Geithner on Yuan: More Analysis

drezner.foreignpolicy.com

Bond markets react wildly to blinding glimpse of the obvious
Thu, 01/22/2009 - 4:35pm

Felix Salmon reviews Tim Geithner's written testimony and concludes that, "Geithner's answers are highly diplomatic and content-free,"

The bond market, however, appears to disagree:
Mr. Geithner’s strong words on China have resulted in a sharp selloff in Treasurys. In testimony to Congress, Geithner wrote, in response to a question from Sen. Olympia Snowe, (R-Maine), that President Obama’s administration “backed by the conclusions of a broad range of economists - believes that China is manipulating its currency.”

“He came right out and said Obama believes China is manipulating their currency,” says Maryann Hurley, bond market strategist at D.A. Davidson, who notes that China’s economy is slowing as well. “It’s very easy to pick another country to be your whipping boy. In an era where we’re looking at deficits as far as the eye can see all we don’t need is somebody starting to dump our debt.”

As the FT's Krishna Guha and Alan Beattie write, "experts said the declaration could fuel trade tensions at a time of global recession and fast-rising unemployment."

I'm as concerned about this as the next guy, but let's be careful here and parse things out.
The bond market is conflating two issues here. The first is that Geithner said out loud what everyone knows to be true. And, to be sure, before the U.S. responds to currency manipulation, it has to say that it's happening. So Geithner's statement is a quasi-first step.

The second issue, however, is what kind of action Obama and Geithner are planning. Beattie and Guha suggest options like, "punitive import tariffs on Chinese goods."

This is where a closer look at Geithner's written testimony would be a good idea. Here are the two relevant passsages:

[W]e look forward to a productive economic dialogue with the Chinese government on a number of short- and long-tem issues. The Yuan is certainly an important piece of that discussion, but given the crisis the immediate focus needs to be on the broader issue of stabilizing domestic demand in China and the US. The latest figures show that China's growth in 2008 was 9%, a full 4 percentage points lower than in the previous year. Because China accounts for such a large fraction of the world economy, a further slowdown in China would lead to a substantial fall in world growth (and demand for US exports) and delay recovery from the crisis. Therefore, the immediate goal should be for us to convince China to adopt a more aggressive stimulus package as we do our part to try to pass a stimulus package here at home....

[T]he best approach to ensure that countries do not engage in manipulating their currencies is to demonstrate that the disadvantages of doing so outweigh the benefits. If confirmed, I look forward to a constructive dialogue with our trading partners around the world in which Treasury makes the fact-based case that market exchange rates are a central ingredient to healthy and sustained growth.

Two signals here. First, Geithner seems more concerned about China expanding its domestidc growth than with any manipulation of the yuan right now -- a conviction shared by Brad Setser, incidentally.

Second, it seems pretty clear that Geithner's first option on the currency issue is jaw-jaw rather than protect-protect. In other words, the bond market should have reacted more like Felix Salmon.

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Obama's Geithner: China manipulates Yuan

from http://www.bloomberg.com/
Obama Deems China ‘Manipulating’ Yuan, Geithner Says (Update2)
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By Rebecca Christie

Jan. 22 (Bloomberg) -- Timothy Geithner, PresidentBarack Obama’s nominee for Treasury secretary, said the new U.S. administration believes China is “manipulating” its currency.

Geithner also said, in written responses to questions from Senate Finance Committee members, that there are “no current plans” to request more financial bailout funds. He played down any need to nationalize U.S. banks, without specifically ruling out the option.

The remarks on China’s exchange rate policy may presage a tougher American line with the nation that is the biggest foreign investor in U.S. government debt. Former Treasury Secretary Henry Paulson preferred diplomacy over confrontation with China to resolve trade disputes and, in semiannual reports, refrained from labeling the country an illegal “manipulator” of its currency.

“President Obama -- backed by the conclusions of a broad range of economists -- believes that China is manipulating its currency,” Geithner said in the remarks, which were posted on the Senate Finance Committee Web site today. “The new economic team will forge an integrated strategy on how best to achieve currency realignment in the current economic environment.”

Characterizing China’s policy as manipulation is “a very substantial change” by the Obama administration, said Nicholas Lardy, an economist who specializes in China at the Peterson Institute for International Economics in Washington.

‘Bent Over Backwards’
“It’s certainly something the Bush administration bent over backwards to avoid,” Lardy said. “It sounds also like he’s giving himself a little bit of wiggle room, saying we’ll take it up when we think it’ll be most effective” and not necessarily as an immediate issue.

Geithner said that in the short term, China should pursue “more aggressive” efforts to boost economic growth, in concert with a similar U.S. economic stimulus package.

The finance panel is expected to vote on Geithner’s nomination today.

The Obama administration is continuing to weigh a proposal to spur home buying by driving down mortgage rates, he said.

“The primary objective of the proposal to provide 4.5 percent mortgages is to assure that affordable mortgages are available to qualified borrowers,” Geithner said. “We share the objective and will continue examining proposals aimed at increasing the flow of credit to qualified borrowers.”

One version of the proposal would use Fannie Mae and Freddie Mac, the federal-chartered mortgage finance companies seized by the government in September, to reduce 30-year fixed home-loan rates to around 4.5 percent, from a current average of about 4.96 percent.

To contact the reporter on this story: Rebecca Christie in Washington atRchristie4@bloomberg.net;Last Updated: January 22, 2009 11:05 EST