Washington learns to treat China with care

WASHINGTON (Fortune) -- America met with its lead banker this week and was forced to answer plenty of tough questions about its spending habits. "Attention should be given to the fiscal deficit," China's finance minister, Xie Xuren, warned the U.S.

And while U.S. officials gamely lobbed back the by-now-familiar refrain that China needs to boost its domestic consumption, rather than relying on exports to the U.S. for growth, it was clear which side was playing defense at this latest round of the three-year-old Strategic and Economic Dialogue.

"We've learned some tough lessons as a country," Treasury secretary Tim Geithner said at the conclusion of the talks. "I think the basic lesson, the importance of living within our means, is best for the country."

The economic balance of power "has shifted a great deal because of the United States' relative weakness and China's relative strength," said Minxin Pei, director of Claremont McKenna's Keck Center for International and Strategic Studies. "We shouldn't be badgering our banker at the moment."

Ah, what a difference a homegrown financial crisis makes.

When then-Treasury Secretary Hank Paulson landed in Beijing in December 2006, with a full array of U.S. cabinet officials in tow, America's focus was on giving the Chinese driving lessons about how to maneuver as a "responsible stakeholder" in the global economy. At the time, victorious Democrats had just taken control of Congress and were threatening retaliation against China, which stood accused of stealing American jobs and manipulating its currency to keep its goods artificially cheap.

The Chinese officials bristled at the lectures, with then-Vice Premier Wu Yi accusing "some American friends" of "harboring much misunderstanding about the reality in China." She added, pointedly, "This is not conducive to the sound development of our bilateral relations."

Now, with a Democratic White House in charge and President Obama making clear he wants to work with China on issues like climate change and nuclear nonproliferation, the China-bashing from Democrats on the Hill has softened. Sure, union leaders and their allies sent out calls for tough talk toward China as this week's talks got underway. "If our nation's leaders stand down as China stacks the deck against American business," said Ohio Senator Sherrod Brown, "the downward trade spiral will continue."

Brown and others also recently raised concerns about the prospect of a government-run General Motors building cars in China. But mostly, China no longer serves as the poster child for American job losses on Capitol Hill.

"Despite double-digit unemployment, China is not identified as the enemy, Wall Street is the enemy," says Pei. (One might accuse the Chinese of supplying the cheap credit that helped fuel a housing bubble, but that's a stretch, and a political message that misses the point.)

Today China, holding $801.5 billion in Treasury bonds, is the largest foreign financier of the record government deficits that this Democratic administration says are necessary in the short run to pull the American economy out of a deep recession. The Chinese, it's clear, are concerned about their investment.

From the outset of this week's high-level talks, Chinese officials wanted details on how the Obama administration planned to control inflation -- and bring down the deficit.

"What was most important to the Chinese was to hear about the trajectory," David Loevinger, Treasury senior coordinator for China affairs, told reporters. That job fell to budget director Peter Orszag.

In contrast to the cultural differences that Chinese officials in particular stressed in 2006, this time around the global economic crisis had highlighted the concerns that both countries shared, U.S. officials said.

"The U.S. and China have acted more like each other than many of the other economies," Loevinger said, adding that both countries are now "grappling with the timing of withdrawal of the macro-economic stimulus."

So far, President Obama's economic relations with China have gotten off to a better start than any President's since George H.W. Bush. President Clinton attempted to use trade sanctions to force China to improve human rights -- and then had to reverse himself. President George W. Bush faced early strains because of his plan for U.S. arms sales to Taiwan, followed by the standoff over a downed U.S. spy plane in Chinese territory.

But the role of China in financing ballooning federal deficits no doubt will bring on its own set of political complications between the two countries in the coming years. As President Obama scrambles to find ways to contain government spending, he will have be looking over his shoulder not only at those independent American voters who worry about deficits, but also at his Chinese bankers.