China is the largest holder of US dollar reserves at over $2 trillion and holds over $800 billion in US government debt.
Due to the Chinese currency regime, the Chinese continue to accumulate US dollars as they attempt to keep the yuan stable at 6.83 to ensure their exporters remain competitive.
In the current global recession, the Chinese have aggressively acted to activate growth via a $585 billion fiscal stimulus program and a massive increase in bank loans.
However, the "stable" currency regime also assist their manufacturers to remain the low cost producers.
Slideshow: Biggest Holders of US Gov't Debt
A free floating currency acts as a stabilizer to the economy. It strengthens when the economy strengthens to ensure there isn't overheating. It weakens when the economy weakens to ensure there is stimulation to exports. This can't happen when one country intervenes to keep their currency weak. Russia and China are examples of this approach.
Under the Bush administration, the US Treasury had a clear policy of pressuring the Chinese to change their currency regime that kept the currency stable and generated massive US dollar reserve accumulation. This structure created the massive imbalances between the countries and created worries that situation was inherently unstable and dangerous.
Under the Obama administration, the US Treasury is not pressuring the Chinese and this was apparent during the meetings this week. President Barack Obama opened Monday's discussions by declaring that the United States sought a new era of "cooperation, not confrontation" with China and that management of the U.S.-China relationship would be a major factor in defining the history of the 21st century according to AP.
This set the tone of the meetings to not upset the delicate fiscal and monetary paradigms that are in place. Treasury Secretary Tim Geithner made no mention of the Chinese currency regime nor of the detrimental effect it continues to have on global imbalances.
The irony is that the Chinese are the ones publicly stating that there are major concerns with the United States and the way the Obama administration and Congress are running their finances. After the Monday talks had ended, Assistant Finance Minister Zhu Guangyao said, "We sincerely hope the U.S. fiscal deficit will be reduced, year after year....The Chinese government is a responsible government and first and foremost our responsibility is the Chinese people, so of course we are concerned about the security of the Chinese assets."
So while the Chinese are sticking up for their workers, the US appears to be abandoning theirs. I wonder how long US manufacturers and US labor will continue to cooperate and not confront the Obama administration on this issue when unemployment breaches 10%?
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