Dog and Pony Show: Geithner (F)lies to China

...but more importantly, the Chinese are happy about it. Indeed, I am not making negative comments about what Geithner is doing in China as what he's saying is what his hosts want to hear. What did Christine McVie sing in that old Fleetwood Mac song? Tell me lies...tell me sweet little lies. Everyone is probably aware that US Treasury Secretary Tim Geithner is currently in Beijing peddling the idea that "China's US investments are safe." His prepared remarks actually contain much sense, especially the bits about the US consumers having to save more and Chinese consumers having to spend more. Longtime readers should hear familiar tropes:

Our common challenge is to recognize that a more balanced and sustainable global recovery will require changes in the composition of growth in our two economies. Because of this, our policies have to be directed at very different outcomes.

In the United States, saving rates will have to increase, and the purchases of U.S. consumers cannot be as dominant a driver of growth as they have been in the past.

In China, as your leadership has recognized, growth that is sustainable growth will require a very substantial shift from external to domestic demand, from an investment and export intensive driven growth, to growth led by consumption. Strengthening domestic demand will also strengthen China's ability to weather fluctuations in global supply and demand.

If we are successful on these respective paths, public and private saving in the United States will increase as recovery strengthens, and as this happens, our current account deficit will come down. And in China, domestic demand will rise at a faster rate than overall GDP, led by a gradual shift to higher rates of consumption.

Globally, recovery will have come more from a shift by high saving economies to stronger domestic demand and less from the American consumer.

But then of course come the tricky bits:

The policy framework for a successful transition to this outcome is starting to take shape. In the United States, we are putting in place the foundations for restoring fiscal sustainability.

The President in his initial budget to Congress made it clear that, as soon as recovery is firmly established, we are going to have to bring our fiscal deficit down to a level that is sustainable over the medium term. This will mean bringing the imbalance between our fiscal resources and expenditures down to the point - roughly three percent of GDP -- where the overall level of public debt to GDP is definitively on a downward path. The temporary investments and tax incentives we put in place in the Recovery Act to strengthen private demand will have to expire, discretionary spending will have to fall back to a more modest level relative to GDP, and we will have to be very disciplined in limiting future commitments through the reintroduction of budget disciplines, such as pay-as-you go rules.

The President also looks forward to working with Congress to further reduce our long-run fiscal deficit. And, critical to our long-term fiscal health, we have to put in place comprehensive health care reform that will bring down the growth in health care costs, costs that are the principal driver of our long run fiscal deficit. The President has also proposed steps to encourage private saving, including through automatic enrollment in retirement savings accounts.

Alongside these fiscal actions, we have designed our policies to address the financial crisis to carefully minimize risk to the taxpayer and to allow for an orderly exit or unwinding as soon as conditions permit. Across the various financial facilities put in place by the Treasury, the Federal Reserve, and the FDIC, we have been careful to set the economic terms at a level so that demand for these facilities will fade as conditions normalize and risk premia recede. Banks have a strong incentive to replace public capital with private capital as soon as conditions permit.

Let me be clear - the United States is committed to a strong and stable international financial system. The Obama Administration fully recognizes that the United States has a special responsibility to play in this regard, and we fully appreciate that exercising this special responsibility begins at home. As we recover from this unprecedented crisis, we will cut our fiscal deficit, we will eliminate the extraordinary governmental support that we have put in place to overcome the crisis, we will continue to preserve the openness of our economy, and we will resolutely maintain the policy framework necessary for durable and lasting sustained non-inflationary growth.

Geithner's brief is to not antagonize China--at least at the moment. For this reason, he has not reiterated his boss's famous line about the PRC being a currency manipulator. However, Geithner would probably do well to explain a couple of things to his hosts if he were more forthcoming:

1. Why does the Congressional Budget Office predict $9.3 trillion in US fiscal deficits over the next ten years? Is Obama's "we'll turn the spigot off after recovering" account for possibilities that (a) the US will not meaningfully recover during Obama's term or beyond and (b) Friedman's notion is more realistic--"there is nothing so permanent as a temporary government program"?
2. Why is the dollar selling off again with gold flirting with the $1,000/ounce level and major currencies rallying against it? Perhaps markets aren't convinced about Geithner's argument. Perhaps they agree with economist John Taylor expressing great concern about the viability of Obama's continuation of Bush's untax and spend policies.
3. Why are Treasuries at the longer end of the yield curve selling off despite the Federal Reserve buying massive quantities to encourage lower mortgage rates and replace dwindling demand by foreign central banks? Could private investors be demanding better returns from this purportedly AAA lender?
4. Why are foreign central banks--like China's--concentrating their purchases in T-bills (Treasuries maturing in less than a year) instead of T-bonds? Could it be that they expect yields to increase even more markedly than they are doing now, or that they'd like to be able to get rid of their dollar holdings at a moment's notice?

None of the answers to the above questions support Geithner's assertions. Still, good diplomats should not make their counterparts look bad. Ultimately, Geithner's visit is a face-saving exercise for all parties involved. Like awkward family gatherings where members pretend to be friendly and ignore uncomfortable truths, the international community also practices make-believe and it does so here. It goes like this: the US "soothes" China by saying its US investments are safe and that the PRC has invested wisely despite overwhelming evidence to the contrary.

Only the delusional fail to accept the consequences of their mistakes (or fail to admit making them in the first place). In the end, the US and China have no one else to blame for what's coming to them for allowing "vendor finance" get out of hand (getting walloped by debt service and getting a haircut on dollar holdings, respectively) and I think both parties are resigned to this fact. Behind this "big happy family" dog and pony show, things are decidedly grimmer. But, as diplomatic conduct dictates, that doesn't stop them from pretending that the world's largest spendthrift runs as smoothly as the Vienna Philharmonic. Who's the dog and who's the pony? Tell me lies...tell me sweet little lies.

UPDATE: If you want to an honest opinion, read Yu Yongding.