Geithner wields little leverage in China talks

[May 30, 2009]  WASHINGTON (AP) -- Timothy Geithner's first trip to China as treasury secretary comes at an especially vulnerable time for the Obama administration.

Mired in a brutal recession, the United States needs Beijing to boost its purchases of U.S. goods, let China's currency rise and take other steps to narrow an enormous trade gap. And it needs China's help to combat any military threat from North Korea.

The problem is Washington's leverage has waned just as China's power over the U.S. has grown.

China is now America's biggest creditor. As of March, it held $768 billion of Treasury securities - about 10 percent of publicly traded debt.

The U.S. needs China's money to finance its budget deficits, which are soaring as Washington tries to end the recession and bolster the U.S. banking system. The Obama administration estimates the budget deficit will hit $1.84 trillion this year. That's four times last year's deficit.

Even so, as Geithner heads to China to meet Monday and Tuesday with top Chinese officials including President Hu Jintao, he brings an ambitious U.S. goal: persuading Beijing to adopt policies that would transform its nation of savers into spenders.

The Obama administration, just like the previous two, is convinced the key to a prosperous global economy rests heavily with China. It wants to get Beijing to rely more on domestic spending, and less on its exports, to power its own economy - and the world's.

That switch would uncork enormous buying power and help rebalance world trade. It could hasten an end to the global recession. And it could narrow America's huge trade gap because the Chinese would be buying more American products.

China would benefit, too.

"Beijing really wants Washington to be successful in bringing the U.S. economy out of this recession as fast as it can because it is critical to Beijing's own economic growth," said Kenneth Lieberthal, a China expert at the Brookings Institution.

Yet the Chinese have their own priority issue: the explosion of U.S. borrowing. Like any bank worried about its loans, the Chinese have fretted over America's budget gap. In March, Premier Wen Jiabao said: "We've lent a huge amount of money to the U.S. Of course, we are concerned about the safety of our assets."

Those comments, plus remarks by the head of China's central bank about whether the world needs a new top reserve currency to replace the dollar, jolted financial markets.

The Obama administration insists it isn't worried that the mound of debt it's creating will jeopardize America's sterling AAA bond rating. But Treasury officials said Geithner still intends to reassure the Chinese.

Geithner plans to stress that the administration sees the $1 trillion-plus deficits for this and next year as temporary. The deficits are necessary to fund a stimulus package to help lift America out of recession and invigorate a wobbly U.S. banking system, officials say. Once those needs are met, the administration says it will make deficit reduction a top priority.

"The Obama administration believes strongly in fiscal discipline," said a senior Treasury official. If the Chinese raise the deficit issue, Geithner "will listen to their concerns," said the official, who spoke to reporters under rules that didn't allow him to be identified.

Security tensions in Asia also have flared since North Korea's nuclear weapons tests and missile firings. Because China is viewed as a critical player in any successful resolution of a North Korea standoff, Geithner is expected to address the topic with Chinese leaders.

For all the gravity of the crises he faces, Geithner's trip will allow him some time down memory lane. He is scheduled to give a speech Monday at Peking University, where he studied Mandarin Chinese during two summers when he was in college.

Geithner will also hold an event at a Ford Foundation program in Beijing to support the study of economics in the United States. The program was started by his father when the elder Geithner was based in Asia as an official with the Ford Foundation.

But the fact that the administration's chief economic policymaker is going hat-in-hand to the Chinese to explain the soaring deficits shows how much has changed since his predecessor, Henry Paulson, met with the Chinese as the Bush administration's treasury secretary in 2006.

Back then, Paulson managed to arm-twist China into agreeing to a new round of economic talks. Those talks were aimed at prodding Beijing to move faster to let its currency, the yuan, rise in value against the dollar. Doing so would make U.S. exports cheaper for the Chinese to buy.

But this time, Geithner is expected to adopt a softer tone on the issue, even though some U.S. lawmakers want to impose tough sanctions on countries like China that are deemed to manipulate currencies to gain trade advantages.

American manufacturers see the undervalued yuan as the major culprit in America's trade deficit with the Chinese, which last year hit $266 billion, the highest recorded with one country.

The Chinese agreed in 2005 to begin letting their currency rise against the dollar. And it's risen about 20 percent. But those gains stopped last summer. China had begun to fear that a stronger yuan was reducing its export sales, already hurt by the global downturn.

Though the crisis has given Geithner a weak hand, Treasury officials said he'll push for something of a grand bargain. The United States would work to reduce its budget deficits once the crisis ends and urge U.S. consumers to save more and shrink the trade deficits that are pumping dollars into the hands of Chinese and other exporters.

But to replace diminished U.S. spending, the administration will push for the Chinese to step up their own spending and stop saving so much. The administration says this can be done if Beijing improves pensions and health insurance so Chinese households don't feel pressured to save so much.

Geithner is expected to point out that U.S. consumers are already rebuilding their retirement savings. The Chinese have pledged to redirect their economy to boost domestic growth. But many private economists question how serious China is about it.

Analysts said they expect Geithner and the Chinese to pledge to do all it takes to end the global recession. Both sides know any hint of discord between the world's largest and third-largest economies would likely roil financial markets.

That's one reason analysts aren't expecting the new administration to press hard on the currency issue. As a candidate, President Barack Obama pledged to crack down on countries seen as cheating on global trade rules and hurting U.S. companies and workers.

Last month, though, the administration chose not to cite China as a currency manipulator. That disappointed U.S. manufacturers and labor unions.

But Frank Vargo, vice president for international affairs at the National Association of Manufacturers, said he understood the change in tone.

"They talked a tougher line during the campaign, but the world changed," Vargo said. "It is a much more delicate time now."

If nothing else, the U.S. and China could walk away with a proclamation that they have shown global financial markets that the two powerful economies are pursuing common goals to fight the global downturn.

"We are China's biggest customer, and they are buying our debt; it is definitely a mutual relationship," Vargo said. "I think the new administration wants to stress that it is willing to work in a cooperative manner, but the underlying problems will still be there."

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Associated Press writer Joe McDonald in Beijing contributed to this report.

[Associated Press; By MARTIN CRUTSINGER]

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