Obama plays China card, but who holds the ace?

WASHINGTON/BEIJING Wed Nov 4, 2009 7:49am EST

1 of 5. A worker washes ink from a screen print bearing an image of President Barack Obama's face over that of China's late Chairman Mao Zedong at a shirt printing factory located on the outskirts of Beijing October 30, 2009.

Credit: Reuters/David Gray/Files

WASHINGTON/BEIJING (Reuters) - Although U.S. President Barack Obama has never set foot there, China cast a long shadow in the Pacific region where he grew up.

Obama, who will visit Shanghai and Beijing for the first time on November 15-18, spent much of his childhood in Hawaii, five time zones away from Washington, D.C.; and beginning in 1967, when he was six years old, he lived in Jakarta for four years.

At the time, China was in the throes of Chairman Mao Zedong's bloody Cultural Revolution. Abroad, the nation was less interested in selling widgets than in promoting Mao's brand of radical communism -- a force the U.S. saw behind communist movements and political upheaval in Vietnam, Indonesia and elsewhere in Southeast Asia.

In 1979, Obama's senior year at Punahou school in Honolulu, China and the United States normalized diplomatic relations, launching a three-decade period in which ties between the two grew inexorably tighter and deeper -- and complicated.

"Think of what China was in 1979: It was an autarkic, insular, inward-looking country that was preoccupied with its own internal things," said a senior U.S. official. "Even 10 years ago ... there was still a sort of sense of 'We're not a part of these global rules, we're not doing this stuff.' Now they see themselves as sitting at the table."

If there were any doubts that China would have a seat at the table from now on, Obama dispelled those when he sent Secretary of State Hillary Clinton there on her first official trip abroad -- not Pakistan, Afghanistan or any other foreign policy hot spot.

"That the first major visit (was) to China, and to Asia as well, is symbolic of where the locus of international economic activity -- and to some degree the locus of international activity, period -- is going to be in the coming years," said economist and author Zachary Karabell, whose new book "Superfusion" posits that the U.S. and Chinese economies have effectively merged.

Beijing, once considered a wallflower on global affairs, is in turn warming to its more prominent role, though it's unclear that will translate into greater cooperation with Washington on issues like climate change and the nuclear disputes with Iran and North Korea -- not to mention human rights differences.

U.S. Deputy Secretary of State James Steinberg highlighted the tension at the heart of the relationship in a speech in September. "Given China's growing capabilities and influence, we have an especially compelling need to work with China to meet global challenges," he said.

But Steinberg added that there was a tacit bargain in which the United States expects China to reassure the rest of the world that its growing role "will not come at the expense of security and wellbeing of others."

That of course includes America's.

"The big challenge there is going to be to maintain a competitive U.S. economy, and at the same time to maintain a high degree of stability and equanimity in the U.S.-China relationship," said Clyde Prestowitz, president of the Economic Strategy Institute think tank.

Indeed, even as the United States and China have grown closer diplomatically, their economic and trade ties have deepened to the point of mutual dependence. Not only does China depend on the U.S. export market to fuel its highflying economic growth rates, the United States relies on China's vast savings to help finance its burgeoning budget deficits.

"It is clearly unsustainable. This relationship helped give rise to global economic imbalances," said Ben Simpfendorfer, an economist with Royal Bank of Scotland in Hong Kong. "If we are ever going to free ourselves of these imbalances, we need to reverse this relationship, get China to buy things in the U.S. and the U.S. to invest in China."

"STAKEHOLDER" STRATEGY

When it comes to the big foreign policy issues of the day, the Obama White House and that of his predecessor George W. Bush tend to live in opposite worlds. The rare exception is China.

Obama's approach builds on aspects of the Bush administration's stance toward China, which encouraged Beijing to be a responsible "stakeholder" in the global community.

But all indications are that the Obama White House intends to move the bilateral relationship to the next level, making it more of a partnership -- and that in turn is raising hackles among some traditional U.S. allies, who often don't see eye to eye with China and now worry they will be marginalized.

One of the clearest signals of the Obama administration's desire to give China and other large, fast-growing economies more global clout was the decision -- adopted at the Pittsburgh Group of 20 summit in September -- to make the G20 the premier forum for discussing global economic issues.

The shift reduces the role of the G7 and G8, groups dominated by rich Western countries that have long enjoyed elite status in global economic decision-making. And that has led to some European anxiety that the G20 could give way to a G2 of the United States and China.

In Pittsburgh, European officials privately vented frustration at a U.S. willingness to bend over backwards to give China a voice. During one session on International Monetary Fund voting power, a European official became so angry at China's position he had to leave the room to cool down.

At a luncheon, some Europeans were less astonished by China's refusal to include climate change in the communique than by the United States' willingness to go along. Several delegates could barely eat their lunch, according to a former U.S. official who was told of how the discussion played out.

But the Obama administration wants to reassure Beijing that the United States, for one, welcomes China's new assertiveness on the world stage, even if the two countries don't always agree.

Climate change is expected to be a major topic of Obama's meetings with President Hu Jintao when he visits Beijing. Ahead of the December 7 global climate talks in Copenhagen, the administration sees this issue as a key test of whether China will step up to the plate as a truly global player.

"What we're seeing here is for the first time really in the history of U.S.-China relations, truly global issues are moving to the center of the U.S.-China relationship," said Kenneth Lieberthal, who was a top Asia adviser to former President Bill Clinton.

IS CHINA A RIVAL OR AN ALLY?

For all the talk of a growing U.S.-China partnership, in many ways the two remain rivals. Both U.S. conservatives and the Pentagon express concern about a decade of double-digit annual growth in the budget of China's secretive military.

"We don't deny the legitimacy, that they're entitled to modernize their military," said the U.S. official. "But given the size of China and its position, its neighbors, we are entitled to ask, 'Why are you doing the things that you're doing?'"

The top concern on both the left and the right in the United States, however, is Beijing's growing economic clout.

Highlighting U.S. ambivalence about China, a Thomson Reuters/Ipsos poll showed that while Americans view China as important, many are wary.

Thirty-four percent of Americans chose China as the "most important bilateral relationship" in a poll of 1,077 adults across the United States. Next were Britain, selected by 23 percent, and Canada, the choice of 18 percent.

When asked to characterize China, 56 percent saw it as an adversary while only 33 viewed it as an ally.

In some sectors, trade issues are going to "pit the U.S. against China" and Obama will need to assert U.S. interests without inviting a "nasty confrontation with China," said Prestowitz of the Economic Strategy Institute.

The Obama administration says it will not shrink from standing up for U.S. economic interests. For proof, it says, look no further than its decision in September to slap a 35 percent duty on Chinese-made tires.

Since Obama took office in January, the administration has twice declined to label China a "currency manipulator" -- a designation that could trigger negotiations leading to possible trade sanctions. But Treasury has made clear it thinks China's currency, the renminbi, is undervalued and the topic is expected to come up when Obama meets Hu.

U.S. manufacturers say Beijing's policy of managing its currency puts them at a big disadvantage because the cheaper renminbi lowers the price of Chinese goods abroad. Last year, imports from China totaled more than $330 billion, making it by far the biggest contributor to the U.S. current account deficit.

But in a sense, no one buys American like Beijing -- at least when it comes to investing in debt securities. Having amassed some $800 billion of U.S. Treasuries, China is the largest holder of the U.S. government debt, giving Beijing new leverage over Washington but also making their economies more closely intertwined than ever.

"SHOT ACROSS THE BOW"

In what some U.S. analysts saw as a "shot across the bow" of the United States this year, Chinese central bank governor Zhou Xiaochuan called for the creation of a super-sovereign reserve currency, all but saying the U.S. dollar's days as the world's preeminent currency were numbered.

He made the suggestion in an essay published a week before the London Group of 20 summit. Clearly aiming at an international audience, the central bank took the unusual step of publishing the paper in English at the same time as it issued the Chinese version.

"The central bank's discussion really did reflect China's anxieties about its massive forex reserves, the depreciating dollar and U.S. monetary issuance," said Dong Xian'an, chief economist at Industrial Securities in Shanghai.

China fears U.S. authorities will be tempted to "monetize the debt" by allowing inflation to rise, eroding the value of U.S.-dollar denominated assets held by the Chinese.

Premier Wen Jiabao put it bluntly when he spoke in March at the most important Chinese press conference of the year: "We have lent a massive amount of capital to the United States and of course we are concerned about security of our assets. To speak truthfully, I do indeed have some worries."

He urged America to maintain its "creditworthiness" and safeguard Chinese assets, a lecture that did not go unnoticed.

CURRENCY TALK HITS A NERVE

Chinese officials have taken umbrage at some suggestions that China's high savings rate contributed to the global imbalances. Some private-sector U.S. analysts say massive capital inflows from China helped fuel the housing bubble that set the stage for the financial crisis.

Zhou said in September that the paper about the dollar had been partly a way of rebuffing such criticisms.

But the central banker's proposal hit a nerve. Persistent complaints from Washington about the Chinese currency have long been a source of friction.

Moreover, the dollar has been sliding lately and public comments about the possibility of it losing its stature could reinforce its weakness, posing dangers for both China and the United States.

So the two countries have since found a way of discussing currencies that causes less of a stir in their capitals and in foreign exchange markets -- and the new name of the game is "rebalancing."

Although it was hesitant at first, Beijing got on board in Pittsburgh with a U.S. call for an economic rebalancing. The idea is for export-driven economies like China to boost domestic demand while big spenders like the United States strive to increase savings.

It is in this context that currencies could come up in the Hu-Obama meeting, said a senior U.S. official who spoke to Reuters on condition of anonymity.

"It will be clear that part of rebalancing is having a more balanced economic growth that depends more on domestic demand and that obviously implicates macroeconomic policy in all its dimensions," the official said.

This official rejected the widely held view that China's vast holdings of U.S. Treasuries are a matter of concern.

"They have an enormous stake in our economic success and we have an enormous stake in their economic success," this official said. "That's not a problem; it's a good thing. It's an enormously good thing and it should be welcomed."

Prestowitz said China's leverage is limited by an awareness that it too, would, suffer drastic consequence if it decided to suddenly unload its holdings of U.S. Treasuries.

"It would be a mutually-assured destruction situation," Prestowitz said in a view shared by many Chinese analysts.

"Under extreme circumstances, it might be possible for Chinese leaders to threaten to sell Treasuries," said Xie Tao, an expert on U.S.-China relations at the Beijing Foreign Studies University.

"But at the moment, I really cannot believe that they would do this," Xie said.

Rebalancing and currency rows are new items on a list of U.S.-China faultlines that has long been topped by Taiwan and human rights.

TENSIONS COOLING WITH TAIWAN

Taiwan is still the one issue that could trigger war between China, which claims sovereignty over the self-ruled island, and the United States, which is committed by U.S. law to provide weapons for Taiwan's defense.

But Obama's tenure has coincided with a cooling of tensions between Beijing and Taipei thanks to the 2008 election of Taiwan President Ma Ying-jeou, who has sought better ties with China. But potential friction over U.S. arms sales remains.

The Obama administration has angered some for appearing to play down human rights in the interest of gaining Chinese cooperation in combating the financial crisis.

Obama broke with presidential tradition and did not meet the Dalai Lama when the exiled Tibetan spiritual leader visited Washington last month. But U.S. officials reject the idea that Obama snubbed the Dalai Lama and tell critics to judge the policies by their results.

Other foreign policy disputes stem from China's scorching economic growth. China's need for energy and raw materials to fuel its growth has led it to deepen ties with countries which have troubled relations with the United States or face international condemnation for their human rights records or pursuit of banned weapons.

China's oil investments in Sudan drew calls for a boycott of the 2008 Beijing Olympics by critics who said China abetted the perpetrators of atrocities in Darfur. China's energy trade with Iran is seen as helping Tehran withstand Western economic sanctions over its nuclear ambitions.

Drew Thompson, director of China Studies at the Nixon Center in Washington, said the United States has started to take into account how Chinese "resource needs and self-perceived insecurities" influence its foreign policy.

"The more we address those insecurities and resolve them as much as possible, the more we will get from China in terms of shaping the behavior of other nations, such as Iran, Sudan and Zimbabwe," he said.

NO LONGER CHURCHILL AND ROOSEVELT WITH A BRANDY

The new dynamic in Sino-America relations was on clear display last April, when Obama brokered a dispute between Hu and French President Nicolas Sarkozy at the G20 summit in London in April.

The G20 was under enormous pressure to show unity amid fears financial markets could face another wave of turmoil after the chaos of late 2008 and early 2009.

But at a luncheon of beef and asparagus, Hu and Sarkozy were deadlocked over the French president's proposal to crack down on international tax havens. China was concerned about the potential impact on the Hong Kong and Macau banking sectors.

Ratcheting up the pressure was a threat Sarkozy had issued on the eve of the summit to walk out unless the G20 talks yielded a firm commitment on financial regulatory reforms.

Obama pulled each leader aside and urged each to give ground, even though his own view on tax havens was closer to Sarkozy's.

At a news conference later, he spoke approvingly of the rise of countries like China and said it was a good thing decisions were no longer made by "Roosevelt and Churchill sitting in a room with a brandy."

"That's an easier negotiation but that's not the world we live in, and it shouldn't be," Obama said.

(Additional reporting by Glenn Somerville in Washington, Chris Buckley in Beijing and Anna Willard in Paris, editing by Jim Impoco and Claudia Parsons)

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