Paola Subacchi
Research Director, International Economics

As China's President Hu Jintao begins a three-day state visit to Washington, the 'currency war' rhetoric will abate, at least for a while. But a spirit of diplomacy will not remove underlying tensions unless critical economic issues are explicitly addressed.

What should the US do?

President Obama should use his role as host to engage President Hu in a dialogue on how the US and China can lead the international effort on coordinating exchange rate policies and rebalancing the world economy. This means moving the focus away from the bilateral exchange rate between the dollar and the renminbi.

The emergence of new powers, of which China is the most prominent, is challenging the notion that the US should automatically take the lead in global economic matters simply because of the sheer size of its economy.

Surplus countries, China in particular, have made it clear that they won't accept pressure from the US, the main deficit country, to bear the burden of adjustment in exchange rate policies. If there is a solution to exchange rate mismatches and global imbalances, it has to be 'shared' so that policy measures are coordinated within an agreed policy framework providing for shared growth and fostering benefit-sharing.

Washington needs to come to terms with the fact that the dollar is not just a US domestic concern, but a matter for the international agenda. Expansionary US monetary policies have been putting downward pressures on the dollar, making adjustment more burdensome for other countries. The US must accept that exchange rate policies need coordination and stop the race to the bottom. This effort should not only be limited to short-term exchange rate arrangements, but also lead to a broader discussion on rules and principles that govern the functioning of the international monetary system. A well defined and efficient system is required in its own right to mediate exchange across borders and to facilitate adjustment to shocks within and across countries.

Shifts in economic power

Obama should grab the opportunity of President Hu's state visit to drop America's confrontational approach to China. China is a developing nation with the ability of deploying a good deal of economic power which will inevitably win many friends. Judging from Hu Jintao's recent state visits - and the recent trip of vice-premier Li Keqiang to Europe - China's economic diplomacy is paying off, with many partnership contracts signed and investment in hosting countries agreed.

Welcoming the leader of such a successful nation will be particularly striking after the financial and economic crisis, but the US should now address how to positively engage with China. How the balance of power and leadership in international economic affairs will be shaped in future years depends on the willingness of the US to play the role of primus inter pares and to show moral authority as well as economic clout to lead the global economic policy debate. President Hu's visit is an opportunity that Washington cannot miss.

Further resources

'One Currency, Two Systems': China's Renminbi Strategy
Briefing Paper
Paola Subacchi, October 2010

Beyond the Dollar: Rethinking the International Monetary System
Chatham House Report
Edited by Paola Subacchi and John Driffill, March 2010