buy US Treasuries (i.e., lend us more money to keep the cycle going). In this way, we can keep interest rates and “consumer prices” (but not technically inflation) low.

Here are the results laid out for the visual among us:

The Chinese government understands the United States’s debt burden is now so large that it must devalue the dollar, and the United States’s government (apparently not Geithner?) understands that the Chinese cannot allow their currency to appreciate against the dollar too quickly or it will destroy the delicate balance currently in play. The Chinese need to diversify – ever so slowly – out of their massive bond position since they know dollar devaulation is coming. The only thing they need is time - and we should graciously give it to them.

If the Chinese even suddenly stopped buying US treasuries (let alone sold their holdings), the cycle could end in castrophe for both countries. Recently, to the chagrin of the Federal Reserve, the Chinese seem to be rolling over their interest into short term notes instead of long term bonds so that their large holdings become more liquid and their currency risk is diminished.

The point is, we’re in far too deep to start accusing the Chinese of currency manipulation. If they are helping keep the dollar from complete collapse so that we can continue to afford their sub-par consumer goods, well.. so be it! There’s no use whining about it now.

So far, the Chinese response to Geithner hasn’t yet been outrage. A presumably straight-faced Chinese official claimed, “we never have used currency manipulation or exchange-rate manipulation as a [means] to gain an advantage in international trade.” Let’s hope Geithner is either gullible enough to believe that, or quickly learns the niceties of economic diplomacy.