China Courts Currency Backlash

"You can lead a horse to water but you can't make it drink". This old English proverb sums up the current situation with the US economy. The government is intending to throw in yet more budgetary stimulus but it seems a better than even chance that neither consumers nor corporates will respond. One consequence: a continuing high – and maybe further increase – level of unemployment as the US moves towards its mid-term elections in November 2010.

In turn that suggests that the scope for some very direct measures against China is in the offing if Beijing persists with a mercantilist trade policy rooted in a cheap, dollar-linked currency. The US administration will need some scapegoats and China's intransigence makes it an obvious target.

The weakness of the US economy is based on the simple fact that no amount of monetary and fiscal stimulus can avoid forever the repair of household balance sheets after a decade of over-spending. Easy money amounts to delaying and easing the process of adjustment – but also making it much longer. Obama would have been wiser to have accepted 18 months of truly dire conditions, which could have been mostly blamed on Bush and bankers, than attempt a too-early recovery. But Obama is not only inexperienced but overly influenced by the likes of US Treasury Secretary Timothy Geithner and Lawrence Summers, the director of the president's Council of Economic Advisors, whose focus has been on rescuing the financial sector rather than re-balancing the broader economy.

Consumer reluctance to spend is absolutely necessary to restore equilibrium but inevitably worsens unemployment. Higher savings outruns official stimulus – particularly when a large chunk of the budget gets spent in Iraq and Afghanistan. Eventually, US manufacturing will revive, helped by a shift in exchange rates. Eventually, fiscal stimulus will focus on useful projects, like rebuilding infrastructure. But these things do not happen overnight in a service-oriented economy with government budgets boxed in by entitlements.

The problem for Asia in all this is that it looks increasingly unlikely that, with the possible exception of China, domestic stimulus will be sufficient to offset continuing weak US demand. Yes, government outlays have increased but private investment and consumption have showed very limited response. Exports have held up better than many had feared but in large part due to currencies, like the Korean won, which have been weak compared with the euro and the yen. Meanwhile many are suffering from increased competition from China's weak yuan policy. Commodity producers have also been helped by price rises which seem more a result of easy money and re-stocking than of end-user physical demand.