By George Wehrfritz
Newsweek International
Sept. 4, 2006 issue - Sometime over the next few weeks, a shipment of lawn furniture, brake pads, lamps or the like is going to make history. The manufacturer, one among tens of thousands churning out product 24/7 in China's humming coast-al cities, will fill an order bound for the United States, take payment in American dollars and add a 12th zero to Beijing's foreign reserve—pushing the tally over the $1 trillion mark. Neither buyer nor seller will realize the transaction's significance, and barring an unforeseen shock to the global trading system, China's reserve will continue to rise by roughly $17 billion a month.
Beijing's growing dollar hoard represents the most dangerous imbalance in today's global economy. The United States is both importing heavily from China and borrowing heavily from the country to finance those purchases, pushing the dollar down and putting the two economic superpowers on a collision course. Washington politicians demand that Beijing raise the value of the yuan against the dollar, and Chinese officials have hinted that if pushed too hard they might shift their near-trillion-dollar reserve out of U.S. Treasury bonds, which could trigger a U.S. and global recession. The main thing preventing this confrontation is the fact that both sides have too much to lose. Former U.S. Treasury secretary Lawrence Summers once called this "the balance of financial terror." What has gone widely unremarked is that, increasingly, this balance is threatening China as much as the United States.
The United States has been worrying for the past 25 years about a mounting trade deficit and the threat it poses to America's financial pre-eminence. But China now views its surplus with growing alarm, too. Its dollar mountain reflects huge demand for Chinese goods and the Chinese currency needed to buy those goods. In mid-2005, Chinese officials, under intense pressure, did allow the renminbi to rise slightly, by just over 2 percent, but they fear—with some reason—that to go further could undermine their export competitiveness and lead to bankruptcies. Speculators, however, are betting that China will have no choice. The global market assumption that the renminbi is destined to rise is now "the key problem" for China's economy, warned the head of the National Bureau of Statistics, Qiu Xiaohua, last week. "It is fair to say that China is actually fighting a game against worldwide speculative capital ... If not handled properly, this will damage the national interest and endanger economic security."
In an economy that, for all its might, is still in the developing stage, it is no small trick to absorb $17 billion a month without destabilizing consequences. The cash is leaching into the economy, fueling growth of 11.3 percent in the second quarter, the fastest rate since 1994, threatening a meltdown. And every solution begets new problems: China has tried command economics, like simply ordering banks to grant fewer loans or publicly denouncing provincial officials who spend too recklessly, but that undermines its efforts to reform the banking sector using the market. It has tried raising interest rates, which can restrain growth but also attracts more dollars—from investors seeking returns, not import buyers—and weakens domestic demand. "They're in a trap," says Ronald McKinnon, a Stanford University economist, in reference to China's surging exports and undervalued currency. "And there isn't an easy way out."