The China currency debate heats up

The war of words between the U.S. and China regarding the Chinese currency appears to be entering a new, more serious phase, particularly in light of developments on Taiwan arms sales, visits with the Dalai Lama, and Google's imminent departure from the country.

Hopefully neither side will be reading Ambrose Evans-Pritchard's latest thoughts on the matter as this could just push one or both sides over the edge.

China has succumbed to hubris. It has mistaken the soft diplomacy of Barack Obama for weakness, mistaken the US credit crisis for decline, and mistaken its own mercantilist bubble for ascendancy. There are echoes of Anglo-German spats before the First World War, when Wilhelmine Berlin so badly misjudged the strategic balance of power and over-played its hand.

Within a month the US Treasury must rule whether China is a "currency manipulator", triggering sanctions under US law. This has been finessed before, but we are in a new world now with America's U6 unemployment at 16.8pc.

"It's going to be really hard for them yet again to fudge on the obvious fact that China is manipulating. Without a credible threat, we're not going to get anywhere," said Paul Krugman, this year's Nobel economist.

It looks as though Krugman is taking a stand on the China currency issue, citing it as a "significant drag on the global economy" in commentary yesterday.

It's funny how no one ever complains about oil exporting countries in the Middle East who also peg their currencies to the dollar and are widely considered to be undervalued, though not nearly as much as the Chinese currency.

We don't normally complain about exporting nation's with pegged currencies who build up massive holdings of U.S. debt unless we think we can compete with them with our exports, something that doesn't seem likely in the case of Saudi Arabia.

In any event, the Chinese government doesn't seem to like where the conversation is going.

China's premier Wen Jiabao is defiant.

"I don’t think the yuan is undervalued. We oppose countries pointing fingers at each other and even forcing a country to appreciate its currency," he said yesterday. Once again he demanded that the US takes "concrete steps to reassure investors" over the safety of US assets.

"Some say China has got more arrogant and tough. Some put forward the theory of China's so-called 'triumphalism'. My conscience is untainted despite slanders from outside," he said

Days earlier the State Council accused America of serial villainy. "In the US, civil and political rights of citizens are severely restricted and violated by the government. Workers' rights are seriously violated," it said.

"The US, with its strong military power, has pursued hegemony in the world, trampling upon the sovereignty of other countries and trespassing their human rights," it said.

Here's where it gets interesting.

Clearly, Beijing is in denial about is own part in the global imbalances behind the credit crisis, specifically by running structural trade surpluses, and driving down long rates through dollar and euro bond purchases. No doubt the West has made a hash of things, but the Chinese view of events is twisted to the point of delusional.

What interests me is Beijing's willingness to up the ante. It has vowed sanctions against any US firm that takes part in a $6.4bn weapons contract for Taiwan, a threat to ban Boeing from China and a new level of escalation in the Taiwan dispute.

In Copenhagen, Wen Jiabao sent an underling to negotiate with Mr Obama in what was intended to be - and taken to be - a humiliation. The US President put his foot down, saying: "I don't want to mess around with this anymore." That sums up White House feelings towards China today.

We have talked ourselves into believing that China is already a hyper-power. It may become one: it is not one yet. China is ringed by states - Japan, Korea, Vietnam, India - that are American allies when push comes to shove. It faces a prickly Russia on its 4,000km border, where Chinese migrants are itching for Lebensraum across the Amur. Emerging Asia, Brazil, Egypt and Europe are all irked by China's yuan-rigged export dumping.

Michael Pettis from Beijing University argues that China's reserves of $2.4 trillion - arguably $3 trillion - are a sign of weakness, not strength. Only twice before in modern history has a country amassed such a stash equal to 5pc-6pc of global GDP: the US in the 1920s, and Japan in the 1980s. Each time preceeded depression.

It could be a very interesting week ... and decade.