Even as he tries to boost the economy, it's not too early for Barack Obama to prevent another credit bubble during the coming recovery. His Treasury secretary-designate, Timothy Geithner, may have been thinking of that last week when he fingered China as a "currency manipulator," or an unfair export machine whose surplus cash ended up in US subprime mortgages.
Clever move. China helped fuel the American housing boom of 2004-07 by recycling billions of export dollars into US debt. It purposely kept its currency undervalued to underprice its products, from toys to tractors. Little did Americans know that those purchases helped provide inexpensive loans for millions of less-than-creditworthy home buyers now in foreclosure.
Alarms over this financial imbalance went off during the Bush administration, which cited China's recycled capital as a major cause for the credit bubble. To lessen pressure from Congress, Bush officials persuaded Beijing to strengthen its currency by 19 percent since 2005. But China stopped that adjustment last July as its own economy slowed. And many economists say the currency is still too low by at least 20 percent.
Now the Obama team has fired a shot across China's bow to warn it to allow its currency to find its true value on global markets. Japan, too, which also intervened in 2004 to devalue its yen and boost its exports, is taking heat to keep it from another antimarket move.
First Japan and later China have long relied on the export model and an undervalued currency to build their economies. But with the resulting bubble contributing to a deep recession, US tolerance for this mercantile sleight of hand has come to an end. The US can no longer, in effect, subsidize Asia's growth. And both those nations need to better stimulate their own consumer societies rather than rely so much on the US.
Mr. Geithner's accusation could result in a formal complaint under US law in March, further embarrassing China and forcing negotiations. But the US has few tools to force China to float its currency without igniting trade protectionism or pushing Beijing toward less cooperation on global issues such as North Korea.
China can also cite its own hefty stimulus package as an example of how it is shifting away from the export model. Beijing may indeed realize, with its exports shrinking, that it must follow a different path to prosperity, including an adequate social safety net for its people, to help prevent another financial imbalance. Its steps to make its currency the standard in Asia – pushing out the US dollar – hint at such a path.
The Bush team avoided a direct confrontation with China on the currency issue. That only worked for a while and only in a small way. A Democratic president with a Democratic Congress may not have the patience for artful persuasion or care much about Beijing's worries over quelling its restless poor. Democrats could again threaten an import tariff on Chinese goods, as they did a few years ago.
The world can hardly withstand these two giant economies in combat over the issue of currency rates. Obama is smart to raise it now before the recovery begins.