China, U.S. `Sugar Daddy,' Eludes Clinton, Obama: William Pesek

Commentary by William Pesek

April 4 (Bloomberg) -- As the U.S. election approaches, China barely seems on the radar screens of Democratic contenders Hillary Clinton and Barack Obama.

That's surprising considering how trade is becoming the battleground issue as the economy tanks. Even Federal Reserve Chairman Ben Bernanke now acknowledges that recession is possible. Central bankers never use the ``R'' word casually.

Given the focus in recent years on China's currency, you might think the word ``trade'' was code for rising competition from the most populous nation. Instead, the spotlight is on the 14-year-old North American Free Trade Agreement, or Nafta.

Much of the China-related rhetoric in Washington is focused on whether President George W. Bush should skip the opening ceremony of the Beijing Olympics to protest China's crackdown in Tibet. That specter was raised by House Speaker Nancy Pelosi.

China's economy should be a much bigger issue as Senators Clinton and Obama duke it out before the November election.

While more jobs are being lost to China than Mexico, Nafta is an easier target given concerns over U.S. immigration. It's a diversion from the real challenge, which is the rapid rise of developing giants the U.S. is more used to exploiting than competing with.

That gets at a little-explored topic in Washington: how the U.S. and China have developed an almost colonial relationship that's unsustainable in the long run.

Colonial Bond

Sound farfetched? Not when you consider how the Belgians, British and French harnessed their far-flung colonies. They provided the mother country with precious resources to increase wealth and provide cheap bases for production. It's a highly unequal arrangement that enriches colonial masters and makes colonies reliant on them.

There's no military protection angle here, yet the U.S. and China are inadvertently creating a colonial-like economic relationship. What's intriguing is that, depending on your perspective, it's not clear which economy will end up the master and which will be the servant.

Until now, the U.S. has been on top. In the 1990s, globalization's heyday, U.S. executives couldn't build enough factories in China to exploit a seemingly infinite supply of cheap labor and lax environmental standards. The dynamic worked brilliantly as a means of pumping up corporate profits.

U.S. Debt

The U.S. became ever more reliant on China to finance its way of life. Rather than keeping its budget in balance or its current account from getting out of whack, the U.S. borrowed more and more from cash-rich Asian governments. China is fast gaining on Japan to become the biggest holder of U.S. debt.

The upshot is that the U.S. isn't just relying on China to produce most of its consumer goods; Asia's No. 2 economy is also bankrolling the U.S. financial system.

Much attention has been paid to how sovereign wealth funds are sizing up U.S. assets. China's state-run fund has made large investments in Blackstone Group LP and Morgan Stanley. Congress is making noises about such purchases.

Elected officials are missing the plot. Economists such as Lawrence Summers have long questioned the sustainability of rich nations being shored up by developing ones. And it's with only a pinch of jest that market strategists, including Joseph Quinlan of Bank of America Capital Management in New York, call China ``America's Financial Sugar Daddy.''

Clinton broached the issue in March 2007, yet at a time when the U.S. economy risks becoming subordinate to China, it would be nice to see lawmakers focused on it.

Forget Nafta

The point here isn't to bash China. It's just striking that so little attention is being paid to this arrangement. This criticism also would be valid if the economy in question were Germany or Canada. The U.S. has built a dynamic economy without realizing that Asia increasingly holds the deed.

Also, the U.S. is suffering from globalization because of complacency, not trade deals. U.S. education standards are falling behind, as is the quality of roads, bridges and communications. The U.S. must prepare its workforce for a world in which more and more economic laggards become rivals.

For Clinton and Obama, Nafta is an obvious bogeyman. Stump speeches questioning how long China will keep lending money to the U.S. may not fire up voters in Ohio or North Carolina.

Imagine, though, the shockwaves if tomorrow China dumped huge portions of its $1.5 trillion of currency reserves. Or if the U.S. overplayed the Olympic-boycott card and China retaliated with trade penalties. When might China seek a higher return than low-yielding Treasuries?

Think China

The U.S.-China bond has a mutually assured destruction clause that soothes some politicians. Economists such as Donald Straszheim of Newport Beach, California-based Roth Capital Partners call it the ``Group of Two.''

The U.S. and China have created an unofficial partnership. China needs U.S. demand; the U.S. needs China to hold down costs for money and goods. Both rely on each other more than they admit and neither member of the G-2 wants to rock the boat. Both also need to understand that it's getting harder to tell where one economy ends and the other begins.

That's the thing with colonial relationships. They can appear to make sense for a while -- until reality sets in.