Resident Fellow  Desmond Lachman

To everything there is a season, and a time for every purpose under heaven. With the U.S. and global economies now experiencing their worst post-war recession and with the U.S. increasingly dependent on foreign financing of its ballooning budget deficit, one has to wonder whether now is the right time for Tim Geithner, the new treasury secretary, to be picking a fight with China over its currency policy by declaring in written congressional testimony that "President Obama--backed by the conclusions of a broad range of economists--believes that China is manipulating its currency."

One also has to wonder whether now is the best time for the new U.S. administration to be seeking unilateral as opposed to multilateral solutions to trade issues, at the very time that the world so sorely needs American leadership to keep global markets open.

There can be little doubt that China has been manipulating its currency for competitive advantage. It has been doing so by heavily intervening in its foreign exchange market to prevent its currency from appreciating under the weight of a persistently large external current account surplus. Indeed, over the past two years, China has been accumulating international reserves at an annual rate of around $400 billion. This has boosted China's international reserve holding to over $2 trillion, or to a level far in excess of what China reasonably might need as a currency cushion for a rainy day.

Dominique Strauss-Kahn, the IMF Managing Director, has repeatedly expressed the view that on a fundamental basis the Chinese currency is "significantly undervalued." He makes this assertion despite the 20% appreciation of the Chinese currency against the U.S. dollar since July 2005. Supporting Strauss-Kahn's view is the fact that China is presently running the world's largest external current account surplus of close to 10% of China's GDP, which shows little sign of narrowing anytime soon.

But it is questionable to say the least whether a confrontational approach toward China by the Obama administration is the best strategy to deal with this problem. This is particularly the case given the fact that the U.S. is so dependent on China for financing its gaping budget deficit. With total holdings in excess of $1.3 trillion, China is already the world's largest holder of U.S. government and agency bonds.

One might also question whether Geithner is right to overly focus on China's currency policy when discussing China's very large trade surplus. For at the root of that trade surplus, even more than its misaligned currency, is more China's excessive domestic savings rate. Were China to significantly revalue its currency without taking the appropriate steps to stimulate domestic demand, it is highly improbable that China's trade surplus will have been materially reduced.

From a global perspective, it has to be regretted that the U.S. appears to be taking a singularly unilateral approach to the Chinese currency issue, rather than seeking a multilateral solution through the International Monetary Fund or the World Trade Organization. With the global recession deepening and with the tide of global protectionism rising, one would have hoped that the U.S. would now be offering the world the leadership that it sorely needs to keep global markets open.

Protectionism is about the last thing the world needs as it hunkers down for a profound and lasting global recession. Yet the new administration's approach to the Chinese currency issue hardly sends a positive signal to the world that the U.S. will play a constructive leadership role on world trade at this precarious moment. This is particularly the case coming as it does as the House version of the fiscal stimulus package egregiously includes "buy American" provisions that will run the risk of emulation by other countries.

If there is one thing that we should have learned from the 1930s, it is how beggar-thy-neighbor trade policies can materially deepen and prolong a global slump.

One has to hope that Geithner's remarks about Chinese currency manipulation were made to secure his congressional confirmation--rather than to point the future direction of U.S. trade policy. If the latter is the case, we should brace ourselves for a long and deep global recession.

Desmond Lachman is a resident fellow at AEI.