Why the US should stop worrying so much about China

...and start worrying more about the Gulf. Cris Sholto Heaton looks at the large - and often overlooked - deficit the US runs with Middle East oil exporters.

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Richard Nixon's visit to China in 1972 eventually inspired an opera. In the improbable event that Hank Paulson's trips get the theatrical treatment, it seems more likely to be a farce.

The US treasury secretary's second Beijing summit inside four months seems to be following the same path as the previous one - Paulson tries to drum up support for a range of economic reforms, including allowing the renminbi to float freely against the dollar, while the Chinese diplomats politely but firmly snub his suggestions.

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Consider yesterday's opening lecture there's no other word for it from vice premier Wu Yi. "We have had the genuine feeling that some American friends are not only having limited knowledge of, but harbouring much misunderstanding about, the reality in China," she

said. "This is not conducive to the sound development of our bilateral relations."

After hearing that, it's hard to imagine that there will be a major breakthrough this time

To be fair to China, it's not as if the tone on the other side of the Pacific is much more co-operative. China-bashing Democrats will soon be in ascendancy on Capitol Hill, while anti-China articles proliferate in the press.

"Think of China as a bunch of high school kids From the consumers to the government, they are simply adolescents... They can't handle our dollars," says Andy Kessler in the Wall Street Journal. His point that US dollars heading into China is causing vast, unsustainable

overinvestment may be right, but his tone is unhelpfully patronising. And his conclusion "we've got the Chinese right where we want them" is baffling.

As far as we can see, nobody's "got" anyone anywhere. The global economy isn't a game of chess; it's a serious problem that requires mature co-operation to fix it, not stone-walling and name-calling.

There are faults on all sides. It does no good implying as some in the US are wont to do that China's policy of holding down the renminbi is solely responsible for the two countries' unequal trade. Yes, of course this makes Chinese imports cheap and attractive. But the China government isn't forcing Joe Shopper to buy these goods in such huge quantities. That problem is home-grown.

The concept of thrift seems to have vanished from US culture; its return has to be part of the rebalancing process. At the same time, it would be desirable if China's high savings rate came down substantially, increasing consumption and helping to rebalance the economy away from exports. But cultural attitudes, memories of tough times and the lack of a Western-style social security system mean that isn't going to happen overnight; there's no point in deluding ourselves that it can.

People should also bear in mind that US-China trade is not single-handedly responsible for the US's current account deficit. There are plenty of other imbalances that need attention. For example, the US runs a collectively larger deficit with the oil-exporting nations. In some respects, this is even more important. Many of these countries are unreliable or outright hostile, and what becomes of the money that flows to them is rather more opaque. This issue also needs attention, yet there are few calling for the Gulf States to increase their imports or unpeg their currencies from the dollar.

There are no easy fixes to any of these problems. Say the renminbi is allowed to rise sharply, as some advocate, to reduce the appeal of Chinese goods. What might be the other consequences? One possible scenario is higher inflation in the US through more expensive imports, combined with higher long-term interest rates, because Chinese and other central banks would no longer buy as many bonds in the process of holding their currencies down. That's not an appealing picture for the US economy.

There's no doubt that Paulson understands these complexities, unlike many members of the Bush administration. But whether he'll be able to do much about it is another matter; he probably only has a limited amount of time to show progress before protectionists in the now Democrat-controlled Congress begin stirring. Meanwhile the Chinese government has a tendency to defer hard decisions as long as possible, while the Gulf governments don't even recognise that there is a problem. And even with good intentions on all sides, it would be a major accomplishment to fix so many years' worth of accumulated imbalances before Bush's term ends in 2008. In all likelihood, this farce will run and run.

Turning to the wider markets

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In London, the FTSE 100 closed 27 points higher yesterday, at 6,129, buoyed by strength in the mining sector. Miners Xstrata and Antofagasta were the biggest blue-chip risers of the day, climbing 5.72% and 2.77% respectively. For a full market report, see: London market close.

Across the Channel, the Paris CAC-40 ended the day 33 points higher, at 5,509, as bargain-hunters swooped. In Frankfurt, news that several heavyweight stocks will book notable one-off gains this year as a result of tax credits caused the DAX-30 to close 31 points higher, at 6,552.

On Wall Street, the Dow Jones Industrial Average set a record close of 12,416 after climbing 99 points on positive results from HoneyWell International and United Technologies Corp. The tech-rich Nasdaq ended the day 21 points firmer, at 2,453. And the S&P 500 ended the day 12 points firmer, at 1,425, just off 6-year intra-day high.

In Asia, the Nikkei closed at its best level since May, climbing 85 points to end the day at 16,914.

Crude oil futures were just over half a percentage point higher this morning, at $62.85. In London, Brent spot last traded at $63.12.

Spot gold was at $626.20 this morning, up from $626.00 in New York late last night.

And Japan Tobacco agreed a £7.5bn bid for Gallaher Tobacco today, the biggest ever overseas takeover by a Japanese company. Merrill Lynch will part-finance the deal which will allow Japan Tobacco to increase its presence in Russia, where Gallaher's LD is one of the most popular makes of cigarette, and other emerging markets. Japan Tobacco shares closed over 3% higher in Tokyo, whilst Gallaher has fallen by as much as 6p in London.

And our two recommended articles for today...

Dollar collapse: what should contrarian investors do?

- It seems as though everyone is kicking the dollar at the moment, says D.R. Barton. So how should traditionally contrarian investors react? For analysis of current investor sentiment towards the dollar and tips on how to invest accordingly, click here: Dollar collapse: what should contrarian investors do?

Global economic trends: what you need to know

- Economist Stephen Roach has travelled the world in the last few weeks investigating the effect of globalisation and noting the major trends which will affect your investments. From Australia's preoccupation with climate change to internal development in the Middle East, this is what he found: Global economic trends: what you need to know

Cris Sholto Heaton

Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.

Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.

He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.