Britannia Radio

EU rescue plans are sideshow compared with US-China currency war

China holds all those dollars while the US holds the key to what they will be worth. It is a Mexican stand-off in which we could all be hurt

Dollars: China has got a lot of them. Photograph: Corbis

George Osborne did his best to be cheerful about progress at the G20 summit negotiations in Seoul on Radio 4's Today programme this morning. Good. It's what chancellors of the exchequer are paid to do. The BBC itself helped him by leading its bulletins on the relatively trivial matter of the EU budget battle.

The odd billion paid – or not paid – to Brussels won't matter much if the brown stuff hits the global fan in the next year or two, which it might as creeping trade protectionism and competitive currency devaluations make the recession up to now look relatively benign.

In asserting that "we're making steps in the right direction", Osborne cited progress on IMF reform that will give greater clout to emerging economic giants such as China, India and Brazil, provide stronger bank regulation and better mutual understanding of the need to avoid beggar-my-neighbour trade policies, and achieve better currency balances between creditor/exports and debtor/importers – notably China and the US.

The upside is that all the players in Seoul have read the textbooks and know what they ought to do to avoid repeating the 1930s, which – I can't stress this enough – ended in world war as the default remedy for a crippling Great Depression.

In those days the US was the protectionist emerging giant, now it is the on-the-back-foot free trader while China plays the injured innocent while coining in the dollars – $2,000bn in its reserves – and keeping the renminbi artificially cheap.

The downside is that they all think it's someone else's problem to deal with. The BBC's Nick Robinson quotes a Chinese official as saying to western negotiators: "It's not quite clear why we have to take the medicine when you got sick."

Dear, oh dear. It would be easy if we could dismiss such silly chatter as primitive Asian mercantilism – that 16th century form of economic nationalism that believes you can only truly prosper at my expense – which long since gave way to more sophisticated doctrines of free trade and comparative advantage.

Unfortunately, the Germans – as European as you and me – take a similarly complacent view of their own huge trade surplus, second only to China's. Debtor countries – the people who buy German and Chinese goods – should put their own houses in order by exporting more and importing less, living within their means.

Fine. But, as the Guardian's grim reports on the Irish economy underline this morning, when applied to Dublin consumers and Dublin restaurants it is a recipe for bankruptcy all round, China and Germany included.

The Irish have attempted to retrench their way back to solvency by deep public spending cuts, only to find that the bond market – the people willing to buy Irish debt in euros – don't see any prospect of renewed growth.

As a result they are therefore charging the Dublin ministry of finance 9% – as of yesterday – for the privilege of lending the cash. As Larry Elliott points out in today's Guardian, Dublin doesn't have to repay money until next summer, but it has cancelled a couple of bond auctions.

Everyone is nervous. The eurozone rescued profligate and dishonest Greece (defrauding the EU's farm budget with claims that aerial photography proved bogus) at great cost to Angela Merkel's limited bank of political credit at home. She has since set up a permanent crisis resolution mechanism, but it is to be introduced next December – and could be overwhelmed.

What if Ireland, Portugal or Italy – the zone's three weakest sisters – need a similar bailout? Merkel made plain overnight that next time she wants private investors to share the pain. In other words, no moreEuropean Union underwriting of profligate national budgets.

Ireland bailed out its banks and is now contemplating selling them off to foreign investors. There is renewed talk of a sovereign debt default inside the eurozone: Portugal, perhaps, or Ireland.

Some experts say it's not an if but a when – and that bringing in the IMF (as Britain did in less serious circumstances in 1976) may be the best solution to ease unbearable pain. Bankruptcy often is, but it's serious for states because the bankers have long memories.

One of the past week's more interesting snippets of inside news therefore is that China – awash with all those US dollars – is sniffing around cash-strapped Portugal, offering to buy some of Lisbon's euro-denominated debt. Now why would Beijing do that, I wonder? Sheer kindness, diversifying its currency holdings – or a strategic toehold?

We'll find out one day, perhaps even before those economists, officials and politicians who told us it was imperative to join the eurozone have got round to admitting they were wrong. We would have joined with a lower exchange rate and lower interest rates than suited our situation – and had an even bigger bubble than we did. Our situation is bad enough, but could have been much worse. Arghh ...

All of which is a North Atlantic sideshow compared with the showdown between China and the US over their currencies. Washington has long suggested – not formally; that would be really serious – that Beijing is keeping the renminbi cheap to boost exports.

Worse, it has suppressed domestic demand – Chinese citizens buying goods – in favour of investment, mostly at home, which Beijing hopes will maintain its political control and domestic stability – always prized by the Chinese state – by creating more jobs and more exports. All those dollars are piling up in China, except when the state goes on its version of a shopping spree, buying up key foreign firms.

The US response has been to print more dollars in the name of quantitative easing – QEII as the next $600bn round is being called – to maintain liquidity by having the Federal Reserve buy US government debt.

This is risky and controversial. The Republicans don't like it and nor do the Chinese or Germans: don't inflate your currency at our expense, they say. But the sensible Keynesian response to that is that their remedy – to follow Japan, Ireland (etc) into deflation – would be worse for everyone. And, if private banks won't lend, then the public authorities must step in.

Both sides have valid points against each other. Both sides have made policy errors. But China, still playing the sulky global teenager, holds all those dollars while the US, the selfish middle-aged hippie in the drama, holds the key to what they will be worth.

It is a Mexican stand-off in which we could all be hurt.

On the radio this morning George Osborne held up the charming prospect of Chinese workers, a bit prosperous for the first time in their lives, being given the chance to "start buying British products". Whiskey, insurance, fashion, aero-engines, pharmaceuticals, video-games and JK Rowlings, I expect; we do better than we tell ourselves.

It's a charming thought: Marmite on the breakfast toast in Shanghai and Nanjing. Here's hoping.