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China's Difficult Choices

Interviewee: Brad W. Setser, Fellow for Geoeconomics, Council on Foreign Relations
Interviewer: Lee Hudson Teslik, Associate Editor, CFR.org
June 2, 2009

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Speaking June 1 at Peking University, U.S. Treasury Secretary Timothy Geithner called on China to make its currency more flexible and offered assurances that Washington would focus on lessening its ballooning deficit to protect massive Chinese investments in U.S. government debt.

In this podcast, CFR's Brad Setser, a former Treasury official and expert on currency flows, discusses Geithner's priorities for U.S. economic relations with China. Setser says one of Geithner's major goals was to assure China that the U.S. fiscal deficit would decline over time. He also reflects on the need for rebalancing global financial imbalances--in which China has exported capital to the United States, which has in turn spent freely and embraced easy credit.

Setser says Beijing is caught between "two very different imperatives." He says one imperative is to maintain a stable exchange rate relative to the dollar, which has meant that China has followed the dollar both up and down over the past few years. At the same time, he notes China is concerned about the risk associated with holding so many dollars. "China has been buying dollars because it didn't want an undervalued exchange rate to support its exporters and that has a price," he says. "And I think the difficulty for China is...that China never really explained to its own population that buying dollars to keep your exchange rate down meant that you were going to lose money."

With respect to China's concerns about the dollar, Setser says China ought to be less worried about inflation in the United States devaluing the dollar and more concerned about currency losses if the United States becomes a less friendly export market. He notes that rather than being a stable source of growth, "China's reliance on exports became a source of volatility and it contributed to the fluctuations in China's own output growth."

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