We should listen to Chinese warnings on the dollar

The Customer Is Right. WSJ Editorial
Mr. Obama should listen to Chinese warnings on the dollar.
WSJ, Jul 29, 2009

"We exercise our leadership best when we are listening," President Obama said in April, when asked how his foreign policy differs from that of George W. Bush. Let’s hope that he and Congress were listening when Chinese officials visited the U.S. this week.

The unambiguous message from these investors who hold more than $800 billion in U.S. Treasury debt: Washington needs to take better care of their investment. Yesterday, China Vice Premier Wang Qishan urged the U.S. to get a handle on its soaring debt to protect the value of the dollar. “As a major reserve currency-issuing country in the world, the U.S. should balance and properly handle the dollar’s supply,” Mr. Wang said through an interpreter. Well put.

Like investors everywhere, the Chinese are concerned that America will simply print money to pay off its ballooning debts. The visitors from Beijing were so concerned about the Federal Reserve’s money-creation binge that Fed Chairman Ben Bernanke had to reassure them that he had an exit strategy from what has been the most accommodative U.S. monetary policy since the 1970s. Our guess is that after a decade of Fed missteps, the Chinese are in a Missouri state of mind about this and will want Mr. Bernanke to show them he means it.

The Chinese also zeroed in on Uncle Sam’s finances. “We sincerely hope the U.S. fiscal deficit will be reduced, year after year,” Assistant Finance Minister Zhu Guangyao said on Monday. We have long held that deficits per se are less important than their size relative to the overall economy, and that the real burden on taxpayers is the spending that creates deficits. However, Mr. Obama and Congressional Democrats have been rapidly raising both. One has to go back to the era of World War II to see deficits consuming so large a percentage of GDP as this year’s 13%.

The Chinese might have cause to be less worried if these deficits were poised to fall quickly amid an economic expansion. But the tragedy is that this blowout of the U.S. balance sheet was used to finance spending, largely on transfer payments like Medicaid and jobless benefits, rather than pro-growth tax cuts. The recession is already bottoming out, but the danger is that the expansion to come will be too mediocre to drive job creation and raise revenues enough to reduce the deficit the way it did in the 1980s.

These deficits must eventually be paid for with cash taken from taxpayers, which limits economic growth, or with inflation, which robs investors of the value of their savings. With the U.S. deficit exceeding $1.8 trillion in 2009, and likely to stay high for years to come, investors in China and around the world have every right to be concerned. The Chinese have economic problems of their own, but when they come visiting with a message of sound money and spending restraint, Americans ignore them at our peril.