Obama plays China card, but who holds the ace? — II

China fears U.S. authorities will be tempted to “monetize the debt” by allowing inflation to rise, eroding the value of U.S.-dollar denominated assets held by the Chinese.

Premier Wen Jiabao put it bluntly when he spoke in March at the most important Chinese press conference of the year: “We have lent a massive amount of capital to the United States and of course we are concerned about security of our assets. To speak truthfully, I do indeed have some worries.”

He urged America to maintain its “creditworthiness” and safeguard Chinese assets, a lecture that did not go unnoticed.

Chinese officials have taken umbrage at some suggestions that China's high savings rate contributed to the global imbalances. Some private-sector U.S. analysts say massive capital inflows from China helped fuel the housing bubble that set the stage for the financial crisis.

Zhou said in September that the paper about the dollar had been partly a way of rebuffing such criticisms. But the central banker's proposal hit a nerve. Persistent complaints from Washington about the Chinese currency have long been a source of friction.

Moreover, the dollar has been sliding lately and public comments about the possibility of it losing its stature could reinforce its weakness, posing dangers for both China and the United States.

So the two countries have since found a way of discussing currencies that causes less of a stir in their capitals and in foreign exchange markets — and the new name of the game is “rebalancing.”

Although it was hesitant at first, Beijing got on board in Pittsburgh with a U.S. call for an economic rebalancing. The idea is for export-driven economies like China to boost domestic demand while big spenders like the United States strive to increase savings.

It is in this context that currencies could come up in the Hu-Obama meeting, said a senior U.S. official who spoke to Reuters on condition of anonymity.

“It will be clear that part of rebalancing is having a more balanced economic growth that depends more on domestic demand and that obviously implicates macroeconomic policy in all its dimensions,” the official said.

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