China's Premier Wen Warns Obama

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to Get America's Deficit to an "Appropriate Size"

Posted Nov 09, 2009 01:32pm EST by Heesun Wee in Investing, Newsmakers, Commodities, Recession, Banking

As President Barack Obama prepares to depart Thursday for his first Asia trip, Chinese premier Wen Jiabao is urging the U.S. to keep its deficit to an "appropriate size," a clear message to the leader of the world's largest debtor nation from its largest creditor.

China is the largest holder of U.S. government debt and has invested an estimated 70% of its more than $2 trillion stockpile of foreign-exchange reserves (the world's largest) in dollar assets, Reuters reports. Further dollar weakness, brought on by enormous U.S. deficit spending and near-zero interest rates, would erode the value of China's huge U.S. holdings, as Henry and Aaron discuss in the accompanying clip.

"Most importantly, we hope the United States will keep an appropriate size to its deficit so that there will be basic stability in the exchange rate, and that is conducive to stability and the recovery of the global economy," Wen Jiabao said over the weekend at a news conference in Egypt.

In contrast, the best strategy for the U.S. may be an inflationary stance. We need stimulus spending to jump start our economy and reduce the real value of our record budget deficit of $1.42 trillion in the fiscal year that ended Sept. 30. An improved U.S. economy also would mean more Americans buying up Chinese-made goods.

Collision course with China? But as historian Niall Ferguson discussed in a recent sitdown with Aaron at Buttonwood, there's danger the U.S. may be on a collision course with the Asian giant. China, notably, is buying up hard assets with its cash including natural resources and oil from regions including Africa. As any history textbook will tell you, many political conflicts arise over disputes about natural resources.

Regardless of whether or not China chooses to unpeg its reminbi from the dollar, longer term the U.S. must come to terms with its deficit structure. Meanwhile, the dollar further weakened against the euro Monday as G-20 finance ministers offered no assurances they would take steps to strengthen the greenback.

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