The Chinese and the Russians have joined forces to launch an assault on U.S. financial hegemony! From China Daily:

China and Russia have decided to renounce the US dollar and resort to using their own currencies for bilateral trade, Premier Wen Jiabao and his Russian counterpart Vladimir Putin announced late on Tuesday.

This all signifies... not much. At most, it is a symbolic attempt to lodge a complaint against perceived U.S. mismanagement of the dollar as a global reserve currency.

Remember, hardly anyone is required to use the dollar. They do so because it is convenient. This is true domestically as well as internationally. A pundit could try to barter a column for a latté, with no money involved, but it would require finding just the right politically-curious barista. It's much easier to use dollars to facilitate exchange.

Globally, there is nothing novel about discovering an exchange rate between the Chinese RMB and the Russian rouble. Once you have each currency's exchange rate against the dollar, it's just straightforward division to calculate (known as the cross rate).

The problem for Beijing and Moscow is that if their trade does not balance - and China, at least, has occasionally had a problem with that - someone is left holding a bag of roubles or renminbi. Other than buying Russian goods, there's only so much one can do with roubles. That's what sets apart the big global currencies, like the dollar or the euro. Even if you don't want to shop in New York, you can always go to a Middle Eastern bazaar and buy a few barrels of oil. 

There are perks to issuing a global currency; it's nice to be able to print money that's accepted around the world. There are also responsibilities. If the U.S. Federal Reserve prints too much, all those bags of dollars will drop in value. China, sitting atop many of those bags, has been particularly vocal about its concern.

That's why the Chinese premier is in Russia, issuing joint proclamations, trying to take the dollar down a peg. The Chinese and the Russians may be joining forces, but given the way global finance works, they're mostly going to end up simply encumbering each other.

President Barack Obama and his advisors formulated their Afghan policy almost exclusively to achieve one goal: deny safe haven to al Qaeda, according to Bob Woodward's book Obama's Wars. Counterterrorism is an important goal, but the administration seems to believe it is the only goal. This is a seriously myopic vision of U.S. national security interests. We have a much broader range of interests at stake in Afghanistan and South Asia. The administration's failure to understand them goes a long way to explain why it settled on a half-hearted strategy in Afghanistan.

So why are we fighting?

• Deny safe haven permanently. If al Qaeda returns the day or the year after we leave, we lose. Our effort in Afghanistan has to be about more than an endless holding pattern or a temporary band-aid. It actually has to enable Afghans to continue denying safe haven after the last U.S. soldier has left. That is the main problem with the scaled-down counterterrorism-only plan: it presents no realistic scenario for the United States ever to leave.
• Prevent instability in Pakistan. Chaos in Afghanistan will bleed over into Pakistan. Woodward's book records only a few brief mentions of this danger by administration officials, yet state failure in Pakistan is probably a much greater long-term danger to U.S. security than al Qaeda regaining another safe haven.
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How can we make sense of a People's Republic of China that is supposed to be, in the words of Deng Xiaoping, "biding its time and hiding its capabilities," but in fact is picking fights with most of its neighbors, including the United States? The Chinese were supposed to be using their deep reservoirs of "soft power" and practicing a highly skilled diplomacy aimed at assuring all that China is rising peacefully. But over the past year, Beijing has been rather more clumsy than the caricature of Chinese cleverness might suggest. China has in effect declared the entire South China Sea -- a body of water that is of critical importance for its abundance of natural resources and for its position as the maritime connection between the Indian and Pacific Oceans -- to be its territorial water.   

Needless to say, this has not gone over well with Vietnam and other Southeast Asian nations. And, just when it appeared that China would return to a lighter touch in the face of strong U.S. resistance to its South China Sea claims, Beijing bullied and coerced Japan into circumventing its legal processes after a Chinese fishing trawler rammed Japanese ships in the disputed Senkaku/Diaoyu island chains. In sum, China's exercise of power has been more hard than soft. Beijing seems to be neither "biding its time" nor rising peacefully.

A recent book helps explain how PRC leaders think about the world and what may lead China to engage in the behavior we and our allies find offensive. In The Mind of Empire China's History and Foreign Relations, Christopher Ford makes a persuasive case for hardwired cultural conditioning as an explanation for China's imperious behavior. China possesses, well, the mind of an empire. According to Ford, Chinese history has no precedent for stable coexistence among sovereign equals. Moreover, struggle over primacy within China and later with other states is a fairly continuous characteristic of Chinese history. Here is Ford:

The Chinese tradition has as its primary model of interstate relations a system in which the focus of national policy is in effect a struggle for primacy and legitimate stable order is possible when one power reigns supreme-by direct bureaucratic control of the Sinic geographic core and by at least tributary relationships with all other participants in the world system.  

According to Ford, China has an enduring sense of global order. Beijing assumes that the "natural order" of the political world is hierarchical and the idea of truly separate and independent states is illegitimate.

But wait, some might argue, what about China's embrace -- if not sanctification -- of the Western construct of international relations: Non-interference in the affairs of other sovereign states? If China's natural place is atop a Sino-centric hierarchy, and other sovereign states are lesser entities that should pay deference to China, then why use the histrionic defense of Westphalian norms which codifies equal status among states?

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Over the past decade, Washington's Taiwan policy has created unnecessary dilemmas for Taiwan's political leadership. On the one hand, if a president of Taiwan is considered too provocative toward China, Washington, rightfully irritated over undue tensions, will freeze relations with the democratic island. On the other hand, if a president of Taiwan reconciles with China, Washington's impulse is to neglect relations, confident that the cross Strait "problem" is resolving itself. It's a small wonder why many Taiwanese believe that Washington is unreliable.

President Chen Shui-bian faced the former from Washington. While no one in Taiwan doubted that he would protect Taiwan's de facto independent status and its hard won democracy, or fight for its international dignity, he lost the confidence of Washington and then his own people when relations with both China and the United States soured.

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On Friday the Nobel Peace Prize Committee in Oslo will announce the winner of this year's prize. One of the leading candidates (the odds-on favorite according to Irish book-makers Paddy Power) is imprisoned Chinese dissident Liu Xiaobo. Liu is the intrepid author of the "Charter 08" document calling for democracy in China. Modeled on the landmark "Charter 77" that played an instrumental role in galvanizing freedom's voices behind the Iron Curtain (and written in part by then-Czech dissident Vaclav Havel, himself a supporter of Liu's Nobel candidacy), Charter 08 has been signed by hundreds of Chinese intellectuals. It has prompted wide attention and support from Chinese dissidents, and the wrath of the Chinese Communist Party, such that Liu is now serving an 11-year prison sentence.

The Chinese Government fears that Liu might receive the Peace Prize, evidenced by the PRC's preemptive threats against the Norwegian Government. Nobel Institute director Geir Lundestad astutely dismissed China's ham-handed efforts at intimidation: "China has come with warnings before, but they have no influence on the committee's work."  

The Peace Prize might go to another worthy recipient, such as Zimbabwean opposition leader Morgan Tsvangirai or Afghan women's rights advocate Sima Samar. We will all know soon enough. This is an opportunity for the White House to begin putting some follow-up action behind President Obama's laudable UNGA speech two weeks ago, affirming his commitment to promoting human rights and democracy - and to show support for a fellow Nobel Peace Prize Laureate. 

For example, if Liu does indeed receive the prize on Friday, how about President Obama makes an in-person, live statement to the press congratulating Liu and calling on the Chinese government to release him from prison, immediately and unconditionally? (The latter meaning not house-arrest but true freedom of movement, speech, and association.) This would be a profound show of support not only for Liu but for all of China's dissidents and prisoners of conscience. And on next month's trip to Asia, President Obama could encourage the leaders of the other Asian democracies he visits -- such as India, Indonesia, South Korea, and Japan -- to speak out on Liu's behalf as well. This would make clear that China's repressive system is not just an American concern but a concern to all free nations. 

China's recent thuggish attempts at power-projection in Asia have alarmed many neighboring nations. But the core problem with China is not that it is a rising power; it is the nature of the regime. China's rising power would be much more welcomed by the region if the Chinese government was accountable to its citizens and respected their rights and freedoms. This is the kind of China that Liu Xiaobo and the other signatories to Charter 08 seek to bring about. They deserve our support.

Last week, the House Ways and Means Committee approved a bill aimed at addressing China's currency practices. It is scheduled for a vote by the full House sometime this week. In hearings, Committee Chairman Sander Levin (D-MI) stated, "the status quo with currency imbalances is unacceptable and unsustainable." He argued that China's "mercantilist policies" distort trade and slow U.S. economic growth and job creation.

Levin had listed a number of potential policy responses. None of the remedies promise quick or significant relief to America's jobs deficit. A number of them risk serious side effects. The committee settled on one which may be more symbolic than potent. The bill seeks to increase the chances for American businesses to win tariff protection by treating China's currency policy as an illicit subsidy. The bill was watered down significantly so it would not run afoul of global trading rules.

The fundamental problem is a disconnect between U.S. policymakers' sense of what global rules of economic conduct ought to say and what they actually say. Two prominent examples of this disconnect can be found in the rules of the World Trade Organization: An agreement on subsidies and countervailing measures establishes the conditions under which a nation can retaliate against a trading partner's export-encouraging practices; Another specific provision -- Article XV -- says that exchange rate manipulation should not be used to frustrate the intent of the trade agreement.

These provisions form the basis of some of the most prominent U.S. plans for action against China. This week's House bill would let U.S. firms seek tariff protection from Chinese goods "subsidized" by an undervalued exchange rate. A WTO case on Article XV would take China to task for the trade distortions resulting from a misaligned exchange rate.

But the WTO does not allow retaliation against any and all subsidies. It sets some strict conditions on which ones are actionable. According to veteran international trade lawyers, there is serious doubt that a distorted currency would meet those conditions. Nor does Article XV offer much clarity about lines that cannot be crossed. In each case, there is an important gap between the rules as they stand and the rules as envisioned by China's U.S. critics.

With such a disconnect, there are three options. The United States government could pretend global rules read more favorably; it could ignore the rules and strike out, perhaps by imposing a broad unilateral tariff; or it could seek to modify the rules through negotiation. The first approach risks the appearance of flouting international agreements and sparking new trade conflicts. The second approach would leave no doubt about U.S. contempt for global accords and would risk destroying the rules-based multilateral trading system.

The remaining option, then, is to seek new agreement on proper international economic behavior. Fortunately, the groundwork for such an agreement is already in place. The Group of 20 leaders, meeting in Pittsburgh last year, endorsed a framework for "Strong, Sustainable, and Balanced Growth." Earlier this month, John Lipsky of the International Monetary Fund said in a speech that, while there had been substantial "buy-in" to the idea of rebalancing, the plans that had been put forward to date fell short of what was needed.

While discussions of the principles undergirding the global economic system should be inclusive, the implementation problems are really the concern of a small number of large countries. This suggests a new solution. A G-20 Implementation Subgroup, consisting of the United States, Japan, China, and Germany, would be well-positioned to craft a more serious program than we have seen to date. Representatives of the European Central Bank and the IMF could also attend, given those institutions' relevant roles.

This should not be a meeting to talk down the dollar, nor to vent criticisms of China. Rather, the Subgroup would have a mandate to discuss the broad range of macroeconomic policies needed to achieve the kind of global rebalancing that meetings of the full G-20 have already endorsed. This would certainly include ways for China to address its unhealthy global surplus, but it would also include discussion of deficit reduction measures to reduce U.S. borrowing. If the subgroup meeting were held in January, it could take into account the recommendations of the U.S. bipartisan deficit reduction commission.

This approach has the virtue of engaging the key players in a multilateral discussion in a group sufficiently small that it might reach agreement on action. The multilateral approach is preferable to unilateral or bilateral pressure both in that the underlying problem is multilateral and in its avoidance of the kind of national rivalries that can emerge in bilateral discussions.

There are obvious potential pitfalls to such an approach. There could be a complete failure to reach agreement, for example. These are deep-seated problems that run up against serious domestic concerns. Or there could be ill-advised attempts at a quick fix, as some have characterized a previous effort at coordinated action, the 1985 Plaza Accord.

But the other options on the palette are unpalatable. There is a broad sense among U.S. policy folk (and some abroad) that bounds of proper international economic behavior have been crossed. The problem is that those bounds are not spelled out anywhere. This mix of ambiguity and discontent seems like a recipe for serious conflict. A meeting with a pre-set mandate to address imbalances would offer the best opportunity to defuse some of those festering tensions.

Over the weekend, the Taipei Times reported that the United States will soon begin operating high-altitude, long-endurance RQ-4 Global Hawk unmanned aerial vehicles (UAVs) out of Guam. When operational, these drones will monitor Chinese forces opposite the Taiwan Strait. Ultimately, they will replace the U-2 and RC-135 aircraft that conduct reconnaissance in the west Pacific.

The Obama administration deserves credit for such efforts to keep a close eye on Chinese military modernization. Although the term "transformation" has fallen out of favor in Washington, it has not in Beijing. China is deploying a range of capabilities aimed at blunting U.S. military power in Asia, including the DF-21D anti-ship ballistic missile, a large family of precision-guided ballistic missiles, anti-satellite weapons, and cyber warfare capabilities. As Jacqueline Newmyer writes in a thought-provoking article in the latest issue of The Journal of Strategic Studies, Chinese strategists believe that the so-called "revolution in military affairs" offers Beijing a historic opportunity to alter the military balance with the United States. Having concealed its military buildup for years, the Chinese leadership has become increasingly open and bellicose in discussing its ability to inflict damage on U.S. forces.

The deployment of Global Hawks to Guam offers more than just an opportunity to monitor Chinese military deployments; it also holds with it the possibility of new methods to enhancing security and strengthening deterrence in Asia -- something that should appeal to an administration that has favored multilateral approaches.  The United States' Asian allies are all concerned about Chinese military modernization, and about U.S. staying power in the face of a rising China. They are also interested in purchasing or developing high-altitude, long-endurance UAVs like the Global Hawk. The door would thus appear to be open for bold action: What if the United States spearheaded a multinational effort to field a constellation of high-altitude, long-endurance UAVs and share the data produced by their sensors to establish a common picture of the west Pacific? With some vision and bold action, U.S. drones could become the core of an Asian allied airborne reconnaissance network. Such a network could increase transparency in the region. Having many eyes watching the region could also represent a powerful deterrent to Chinese aggression, whether across the Taiwan Strait or in the South China Sea.

The deployment of UAVs to Guam is a good move. With a bit of boldness and creativity, it could yield much more.

What was the administration trying to achieve by sending Larry Summers to Beijing? What message was it trying to convey? And was the intended audience American or Chinese?

Taken at face value, Dr. Summers, as head of the National Economic Council, was there to deliver a message about American economic concerns. Foremost among these has been the stubborn stasis in China's exchange rate against the dollar. If this was the real purpose of his trip, he achieved little; the Chinese did not even pretend to accommodate. According to the Wall Street Journal:

Chinese officials have consistently said that they won't change key economic policies because of foreign pressure, and argued that the exchange rate has little bearing on the U.S. trade imbalance with China. "Our exchange rate reform can't be pressed ahead under external pressure," Foreign Ministry spokeswoman Jiang Yu said at a regular press briefing Tuesday.

If Dr. Summers' mission was to describe mounting political pressure in Washington, it is not clear what he could have said that would have surprised his hosts. The Chinese have certainly already heard of Sen. Schumer (D-NY) and they have undoubtedly read the Ryan-Murphy bill in the House.

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The Washington Post recently reported that China is pushing for a resumption of the Six Party Talks. This means one thing: President Obama's North Korea policy is working. The relationship with China works best when China needs something from us. Consider this: former Secretary of Defense Donald Rumsfeld refused to see the Chinese for a year after the PLA rammed our EP3 surveillance aircraft with a fighter jet. The Chinese were begging to see him, and DOD got what it wanted from the relationship. That is the proper way to handle Beijing -- the deft use of leverage.

Now we want China to use its influence to disarm North Korea, join our contingency planning for a political transition in Pyongyang that could get messy, and discuss the eventual unification of the peninsula. The fact that China is practically begging the other Six Party participants to come back to the table means that China is feeling the pain of Obama's policy. The administration has conducted joint exercises with the Republic of Korea, enacted harsh sanctions on Pyongyang, and refused to negotiate with Pyongyang unless it stops its provocations. We are demonstrating to Beijing that if it does not control its North Korean ally, China should be ready for intense U.S. pressure on its periphery. The administration should stick with its approach until Beijing forces Pyongyang to abide by international law and give up its nuclear weapons.

But the Washington Post article closes on a somewhat troubling note: the administration wants some contact with Pyongyang. This is not the time to talk to Pyongyang. Obama should not repeat President Bush's mistake -- as soon as he used U.S. leverage over North Korea and China in the form of biting sanctions, he lifted them only to receive more dangerous provocations in return. Obama should wait until China is clear about its choices: disarm Kim or face unrelenting U.S. pressure.

In 2009, the Group of 20 nations committed themselves to rebalancing the world economy. Summiteers in London and Pittsburgh resolved that the large trade surpluses and deficits that had characterized the global economy in the lead-up to the financial crisis should no longer be tolerated.

The G-20 leaders were so effective in their proclamations that much of the requisite rebalancing took place in anticipation, before the leaders could even implement any collaborative policies. China's current account surplus of $426 billion in 2008 fell 33 percent to a surplus of $284 billion in 2009. The Middle East, which as a region ran a surplus of $348 billion in 2008, saw it drop 90 percent to just $35 billion in 2009. The United States current account deficit of $706 billion in 2008 shrank by over 40 percent to $418 billion in 2009.

Such anticipatory compliance on the part of the world economy would have been most welcome, had it only continued. Yet recent economic data shows it has not. The New York Times summarized the latest numbers:

The United States trade deficit ballooned to $49.9 billion in June, the biggest since October 2008. In July, one month later, China recorded a $28.7 billion trade surplus, the biggest since January 2009. In the first five months of the year, Germany's trade surplus... rose 30 percent compared with 2009, to about $75 billion.

So what does this mean? Before the world's leaders could even assemble, the imbalances shrank, but once they issued their proclamations, the imbalances revived. The moral is that trade balances are driven by deep-seated forces within an economy and are difficult to manipulate. The shock of the housing bust and financial crisis dampened consumption and, thus, imports. Some countries were hit harder than others. U.S. monthly imports peaked at $232 billion in July of 2008. They bottomed out at $151 billion in May of 2009. That 35 percent plunge is a pretty good depiction of economic panic. Over the same period, exports fell by "only" about 24 percent, and they were smaller than imports to begin with (hence the deficit).

Of course, relative consumer confidence around the globe was not the only factor driving these numbers. There were also wild exchange rate swings as investors tried to puzzle out which of the world's major markets posed the least risk.

The point is that none of this was due to the fine-tuning of finance ministers or chancellors of the exchequer. They were all trying everything they could to restore confidence among consumers and investors and to revive economic growth. The standard tools that would be used to manipulate external imbalances were instead directed toward crisis response. This is unlikely to change in the near future. China is much more worried about steering between their Scylla and Charybdis of inflation and unemployment than it is about its trade surplus with the United States. Fed Chairman Ben Bernanke is far more preoccupied with concerns about a double-dip recession and deflation than he is about the value of the dollar. Their moves may end up shrinking global imbalances -- significant new quantitative easing by the Fed might depress the dollar --  but this would not be the principal intended effect.

From an economic standpoint, the inability to tackle the imbalances is less worrying than some commentators made it seem. There was a connection between a global savings glut (one aspect of the imbalances) and the U.S. financial crisis, but the latter did not follow inevitably from the former. It took a whole raft of unwise U.S. domestic policies to mishandle the offer of cheap global funds (e.g. offering mortgages with no money down to purchasers of dubious credit was problematic). Similarly, there is no inevitable link between trade deficits and unemployment. Countries with flexible exchange rates and sound policies can adjust to all kinds of external shocks, though the adjustment may be painful.

From a political standpoint, however, the situation may be more dire. Michael Pettis, an astute observer of the Chinese scene, this week concluded that "The world seems to be marching inexorably towards trade war." He argued that the United States will be forced to choose between protection and soaring trade deficits, with the former threatening an ensuing round of global protectionism.

The issue will re-emerge in Washington when Congress returns next month. The Obama administration won a respite from Congressional pressure when China agreed to allow its currency to move in June. Since then, the Chinese yuan has appreciated from a rate of 6.83 to the dollar all the way up to 6.80 to the dollar (less than half a percent). Congressional hearings are already scheduled.

None of this is to argue that it was wrong for the world's major nations to try to address imbalances at their 2009 gatherings, just that the problem is more intractable than they acknowledged. To navigate the economic and political imperatives successfully will require substantially more deft diplomacy.  

What happened to China's much vaunted "soft power" and "good neighborly" diplomacy about which we have heard so much in recent years? China's supposed "soft power," always overstated, has passed from the scene in short order.

Over the past few months, the Chinese have not-so-softly declined to invite Secretary of Defense Gates to visit Beijing; called the South China Sea a "core interest" (akin to claiming that the sea is China's territorial water); threatened to retaliate if the United States proceeds with the sale of additional F-16s to Taiwan; and refused to so much as condemn the North Koreans for killing 46 South Koreans sailors in cold blood.

Why are the Chinese coming out swinging now? Two reasons. One is the smell of American weakness, which Obama appears to be correcting. The second is that all is not well within China.

On reason one: As master practitioners of it, the Chinese Communist Party understands and respects power. It was no accident that Sino-American relations were stable, and at times even constructive, while President Bush was balancing China's power by upgrading relations with Japan, selling arms to Taiwan, and developing a strategic partnership with India.

President Obama approached China differently, eschewing balance of power politics and going out of his way to avoid ruffling Beijing's feathers. For example, the U.S. relationship with India was not considered an important part of Asia's balance of power, China's human rights abuses were ignored, and the administration put off selling needed arms to Taiwan or meeting with the Dalai Lama for as long as it could. While Obama saw these moves as strengthening a partnership with Beijing, China jumped at the chance to end what it views as America's irritating practice of meeting with the Tibetan spiritual leader and helping Taiwan defend itself.

On top of these misguided policies, Japan was going through its own political turmoil and, through no fault of President Obama's, thus unavailable to help maintain the balance of power.

Predictably, Beijing saw a U.S. government it could push around and wanted more. Now it is going for the jugular, demanding an end to arms sales to Taiwan and declaring the South China Sea a Chinese lake.

China's manifold domestic problems are another cause of China's belligerence. With an upcoming political succession in 2012, featuring party cadres without any ties to the communist revolution vying for leadership roles, the politburo has every reason to worry. Popular unrest is also becoming more political, sophisticated, and organized, as many migrant workers have worked in different places, and seen inequalities and injustices all over the country (see Minxin Pei's recent article in The Diplomat).

It is likely that the People's Liberation Army and China's anti-American nationalists see a ripe time to put pressure on the political system and to "get tough." What one hears from the Chinese is, "we are strong and not going to take it in anymore." The "it" includes arms sales to Taiwan and U.S. military activity in China's periphery.

The Obama administration appears to have gotten the message. They did sell a much needed package of arms to Taiwan. Secretary Gates did not mince words in talking about U.S. and allied interests in the South China Sea and the administration appears to be going forward with joint anti-submarine warfare exercises with the South Koreans despite howls of protests from China.

Washington still has a strong hand to play. China is growing stronger, but, for all of its chest thumping, it pales in strength compared with the United States and its allies in Asia. And none of our Asian allies want a dominant China. Indeed, one of the untold stories in Asia is the region's military modernization. Almost all of our allies are buying advanced tactical aircraft (mostly the F-35), maritime surveillance capabilities, and diesel submarines -- to deal with a rising China. The atmosphere is ripe for us to begin creating an informal network of alliances operating more closely together, particularly since much of what our allies are buying is American equipment. Washington should start to build the institutions today that will allow the allies to train together on their fifth-generation aircraft, patrol the South China Seas, and hunt for submarines. How about announcing the creation of a fifth generation aircraft "center for excellence" in Singapore, where all allies can train?

The point is that there is still a chance to present China with a choice: act like a responsible power or face a great wall of resistance. The good news is that there are many Chinese who want the former.

Did the Obama administration just score a big foreign policy victory on Chinese currency practices? Over the weekend, China announced that it would let its currency begin to move for the first time in years. As trading for the week opened, the Chinese renminbi (RMB) broke free from its long-held 6.83 rate to the dollar, and rose above 6.80.

This certainly seems like the successful culmination of a strategy the administration pursued at some political risk. In the spring, pressure was mounting on the Treasury to name China a "currency manipulator." The administration resisted the pressure and ignored the Congressionally-mandated April 15 deadline for a determination. Top administration officials persuaded Congress to await the outcome of multilateral efforts to persuade the Chinese to move. Key Congressional figures, like House Ways and Means Chairman Sander Levin (D-MI) set out a new deadline: get results by the G-20 meetings at the end of June, or Congress would act.

Now, the Chinese seem to have responded in the nick of time. Not only did China seem to relent, but it did so on the eve of the G-20 summit in Toronto. The Obama administration had previously trumpeted the elevation of the G-20 as the world's premier multilateral forum as a principal foreign policy success of its first year.

So what's not to celebrate?

China has long said it would change its policy; it had just not said when. In its weekend announcement, Chinese authorities were exceedingly vague about the specifics of the new policy. The only real clarity is that the change will not be a dramatic one-off appreciation of the sort that some U.S. critics of China have been calling for.

The most likely outcome is that the RMB will bounce around as it gradually appreciates, perhaps at a rate of 6 percent per year. This is the most likely outcome only because it is the policy China pursued in the only other instance in which significant appreciation was allowed, from 2005 to 2008. Nouriel Roubini has even noted that the RMB could depreciate, should the euro continue its sharp decline.

The change could be sufficiently minor that the real puzzle is why China did not do this months ago. The move relieves a great deal of international pressure on the Chinese and they incur minimal costs in terms of new competition for their exporters. Now the Chinese are free to spend their summit time criticizing Western budget deficits.

The U.S. domestic politics of China's currency move get complicated. The only position that really united the bulk of Western critics was that Chinese stasis on currency was unacceptable. Some prominent critics pointed to Chinese revaluation as a cure for U.S. job market ills.  Fred Bergsten, Director of the Peterson Institute for International Economics, wrote that Chinese revaluation would be "by far the most cost-effective possible step to reduce the unemployment rate and help speed economic recovery" in the United States. A Washington Post story Sunday cited Bergsten to note:

"A jump of 20 percent (in the RMB) could cut as much as $150 billion off the U.S. trade deficit with China and create as many as 1 million U.S. jobs by making American exports more competitive..."

This weekend's move will not come close to meeting those expectations. The analysis promising job gains is problematic at several levels. For example, in our sole previous experience with Chinese appreciation, the 20 percent rise from 2005 to 2008, the U.S. bilateral trade deficit with China actually expanded.

A more fundamental issue is that the link between trade deficits and jobs is tenuous. The United States has experienced full employment at times of large trade deficits, and we've experienced painful rates of unemployment at times when deficits were declining. Normally, we think trade deficits have little to do with the overall rate of unemployment. The relatively sophisticated argument being put forward by Paul Krugman is that we are suffering from a ‘liquidity trap,' placing us in an exceptional time in which the standard rules do not apply. That view is controversial, but let's accept it for the moment. There is little indication that the liquidity trap, if we are in one, will go on indefinitely. [A key feature of liquidity traps is that interest rates are near zero, and right now longer term interest rates are not]. Thus, if Chinese currency appreciation were to cure U.S. unemployment, it would have to be big and quick. The Chinese announcement just made clear it would be neither.

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Is the "China Fantasy" starting to get deflated by reality? Three years ago, Jim Mann's provocative book of that title identified the "China Fantasy" as the dogmatic belief of many Western political and commercial elites that China's economic liberalization and growth would lead inevitably to democracy at home and responsible conduct abroad. The operative word was "inevitably" -- the assumption being that China's remarkable economic success would automatically produce a middle class that demanded greater political rights, and that China's growing integration with the global economy would produce benign and responsible international behavior. Based on this assumption, the corollary policy prescription for the West was to pursue a policy of engagement and encouragement towards China's rise.

This paradigm seems to be shifting. I recently participated in a conference in Europe on China, attended by a cross-section of policy, academic, and commercial leaders from Europe, the United States, and China, and came away struck by palpable attitude changes in at least three dimensions. Taken together, these are signposts that the previous conventional wisdom on China is coming under question:

• European attitudes. Many of the Europeans present voiced a pronounced skepticism towards China, both for the Chinese Communist Party's ongoing refusal to liberalize the political system as well as for what they perceive as China's irresponsible international posture. Various reasons were suggested for this change in European attitudes from even two years ago, but the most salient one seems to be European ire over China's obstreperous conduct at last year's Copenhagen climate change conference. If Europe has a litmus test for international good citizenship, it is climate change. But China's behavior on that front seems to be prompting increased European frustration with China on other issues as well, including human rights, Iran's nuclear program, and China's military build-up.
• Business attitudes. American and European business leaders with extensive China experience also expressed significant disillusionment. As one noted, whereas 5 or 10 years ago the business community was virtually unanimous in its enthusiasm for the China market and in support of closer political ties between China and the West, now the consensus is fractured. Causes for this disenchantment include widespread corruption, intellectual property rights violations, the protectionism of the new "indigenous innovation" policy, and the general restraints on private sector flourishing imposed by China's state capitalism model.  To be sure, many multinational companies remain profitably invested in what is still the world's largest emerging market, and many more are eager to get in. But Google's recent exit from China may not be the only one, and some multinationals looking at China are weighing a new set of cost-benefit analyses.
• Chinese attitudes. If assessments in the West are changing, so are elite Chinese attitudes. Most of the Chinese participants were from universities or think-tanks (i.e. not People's Liberation Army hard-liners), but even they displayed a nationalistic confidence and rather defiant posture towards the West, especially the United States. At its most benign, this is an understandable attitude of a proud rising power. But in too many ways it is not benign, especially considering that the Chinese participants took worrisome stances on issues such as human rights, Taiwan, Tibet, mercantilist nationalism, Iran's nuclear program, shielding North Korea, and especially the security "threat" purportedly posed by the United States.     

The erosion of the "China fantasy" does not mark from a precise date, but a watershed moment ironically may have been the 2008 Beijing Olympics. Anticipated as China's grand arrival on the global stage, the Olympics were by many measures a major success -- and not just for people named "Michael Phelps." Yet surrounding the Olympics were constant reminders of Beijing's authoritarianism, whether the petulant rhetorical attacks on Tibet supporters, the draconian efforts at pollution reduction, the omnipresent surveillance, and the tight control on any voices of dissent. Put it this way -- as obnoxious are those %&*!@ vuvuzelas at the World Cup, they are also the sound of a free society.  You can bet they would have been banned in Beijing.

The end of the "China fantasy" does not necessarily prescribe a wholesale shift in the free world's posture towards China -- just a more realistic one. For the United States, this has several policy implications:

• Remember that "engagement" doesn't just apply to the government to government relationship with Beijing, but also to the people of China. A forward-looking China policy must include increased support for the seeds of civil society in China -- especially young entrepreneurs, religious leaders, human rights activists, students and scholars. Much more than the CCP, they are the best hope for the future of China.
• Keep cultivating our alliance partners in Asia, and also build ties with emerging powers. Nations as diverse as Australia, Japan, Vietnam, Indonesia, South Korea, Singapore, and India have two things in common: they are wary of China's aspirations to regional hegemony, and they desire closer ties with the United States. 
• Strengthen our defense capabilities to deter China's emergence as a viable peer competitor. The problem with China's military build-up is not just that it is non-transparent, but that much of it seems designed specifically to counter American force projection and capabilities. For the United States, this means everything from improved cyber-security, command and control system protection, and anti-ship missile defense to, yes, a sufficient F-22 force to preserve air superiority.
• Get our debt under control. Not that the United States needs yet another reason to tackle its mind-blowing $13 trillion debt, but the fact that China owns close to $1 trillion of it is a further concern. The debate will continue over whether this debt financing imbalance actually leaves China or the United States more vulnerable in the aggregate (see this Dan Drezner article for a thoughtful analysis), but at a minimum it is a strategic constraint on the United States.

None of this precludes continued bilateral cooperation with China on important issues, or continued support for sound investment in such a vast market. The "China fantasy" was based more on hope than experience, but the benefit of recent experiences with state capitalism is the chance to replace hope with prudence.   

My last post for Shadow Government elicited some concern from friends in the Obama administration that our criticism of the President's Asia policy was overblown. I stand by what I wrote, but this pushback is fair. Not all the problems in U.S. relations with important Asian powers can be laid at Washington's door. And the Obama administration has taken some constructive early steps. 

On the positive side of the ledger, President Obama can claim credit for intensifying U.S. outreach to Indonesia -- although formalization of a new Comprehensive Partnership remains unfulfilled given the postponement of the President's trip there to launch it. President Obama also deserves plaudits for committing the United States to exploring membership in the East Asia Summit, meeting with ASEAN heads of state, and fostering strong relations with key ally South Korea. Here again, however, the Korea-U.S. Free Trade Agreement, whose implementation should be a centerpiece of the relationship, remains stalled; President Obama seems unwilling to push Congress to ratify it. In another welcome trade-related move, the President has expressed his support for the Trans-Pacific Partnership. This is a worthy minilateral trade initiative, but it excludes Asia's big economies and is no substitute for a wider Asia-Pacific trade liberalization agenda. These are all early steps in the right direction, but they do not amount to strategic accomplishments.

On the negative side of the roster, there is no question that President Obama has been dealt a particularly difficult hand in relations with core Asian ally Japan -- where a veritable political revolution last August deposed America's staunch allies in the Liberal Democratic Party and brought to power a new and untested government. It has defined itself in office in part by opposing a previously agreed plan to realign American forces in Okinawa, leading to growing concern over the future of the alliance. The U.S. administration has struggled with how to handle this unresolved conflict -- which has been badly mismanaged by Prime Minister Hatoyama and his colleagues. Resolution may be in sight, but the whole affair risks tarnishing the alliance at a time when Chinese and North Korean assertiveness is intensifying.

Indeed, President Obama has been on the receiving end, until recently, of an increasingly sharp-elbowed China's projection of its power and influence in world affairs, which has created the rockiest period in Sino-American relations since the EP-3 incident of 2001. Here, a firmer and more balanced approach to China early on -- one that prioritized U.S. relations with allies in Asia a little more and reassured China a little less -- could have paid strategic dividends. But the administration's recent recalibration of its policy promises a sturdier defense of American interests and values and, by extension, a more stable relationship. It may even result in a Chinese decision to allow the renmimbi to appreciate. This would be an important accomplishment indeed -- one that China should take in its own interests, given its overheating economy. It would be welcomed by India, South Korea, Indonesia, Singapore, and other U.S. partners in Asia whose competitiveness has suffered from China's artificially cheap currency.

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