Economics

After my previous posts in this series grappled with the likely plight of the falling dollar and some of the economic implications of its privileged status in the global economy, this concluding post will consider the question:

What do the dollar's role and value mean for U.S. foreign policy?

There is a macho tinge to the U.S. Treasury mantra that a strong dollar is in the U.S. interest. After all, isn't it always better to be strong than weak? There is a suggestion that at $1 to the euro, we are virile and able to bend other nations to our will, while at $2 to the euro, we will be feeble and submissive.

It is not obvious why that should be so. There are a couple upsides to a weaker dollar. Fred Bergsten, in a new Foreign Affairs analysis, argues that "the United States itself would benefit from a reduction in the international role of the dollar." In Bergsten's view, the easy credit that has accompanied dollar primacy has tempted the country into misguided policies. He writes: "Unless the United States quickly achieves and maintains a sustainable economic position, its ability to pursue autonomous economic and foreign policies will become increasingly compromised." A falling dollar is thus a mechanism whereby excessive U.S. borrowing from abroad can be rolled back. To the extent a weakened dollar would bring about such global rebalancing, it would help to meet a stated goal of world leaders in recent G-20 meetings.

Beyond this indirect gain, the most direct effect of a weakened dollar would be to hike the cost of goods imported into the United States and make American goods appear cheaper to the rest of the world. This, over time, would likely ease the pressures for trade protectionism that have increasingly strained U.S. relations with countries like China, Canada, Mexico, and the members of the European Union.

Each of those benefits to a diminished dollar shares a similar quality. Under a strong dollar, the argument goes, we cannot resist the temptation to sin. We know that excessive borrowing is a bad idea, but we just can't help ourselves. We know that trade protection is ill-advised, but who can resist the political pressure?

As soon as we move away from introspection, we see some of the foreign policy downsides to a weaker dollar. The first and most direct are the economic impacts. With a weaker dollar, all U.S. ventures abroad become more expensive. During the period of the dollar's decline, the United States becomes less attractive as an investment destination, since foreign investors would expect to recoup fewer yen, yuan, or euros when they cash out. Future financial crises - and they are sure to come -- will be much more painful if global investors do not rush to the dollar as a safe haven.

An even greater difficulty, from a foreign policy standpoint, could be a sense among allies that the United States is an unreliable partner. As the provider of the world's reserve currency, America has had both special rights and special obligations. The rights have included the ability to print money to pay for whatever we liked (technical term: seigniorage). The obligation has been to keep the value of the dollar relatively stable. From the reactions to the dollar's recent slide, we can anticipate the sort of discord that might accompany a more significant move. From Thursday's Washington Post:

The weak dollar is becoming a source of international tension, particularly in U.S.-European relations. Officials in the 16 countries that use the euro warn a continued slide of the dollar may pose long-term structural problems for Europe, forcing down wages and hurting employment in the months and years ahead. This week, a top aide to French President Nicolas Sarkozy called the value of the dollar "a disaster" for Europe, warning of dire consequences to the global economy if it remains at its current levels.

China reacted to U.S. borrowing plans at the beginning of this year with a call for guarantees of the value of its dollar lending. They were clearly worried about a depreciation of the dollar, which would undercut the value of China's massive reserves.  While G-20 nations were calling for global rebalancing at their Pittsburgh summit (by which they really meant that China should appreciate its currency and import more goods), Chinese President Hu Jintao said:

"Major reserve-currency issuing countries should take into account and balance the implications of their monetary policies for both their own economies and the world economy with a view to upholding stability of international financial markets."

This nicely captures the dilemma facing the Obama Administration. How do you catch a falling dollar? A classic approach would be for the U.S. government to stand ready to raise interest rates and adopt plans for future fiscal austerity. It would be responsible, but it would not be much fun, particularly at a time when U.S. unemployment is approaching 10 percent.

Suppose, instead, the dollar continues to slide and loses its premier status among world currencies. There could be domestic political benefits, but it would leave key countries economically bruised and seething. It is very difficult to tell such a story in which the United States' standing, prestige, and ability to project power do not decline along with its currency. U.S. foreign policy prowess would not be immune should the dollar fall from grace.

John Moore/Getty Images

The U.S. dollar enjoys a privileged position in the world. The federal government can print up the little slips of green paper and exchange them for barrels of oil or digital cameras. That trick is not unique to the United States; almost all countries print money and spend it at home. The difference is that the dollar can be so easily spent abroad and that foreigners are so willing to hold on to large quantities of those little slips of papers, instead of trading them back in for American-made goods. This raises the question: Is the dollar likely to be replaced as the world's reserve currency?

There have certainly been similar shifts in the past. Some time in the first half of the last century, the dollar took over the exalted position long held by the British pound. Nor are the questions about the dollar's status as a reserve currency merely conservative fantasies aimed at stirring doubts about President Obama's leadership. As with so many other things, this idea was made in China. Alarmed by his country's exposure to a potential slide in the dollar, the head of China's central bank floated the idea of a global currency to replace the dollar. The Russians liked the idea. The United Nations and the IMF were intrigued.

If we're to hold auditions for a new dominant global currency, we can start by considering the job description. We're really looking for three things in an aspiring new currency:

1. It must be widely traded.
2. It must be linked to deep and open capital markets.
3. It must provide a stable store of value.

The dollar excels on the first two counts. Given the size of the U.S. economy, the dollar has a broader reach than any other currency. U.S. capital markets (bonds, stocks) feature enormous trading volumes; that means that a government wishing to adjust its reserve position by selling Treasury bonds generally need not worry about whether it can unload them.

The dollar concerns stem from fears about U.S. fiscal incontinence. The Obama administration often deflects such concerns by arguing that it is necessary to run large deficits in a time of economic crisis. This conflates the short-term and long-term deficit problems. The administration declared early on that America's fiscal position was unsustainable because of burgeoning entitlement costs, especially in health care.  Yet the plans under consideration would likely increase overall health spending while raising the government's share of costs. Nor has the administration earned much credibility for its promises to offset costs.  The situation beyond health care does not look much brighter.

Runaway deficits can spiral out of control and have frequently ended in bouts of serious inflation, as governments print money to cover costs. That directly undermines the currency's role as a store of value. Inflation means that those green slips of paper buy less tomorrow than they do today.

Hence, the search for a successor to the dollar. But a review of the serious applicants suggests the dollar's position is secure, at least for a while.

At the front of the line is the euro. It already accounts for almost 30 percent of global reserve holdings, compared to the dollar's roughly 60 percent. The euro zone certainly has the economic size to be a viable contender. But the recent crisis has shown up some serious weaknesses in the currency. First, there was the question of how the euro zone would deal with bank failures, as in Ireland and Iceland. The European Central Bank does not have the full panoply of powers enjoyed by U.S. federal bank overseers. Europe also faces its own deficit problems, exacerbated by the fact that some members are more profligate than others.

In line behind the euro are the British pound and the Japanese yen. The economies are smaller, but still large enough to be contenders. Yet British debt problems are even more serious than those in the United States. Japan's fiscal problems are severe as well, offset only by that country's great propensity to save.

Beyond the yen and the pound, we come to the long shots, such as the Chinese yuan or the Brazilian real. For all its eagerness, China is disqualified because it does not have an open capital account (the opposite of deep capital markets; good luck unloading those RMB bonds). Brazil recently got a small taste of what it is like to be a favored currency and started running in the other direction. After the real appreciated 36 percent against the dollar this year, the Brazilians decided to start taxing investment flows.

So who's left? Just the imaginary currencies. These are artificial constructs like the IMF's SDR (special drawing rights). It's not widely traded; there are no deep SDR capital markets; nor are there any special guarantees about its prospects as a store of value. It has gained a following because it seems to offer an escape from all the failings of the other currencies. In fact, the SDR is nothing more than a basket of those very currencies.

So the dollar's reign looks likely to continue for a while. It's not a very resounding victory -- champion because everyone else fell over -- but a win is a win, as the cliché goes. It does beg the question: is it a win? Has the U.S. benefited from the dollar's special role? More particularly, what do the dollar's role and value mean for U.S. foreign policy?

That will be the subject of the next and last post in this series.

By Phil Levy

Some discussions of the dollar’s recent fall have a tone of impending doom. They worry that the 15 percent drop of the last 6 months could accelerate out of control. The first post in this series argued that the recent decline has not been the result of manipulation, but that’s not saying that the dollar has reached a new equilibrium. This post will take on the question:

Has the dollar stabilized or is there risk of a further plunge in its value?

One way to rephrase this is to ask whether the dollar is reasonably valued right now. A classic measure is to take a bundle of goods (some groceries, some transport, some electronics, etc.) and ask what exchange rate would make that bundle cost the same in a pair of countries. The Organization for Economic Cooperation and Development (OECD) is one of several groups that produces these Purchasing Power Parity (PPP) estimates.

With these numbers, one can argue that it should take about $1.67 to buy a British pound. As I write this, the exchange rate is $1.63 – pretty close, with the dollar slightly overvalued. Other currencies look much different, though. For Germany, a PPP rate of 1.11 dollars to the euro compares with the current rate of 1.49. Instead of the PPP rate of 130 Japanese yen to the dollar, the rate is 91. In those cases, the dollar is badly undervalued.

While we’re playing with PPP exchange rates, we might as well check in on China. We’ve just been told that China is not a currency manipulator, but the PPP exchange rate is 3.4 RMB to the dollar, versus the market rate of 6.83 RMB to the dollar. That says several things. First, China’s currency is seriously undervalued. Second, PPP exchange rates are imprecise and can vary a lot. More careful estimates of China’s undervaluation run from 20-40 percent, not 100 percent. Finally, we can see that PPP rates offer only loose, long-term guidance about where currencies might go. They say very little about what will happen in the next six months.

In part, that’s because exchange rates are driven by investment decisions, not just the consumption of goods. Investors in Frankfurt and Tokyo ask whether they will make more money lending in euros or yen, or whether they would make more converting to dollars and buying American stocks or bonds. If they do invest in the United States, they’re going to have to venture a guess about what exchange rates they will face when it’s time to retrieve their funds.

How do they know what those rates will be? Here we land in the world of the Keynesian Beauty Contest, in which you get a prize for selecting the most popular contestant. While objective measures of beauty may offer a clue, the subjective preferences of the other voters are most important.

Applying this to exchange rates, we know objectively that currencies tend to suffer when countries have uncontrolled fiscal spending and growing debt. Persistent large trade deficits also suggest that a currency is due for a fall. Those are the situations facing the dollar. But the dollar retains value so long as everyone wants it – a self-supporting popularity. The concern is that a falling dollar will convince investors that their counterparts no longer find the dollar so beautiful and that a sharp unraveling in the dollar’s value could follow. In this scenario, the dollar wouldn’t fall without limit: at some point, US exports and facilities would look irresistibly cheap. But such downward spirals – the flip side of bubbling enthusiasm – can be dramatic and wrenching.

We thus have two contrasting views about where the dollar might go. On the one hand, cross-country price comparisons don’t look too bad for the dollar. They seem to support the more comforting story that the dollar’s recent fall is just the unwinding of its extraordinary rise as investors reacted to the crisis. On the other hand, the descent of the last six months looks very much like the start of a rush for the exits would look, as investors abandon the dollar and give in to their concerns about U.S. prospects.

It was just such a situation that prompted Harry Truman to cry out for a one-handed economist. In this case, though, the uncertainty is essential to the story. That’s one of the valuable economic insights that emerged unscathed from the recent crisis. To quote John Cochrane from the University of Chicago: “the central empirical prediction of the efficient markets hypothesis is precisely that nobody can tell where markets are going.” In a nutshell, if we knew for sure that the dollar were to fall another 15 percent in the next six months, the fall would occur right now. Financial titans like George Soros would borrow dollars and buy other currencies, guaranteed to receive glorious returns. That would push the dollar down immediately.

So the dangers are real, but uncertain. They are particularly troubling because the bad scenario could have lasting effects. It could undermine confidence in the dollar that has supported its role as the world’s principal reserve currency. This potential has already led to calls for dethroning the dollar in such official transactions. Whether that’s a likely prospect will be the subject of the next post in the series.

GABRIEL BOUYS/AFP/Getty Images

By Phil Levy

The dollar has been drooping. This week, a broad measure of the dollar's value against other currencies fell to a 14-month low. Depending on the commentator, this is either a global vote of no-confidence in the United States; or it is good news, a return to normality as worldwide fears subside. Without exactly leaping between Paul Krugman and his latest sparring partners, there are a number of questions one might ask about the dollar's recent decline. This post kicks off a short series to consider four of them, beginning with: Is the drop in the dollar "natural" currency depreciation or the result of "manipulation?"

The dollar has fallen roughly 15 percent from its recent high this spring. When we see sharp movements in a price, it's natural to look for an active protagonists driving those movements. Every now and then in the past, we've found some. There have been attempts to corner markets in silver, wheat, and even salad oil. Each of these instances involved attempts to drive up a price and some were spectacular failures, but that's not what sets them apart from the case of the dollar. The market for currency absolutely dwarfs these other markets.

The last time statistics were gathered on this (late 2007), the average daily turnover in foreign exchange markets was $3.2 trillion and growing rapidly (up 69 percent since the 2004 survey). To put this in perspective, if we divide U.S. GDP over 240 business days in a year, it was about $0.06 trillion ($60 billion) in 2008. So every business day, the value of currency transactions averaged about 50 times the total value of U.S. output. 

The implication is that it's very hard to manipulate the value of the dollar. In fact, this enormity of the market for dollars is one of its great strengths as a reserve currency; no one wants to keep their wealth in a thinly-traded currency that can be easily manipulated. As a general rule, the U.S. government doesn't even try to move the dollar around, and it gets to print the stuff. Every Treasury secretary since Robert Rubin has chanted the mantra "a strong dollar is in the U.S. interest" to avoid making any news that might move the markets in unpredictable ways. 

But how can it be "natural" for the dollar to drop as far as it has in the last six months? Ever since the dollar was de-linked from gold almost four decades ago, the value of the dollar is determined continually in those massive global markets. The markets are populated by investors and traders, some with business ideas, some with money to save, some with goods to buy and sell. Some of them want to turn their dollars into euros to buy some French wine, others wish to turn their yen into dollars to buy some oil, a Treasury bond, or an American office complex. Exchange rates balance dollar buyers against sellers.

That means, in part, that we can have many explanations for what happens in these markets. The dollar could go up because American vinophiles turned to Sonoma Valley, or because the U.S. commercial real estate market became more attractive. One popular explanation for the dollar's rise and fall in the recent crisis is offered by Paul Krugman: "the dollar rose at the height of the financial crisis as panicked investors sought safe haven in America, and it's falling again now that the fear is subsiding."

That certainly seems to be part of the explanation. But it gives the impression that all is well, that we have returned to normal and there's little to worry about on the currency front. In fact, there is no indication that we've reached a long-term equilibrium and there is a serious basis for worries about the dollar's fall. That, though, will be the subject of the next post in the series: Has the dollar stabilized or is there risk of a further plunge in its value?

PAUL J. RICHARDS/AFP/Getty Images

By Phil Levy

The Pittsburgh G-20 meetings concluded with a call for strong, sustainable, and balanced global growth. Countries were going to get their acts together, to shape up, to mend their ways. And if they don't? What if they just go with their own domestic political imperatives? Then someone will call them out, the leaders said.

But who? The International Monetary Fund, perhaps. After a meeting of finance ministers, the AP reported:

Four governments -- including the United States and China -- renewed promises to enact policies aimed at rebalancing global trade.

They said an orderly reduction in the U.S. trade deficit and trade surpluses in Asia would benefit the world by defusing protectionist trade action...

"It was agreed that a rebalancing of domestic demand growth across economies would be key to reducing imbalances...," said the statement, issued on behalf of the group by the IMF.

China pledged to take steps to increase domestic demand, deepen financial reforms and increase the flexibility of its currency, a step long demanded by the United States and other industrialized nations.

Wait! This story is from April 2007, on the eve of the global financial crisis. (Plus ça change...). That meeting followed a 2006 agreement that the IMF would adopt a new surveillance system to identify misaligned exchange rates. The surveillance program essentially came to naught. This ineffectiveness was not due to any analytical weakness on the part of the good folks at the IMF. It turned out, rather, that big countries like the United States and China dislike being publicly criticized.

Of course, smaller nations share this distaste for criticism, but they usually have no choice. The IMF has leverage when it lends money. When a nation like Hungary or Iceland finds itself in serious trouble, it must accept IMF policy prescriptions along with the cash. The bitter memories of this cash/criticism combo from the Asian financial crisis of the late 1990s help explain why Asian countries have built up such substantial piles of exchange reserves; they want to ensure they are not in that position again.

Why should the IMF or World Bank care, though? Why not just call it the way they see it and let the big countries deal with their own bruised egos? Because the big countries are the IMF and World Bank. The leaders of the bank and fund spend their days reporting to boards of executive directors, seeking the boards' approval for all they do. These institutions are not like the U.N. General Assembly -- one country, one vote -- the executive directors' votes are roughly weighted according to the economic heft of the countries they represent.

This creates a dynamic that played out this week in Istanbul, where the bank and fund are holding their fall meetings. According to the Financial Times, World Bank President Robert Zoellick asked his governing council for an infusion of $5 billion. Without it, he said,

"[A]s we start to get towards the middle of next year we are going to start to face some serious constraints and we would have to ration..." He said uncertainty over future financing capacity was already affecting bank work with developing countries.

Developing nations voiced unanimous support for a capital increase.

But developing nations are not the ones paying the bills. Zoellick faced a much more skeptical reception from the British, the French, the Japanese, and the Americans. It is the major donors to which any bank president is beholden. This dependence did not stop Zoellick from making a relatively forthright speech about global imbalances last week at the Johns Hopkins School of Advanced International Studies, but the FT pictured him yesterday with his head in his hands.

The independence deficit of the IMF and World Bank is serious, but perhaps not the most significant obstacle to achieving global rebalancing through coordinated reform. Even if Bob Zoellick launched the kind of scathing critique of which he's certainly capable, it would not suffice to bring serious cuts to U.S. federal deficits or to prompt revaluation of the Chinese currency. President Obama's political prospects depend heavily on delivering a costly expansion of health-care coverage. The Chinese leadership's legitimacy rests heavily on maintaining employment in the manufacturing sector. In each case, the domestic political stakes are far too high to be overcome by global opinion, no matter how blunt.

Change will come, of course. But it will be through average American voters worrying about borrowing from their grandchildren, or from average Chinese worried about the value of their massive dollar holdings. Right now, even if the IMF or the World Bank were to call out, those key constituencies aren't listening.

Win McNamee/Getty Images

By Phil Levy

We know President Obama is proud of his proposal to reform the nation's health care system; he spoke of it before a joint session of Congress last Wednesday evening. Judging by the timing, he was distinctly less proud of his decision to slap three years of hefty tariffs on low-cost tires imported from China. That announcement came at 9:45 pm on Friday. The decision was due this week, but the move smells of rank protectionism, and there was no better opportunity to bury the story than last Friday night.

It made for an awkward sendoff for Wu Bangguo, Chairman of China's legislature, who had just been visiting Washington. It did not escape notice back in Beijing, either. The Chinese had been sending warnings about how seriously they took this case for months. A Chinese Ministry of Commerce official was quoted on Saturday as saying that China "strongly opposes the serious act of trade protectionism," and that the tariffs mark a breach of U.S. pledges made at the April G20 summit in London to avoid raising trade barriers. Fortunately, there is no indication that the spokesman actually uttered the phrase, "You lie!"

Nor has any Chinese official been heard to say: "Don't worry. We understand. It's just economics." Obama has long seemed to draw a distinction between a warm, multilateral approach to international diplomacy, and a cautious or even hostile approach to international economic relations. For many countries, however, international economic relations are so important to their well-being that they are inseparable from those countries' foreign policy concerns.

Increasing tensions with China have also featured some classic international relations misunderstandings, such as misattribution of intent. The Chinese were already upset about a U.S. countervailing duty decision last week that imposed new barriers against Chinese steel pipe. The pipe and tire decisions seemed to constitute a trend of protectionist U.S. actions. In fact, the two decisions are very different. Obama had full discretion over the tire tariffs and none over the pipe decision.

But the Chinese were not the only ones to be confused. In the wake of the tires decision, United Steel Workers President Leo Gerard exalted, "The President sent the message that we expect others to live by the rules, just as we do." U.S. Trade Representative Ron Kirk certainly encouraged this interpretation, by linking the decision to the Obama administration's campaign for enhanced enforcement of trade laws. In fact, the tires decision had nothing to do with malfeasance on China's part.

To clarify, there are a number of ways the United States might slap tariffs on a country. Congress could pass a tariff bill, in the tradition of the Smoot-Hawley Act of 1930, but that's very rare. It's much more common to use mechanisms that are permitted under world trade law. Two of these, the antidumping (AD) and countervailing duty (CVD) mechanisms, address transgressions by trading partners. The steel pipe decision was an interim step in a CVD (anti-subsidy) case. Congress allows the president no role in these cases. Even if Obama had thought the steel pipe decision was ludicrous, there was nothing he could have done about it. 

In contrast, Friday night's tire decision was the culmination of a "safeguard" case. Safeguards allow the president to respond when a U.S. industry has been injured by a surge in imports. The ITC can recommend a remedy, but the president is free to accept, modify, or reject that recommendation. In the tires case, Obama imposed lower tariffs than the ITC called for. The China-specific safeguard he relied upon was agreed as part of China's entry into the WTO in 2001.

President George W. Bush had four opportunities to impose such tariffs on Chinese goods and turned down all four. Critics decried these decisions as selling out U.S. workers, appeasing China, and demonstrating a slavish adherence to free-trade ideology. I played a very small role in two of those four decisions and remember the reasoning somewhat differently. The only beneficiaries of tariffs in those cases would have been Vietnamese, Brazilians, or Indians.

Here's the problem. The China safeguard is a bilateral policy in a multilateral world. The Chinese are often the lowest-cost suppliers of a good, but they're not the only suppliers. In the Bush cases, importers testified credibly that if Chinese imports were blocked, other countries would undersell U.S. manufacturers in these particular products.

The tire situation appears to be similar. U.S. tire producers did not even support the case; they said they were more interested in producing high-end tires. The petition was filed by the United Steel Workers. If U.S. tire producers are uninterested, then there is little prospect of gains for American workers. The tires will just be sourced from other countries at somewhat higher cost.

So where does this all leave us? New American jobs appear unlikely. Prices should rise a bit for U.S. consumers. Some lucky third country will gain new American orders, redirected away from China. And there is real concern that other countries will follow the U.S. lead. China is exploring ways to block U.S. cars and poultry. Later this month, Pittsburgh G20 discussions of how to pursue open markets together should be particularly awkward. But at least Obama retains the support of organized labor.

By Phil Levy

This week brought some rave reviews for the Obama administration's foreign policy performance at the six month mark. My colleague Dan Drezner remarked upon a puff piece sympathetic analysis this week in The New Republic that described the White House's diplomatic maneuvering as a work of genius. The Washington Post opened a lead editorial by stating that "...only one country has worse relations with the United States than it did in January: Israel."

The Post backed up this bold claim with survey data about America's popularity in nations around the world. The data show that President Obama is distinctly more popular than President Bush. But is this the right measure of the state of bilateral relations?

It's hardly the only thing one would find in a scenesetter cable on the eve of a high-level visit. Such an analysis would properly include factors like disputes, ongoing or resolved, and the willingness of the other government to cooperate with the United States on issues we deem important.

Public opinion is certainly relevant, but it can be misleading about the state of government relations. For example, a poll of Iranians fielded just before their recent election found a large majority favoring normal ties with the United States. That's hardly conclusive evidence that all is well between the United States and Iran. Even The New Republic piece acknowledged U.S.-Iranian tensions as the one discomfiting blemish in an otherwise carefree diplomatic landscape.

What if we survey that landscape with a more critical eye and move beyond public goodwill toward our leader? In the interest of stoking some debate, let me offer my list of countries with which relations have deteriorated in the last six months. I'll pocket the Post's Israel point and omit Iran, since relations with them are bad, but not necessarily worse. The list is necessarily subjective, but I'll give my reasons for each. You can apply your own weights.

1. Canada. Relations were not particularly bad between the Bush and Harper administrations. It's hard to think of an irritant as significant as the Buy American legislation that Obama signed into law with the stimulus bill. Though Canada was supposed to be exempted from that provision by an amendment recognizing U.S. obligations at the WTO and NAFTA, the Canadians are very upset about the way the measure has been implemented.

2. China. While the major issues between the United States and China are qualitatively unchanged, China is expressing substantially more concern about U.S. economic behavior than they did under the Bush administration. China is worried about the sustainability of U.S. deficit spending and what it will do to their trillions in dollar reserves. Of course, neither Bush nor Obama ever tabled a plan for a balanced budget, but the worst Bush deficit was 3.55 percent of GDP in 2004. According to the CBO, the best Obama-planned deficit in the next ten years will be 3.9 percent of GDP in 2013; the worst will be 13 percent in 2009.

3. Colombia. The Obama administration has done nothing to pass the Colombian Free Trade Agreement (FTA). The Colombians have been very explicit about how important the agreement is to them economically. All explanations for delay are based upon harsh criticism of the Uribe administration's performance.

4. Honduras. Whatever the merits of the argument over President Zelaya's ouster, in January we were getting along with them quite nicely.

5. Panama. Not only has the Obama administration teased the Panamanians with intimations of FTA passage that were later retracted, it has annoyed them with a never-ending series of requests to remove obstacles to the already-signed accord.

6. South Korea. While the Obama team has at least hinted that the Panama FTA may be passed soon, there have been no such suggestions about the FTA with Korea. The agreement was wildly controversial in Korea and the government ran serious risks by promoting it. They can hardly appreciate the way it has been placed in purgatory, particularly given the irony of the principal U.S. objection: Korean interference in its auto market. Nor has there been any notable security success with the North to offset the chill in economic relations.

7. The United Kingdom. This is a close call. On the one hand, the two countries have been enthusiastic partners in economic stimulus. On the other, a series of Obama nubs (the Churchill Bust bust, wrong-region DVDs, an iPod for Her Majesty) led some in the British press to ask how special the special relationship still was. The scales tip in favor of inclusion because the British have some of the same trade concerns as the Canadians.

The list clearly reflects my emphasis on the diplomatic importance of international economic relations. But a number of Washington ambassadors and foreign officials seem to share this view. Both at home and abroad, personal admiration for Obama has to be balanced against concerns about what his policies will do the pocketbook.

By Phil Levy

Perhaps the most striking aspect of this week's Strategic and Economic Dialogue between top U.S. and Chinese officials is how amicable and sedate it has been. The Washington Post described how Chinese officials heard "soothing words of reassurance" in lieu of the traditional litany of currency and trade complaints. Secretary Clinton acknowledged that there may not have been a lot of concrete achievements, but said the talks laid the groundwork for closer ties. Meanwhile, the Chinese currency remained roughly fixed against the dollar, just as it has been since last summer.

Had this been a Bush Strategic Economic Dialogue, one could have expected howls of outrage: The American worker is being sold out! When will the administration get tough? Don't they know what has happened to manufacturing employment? Let's pass a law and force their hand! I suspect a McCain administration would have been similarly attacked. Indeed, it is a sign of how far Sino-American relations have come that a U.S. leader on the left now enjoys an advantage over his right-wing counterparts in the eyes of most Americans when negotiating economic issues with China.

Just think back almost forty years ago to how Nixon was uniquely positioned to open relations with the People's Republic. The issue then was whether a president who made such an overture would be seen as soft on communism. As an ardent and well-established anti-communist, Nixon was relatively immune to such attacks. In the same way, Obama is now relatively immune to attacks that he is soft on China's currency. He's not lacking in his desire to bring change, and of course, he's not doing any better in delivering it. He's just more credible when he says he can't.

To be sure, there were some grumbles even for the Obama team. Simon Johnson writes:

The US should put on the table the possibility of more assertively taking China to the World Trade Organization over its fundamentally undervalued exchange rate and associated trade policies ... The Treasury apparently thinks it should be deferential and on the defensive vis-a-vis China. This is not only bad economics, this is bad geopolitical strategy.

The economic arguments for a reorientation of the Chinese economy and an appreciation of China's currency are compelling and are qualitatively the same as they have been for several years. China's current economic path is unsustainable. The day of reckoning has only been brought closer by China's recent approach to stimulus through wild bank lending. As Derek Scissors puts it: "China's economic policies have shifted from being unsustainable over the very long term to being unsustainable for any more than one year."

So why not threaten and abuse the Chinese until they push their currency up by 20 percent? That would encourage Chinese consumers to buy up newly-cheap imports and would help reverse China's astonishing surpluses and reserve accumulation.

The answer: because there's no sign it would work. For the Chinese leadership, this is their paramount domestic issue. Their legitimacy rests heavily upon a record of economic success. A wrenching and sudden economic shock, of the sort that would come with a large appreciation, would threaten to flood the streets of southern China with aggrieved, unemployed workers. On the other hand, a gradual appreciation of the currency would threaten to flood China with inflows of hot money as global investors perceive a guaranteed return. None of China's choices look particularly appealing, but it is the central domestic issue they need to fix.

To draw a parallel, imagine that the Chinese delegation had arrived in Washington this week and issued an ultimatum: Obama must set aside plans for expanding health care coverage, and whatever savings or increased revenue he can muster should be used to pare down unsustainable federal budget deficits. The Chinese did no such thing, of course. They are vocally worried about U.S. deficit spending, but they are sensible enough to realize that no external threat would deter Obama on this point; his promise to deliver on healthcare is at the core of his political legitimacy.

With similar good sense, Clinton and Geithner opted to build understanding in this week's S&ED rather than to pick a fight. The rationale is the same as that given in the Bush administration, though, so how does Team Obama avoid getting lambasted as their predecessors did? If anything, recent economic developments make the question more acute: the U.S. labor market is distinctly worse than before, and we are -- for the moment -- less dependent on the Chinese for financing as the U.S. current account deficit has dipped sharply.

Obama has street-cred on China in a way his predecessor did not. Whenever bilateral talks end and an administration is left extolling the virtues of better mutual understanding, it raises the question of whether diplomatic imperatives trumped advocacy. That was clearly the suspicion in the Bush administration; hence the recurrent attempts at legislation demanding more economic advocacy. In Obama's case, there is greater confidence among the critics that he has done all he could.

This week culminated six months of "new" diplomacy toward China, and the results look indistinguishable from the old diplomacy. It's laudable that the two sides are working to better understand each other, but for each, domestic political imperatives still trump the urgings of a foreign partner.