G7 rallies the ranks

LONDON, Feb. 16 (UPI) -- After some worrying signs of unsteadiness in their ranks, the world's financial elites have rallied and planted their flag boldly and publicly against any drift toward protectionism.

The Group of Seven finance ministers endorsed once again the principle of maintaining open markets and free trade, including the now-ritual lip service to the need to complete the Doha Development Round of trade talks.

Even more than the appalling economic figures that emerged from Europe and Japan as the G7 meeting convened in Rome over the weekend, the main concern as the summit opened was the protectionist threat. There were two main examples on offer from the American side.

The first was the "Buy American" clause in President Barack Obama's stimulus bill, and the second was the clear threat of U.S. retaliation against China for what the new Treasury Secretary Tim Geithner had described as "currency manipulation" in his confirmation hearings before the Senate. Geithner was simply echoing his master's voice. Last October, Obama, while still a U.S. senator, had made exactly the same charge against China in a letter to the U.S. Treasury that he co-signed with other senators.

Each of these has now been resolved. The final version of the bill agreed on by the U.S. Congress includes a preference for buying American-made products but only in a way compatible with World Trade Organization rules. This is a loophole that clever lawyers can and will exploit, but it at least maintains the principle of free trade.

The question of China's manipulation of its currency to keep its exports cheap is more complex. Most countries at some time have tried to engineer favorable exchange rates in their own economic interest, usually by manipulating interest rates. China, however, maintains a form of currency control that allows the renminbi to be traded on current accounts but not on capital accounts. This makes currency manipulation easier, and also makes China vulnerable under WTO rules.

But Geithner and the G7 have decided to grant China a waiver, on the grounds that they would rather make China a partner in recovery than an antagonist in a trade war.

"We welcome China's fiscal measures and continued commitment to move to a more flexible exchange rate, which should lead to continued appreciation of the renminbi in effective terms," said the G7's formal post-summit communique.

G7 officials later told reporters the finance ministers felt it was important "to show solidarity with China's steps to overcome the crisis and avoid undermining G20 discussions involving Chinese officials" ahead of the Group of 20 summit scheduled for April 2 in London.

Geithner later echoed this tone, saying the United States was committed to working closely with China.

"We very much welcome the steps they've taken to stimulate domestic demand, and we welcome their commitment to continue further evolution of their exchange-rate system," he said. "All countries need to sustain a commitment to open trade and investment policies which are essential to economic growth and prosperity."

Asked about this distinct change of stance by Geithner, at a later non-attributable briefing a senior Treasury official said, "A lot has changed in the last few months, and we're in a delicate moment."

There has been a great deal of intense but behind-the-scenes diplomacy on this issue over the past two months, with German and British officials stressing discreetly that the last thing the global economy needs at this time is any hint of a trade war across the Pacific Ocean. Dominique Strauss-Kahn, managing director of the International Monetary Fund, stressed last month that a globally coordinated policy of supporting growth that included China is more urgent than longer-term currency imbalances like the undervalued renminbi.

China has demonstrated its readiness to be part of the global solution rather than part of the problem. Even though it is not a member of the G7, China joined the coordinated interest rate cuts announced by the G7 members last October and was also the first to announce -- and to start spending -- a $586 billion investment package.

One result of China's early action has been the recent emergence of some hopeful signs of recovery. The confidence index of purchasing managers in China, a reliable leading indicator, has shown a modest rise, bank lending has risen, and the Shanghai stock market is climbing again.

But China has been hard hit, with its exports falling for the third consecutive month in January, falling 17.5 percent from a year earlier, after a 2.8 percent decline in December. Imports plunged even further -- 43.1 percent, twice as much as December's 21.3 percent year-on-year drop. The biggest falls were in components from Japan, South Korea and Taiwan, which usually would be assembled in China for subsequent export. The figures may have been distorted by the Chinese new year holidays, but top analysts like Morgan Stanley and Standard Chartered estimate its growth since the fourth quarter of last year to be close to zero.

The bottom line is that the G7 could develop a common front that includes China on the importance of maintaining open trade and concerted international action to revive the global economy and prevent the world recession from sinking into a full-scale depression.

"You do hear around the world a much greater sense of urgency and commitment now," Geithner said at a news conference. "I think we all recognize that the power of what we do individually would be much more effective if we're moving together."

But the poor stock market response to Geithner's disappointingly vague plan to rescue the U.S. banking system meant that the new U.S. treasury secretary remains on the defensive. And the dismal results from Japan and Europe, with Japan's exports down a stunning 35 percent in December and German export orders down 25 percent (and exports account for half of Germany's GDP) point to tough times and more unemployment ahead.