The U.S. President-elect conducted a masterly campaign without even giving a clue as to how he views China. Such is the intrinsically inward-looking nature of U.S. politics. However the President of China, Mr. Hu Jintao has suddenly shown unprecedented affability towards America and its President-elect. Obama needs to understand the reason why before he goes on his first visit.

The relationship between the U.S and China can only be described as symbiotic. At the same time as China is flooding the U.S with cheap goods, China is building up a massive dollar stock-pile, thereby making it the largest U.S. bond holder. The symbiotic part however is that the US is hooked on Chinese cheap labor and goods. The U.S. consumer is not about to buy U.S. made $20 tee-shirts from Fruit of the Loom when he can get a $7 good quality Chinese shirt. Many of  those cheap goods are produced by U.S. owned factories in China. Ever more businessmen from around the world are adopting Chinese cheap labor as their basic business model and cannot manage without it. Take for example the recent public groveling type of apology given by the president of Mattel for any offense caused to the Chinese people over the affair of the lead-painted toys produced there.

China’s moneybags status has made it a target for investment in the U.S. One question is whether or not the Chinese will soon go down the road of local production like the Japanese and another is whether they can produce high quality low-cost goods in the U.S without paying Chinese type wages to American workers. Part of Chinese economic power is that wealth created by the giddy growth rates stays in the hands of the State (that is the whole idea behind Communism) thereby avoiding the need to borrow. The result is that the Chinese public has not gone on a spending binge because the income per capita leaves almost no disposable income or easy consumer credit.

China has so far avoided the wave of embourgoisement which plagues the West and most emerging countries. This phenomenon drives affluent workers to seek to emulate the rich by flashing their money in the form of expensive brands. A Marxist-Leninist government loathes embourgeoisement as an inevitably atrophied form of material progress which is almost as abhorrent as the preceding capitalistic regimes. Therefore the fruits of collective labor must stay with those who supposedly know best how to handle them; the State. However the pact involves providing the Chinese population with a job and mass unemployment can lead to turbulence as is taking place right now so the Chinese government is being obliged to buy off the public by covering wage arrearages on the payroll owed by private companies. The government is discovering that people may be willing to exchange their political rights for job and financial security but they fully expect the government to live up to its side of the deal as was the case in East Germany where some people yearn for a return to the days of the communist Democratic Republic. The Chinese problem is that with a population of 1.3 billion any calculation involving “per capita” gives an unfavorable ratio such as per capita income and even the recent $586 billion stimulus package is only $450 per capita.  It is already clear that Plan B, that the internal market will offset lagging exports is not transpiring so what exactly does the Chinese government do for an encore? The package was the official Chinese response to the possibility of a drop in GDP growth to 5% in 2009.

Perhaps the only benefit that the US may get out of this recession will be a sharp reduction in its trade deficit albeit at the cost of a spiral in its fiscal deficit. This strengthens Obama’s hand in China because for the first time in many years demand is weaker than supply. It may offer a pyrrhic negotiating victory because the advantage exists only as long as the U.S. is in a recession and any recovery will put the Chinese back in charge. Ironically, China has increased its trade surplus by cutting back on imports (as Brazilian steel and mining companies have felt first-hand) but this does not create jobs in China because there is no import substitution. Also China has stepped up its efforts to penetrate non-traditional markets such as Latin America thereby putting the squeeze on countries like Brazil which also has the same intention.

Obama’s agenda could read as follows:

Persuade the Chinese government to buy GM and Chrysler

At some time the U.S. will be obliged to adopt market protection at home from Chinese products and one of the most sensitive problems is its auto industry, which is not actually hurting because of Chinese cars. In fact not a single Chinese-made car sits in a U.S. showroom. China's ambitious plans to crack the U.S. market are woefully behind schedule. The country's cars still haven't met the emissions and safety standards necessary to export to the U.S. Some analysts predict for example, that Chery, the country's largest independent carmaker, will have to delay its U.S. roll-out for another five years. Ironically, GM plans to increase its stake in its thriving joint venture with Chinese automakers SAIC and Wuling Automobile by seeking to raise its 34% stake in the joint venture. It is unclear how cash-strapped GM would finance such a move, or even if it would be able to convince either of its partners to sell. Although growth in China's auto sales has slowed recently as the chill from the global slowdown spreads, the country remains one of GM's fastest growing markets with an 18.5% growth in 2007 to 1.03 million units. 

In other words, there is a clear coincidence of wants: China wants to sell cars in the U.S. but cannot get emission approval, GM wants to invest in China and the U.S. Treasury does not want to hand money to badly managed U.S. auto companies. 

Just like Mr. Sarkozy and Mr. Brown, Obama will have to become a high-level salesman in order to save strategically important domestic corporations. He could induce the Chinese state-owned auto companies to buy G.M. and Chrysler in exchange for loosening up on emission requirements for a while. In the same way that Lenovo still uses the old IBM ThinkPad name, Chery could produce Buicks.

Yuan/US dollar Exchange rate

The United States, which had a trade deficit of $232.5 billion last year, has said that China's currency controls amount to unfair, predatory trade practices. However, the USA has not yet adopted a hard-line with China, although the US Senate passed a bill that would make it easier to label China as a currency manipulator. In the meantime, the neglect of the value of the US dollar had temporarily relieved the tension with the Yuan FX rate strengthening from 7.3 in January 2008 to 6.82 in August where it has been ever since without reflecting the strengthening of the dollar elsewhere. Only because it is a managed currency did the Yuan not fall along with the others. However, the central bank may continue to stall currency gains and let the Yuan depreciate against the dollar next year to help boost exports. The Yuan could drop to 6.9 against the dollar by the middle of next year. Interest rates have been cut three times recently and another cut is on the way. In other words, the chances of a spontaneous strengthening of the Yuan range from grim to non-existent. Obama will have to use the proverbial iron fist in a velvet glove to solve this one. Now is the time to do it because if a cheaper Yuan does stimulate exports they will be heading mainly to the U.S. during a world recession. Senior U.S. government visitors to China usually took a discretion is the better part of valor approach once they arrived there because the situation at home was not disastrous and nobody wanted to antagonize this  already hypersensitive powerhouse, so they muttered that it would be desirable for China to revalue the Yuan. Now, veiled ultimatums are the order of the day with a calendar of deadlines; the U.S. should not worry that it was the first one to respond to its problems by interest rate cuts because that did not weaken the dollar.

Emissions and Pollution

One of the few per capita indicators that actually favor China is the Emissions per Capita ratio when compared against the same U.S. ratio. China is now the world’s largest polluter in absolute terms but conducts its dialogue of the deaf environmental negotiations by insisting with false logic that the U.S. come in line with the Chinese ratio. Unfortunately the U.S. finger-pointing is a severe case of the pot calling the kettle black. However, not only the quantity but the quality of China’s emissions are about to choke its own population and then the world. At least in the U.S. the horizon is visible without the dense clouds which are commonplace in China. The problem is that if the U.S. does not lead this process, which is supposedly dear to Obama´s heart and may be side-tracked through a temporary recession-based relief, no-one else will.  

Defense concerns

China has been arming itself to the teeth. Since there is no obvious potential threat apart from India or more remotely Japan, which are both democracies it is difficult to justify this as defensive alone. When a country the size of China places so much emphasis on the military the rest of the world gets uneasy. The U.S. was not too concerned about itself because it has the ultimate deterrent as well as other toys but is now paying more attention since the Chinese are making missiles which can take out U.S. satellites. Obama definitely needs to focus on this problem before it gets out of hand. However, China can play a crucial role in holding back the development of nuclear weapons in Iran and North Korea providing it wants to.

Conclusions

International relations pundits say that China needs dialogue and engagement rather than Bush-type confrontation. The pragmatic Chinese government is not likely to get into any dialogues which do not favor it so engagement may become capitulation. Both China and India have already stated flat down that they have no intentions of opening up their markets as their contribution to allieviating the international crisis. All indications are that the cultural gap will cause misunderstandings especially over the speed at which movement can be achieved in China. The main card that Obama has to play is to point out that he needs concessions to keep Congress from pushing through trade barriers. He does not have much else to juggle with.