Recently, President Barack Obama hosted the Asia-Pacific Economic Cooperation (APEC) summit in Honolulu, Hawaii. Tough talking in front 21 APEC nations and a world audience, the U.S. President chided China (by saying it was time for China to act like a "grown up") and its economic policies that, in the minds of many, have left the value of the Chinese currency artificially low, which in turn has harmed American companies and increased unemployment in the U.S. China retorted by saying the U.S. does not dictate terms to China on trade and other international affairs unless Chinese policymakers agree. This dialogue is a continuation in a long running spate that lately has been heating up.

One has to speculate that part of this tougher talk from the U.S. side is due to the approaching 2012 elections. Obama wants to counter Republican claims that his administration has been too easy on China and that part of the current U.S. economic malaise is China's fault. The Trans Pacific Partnership (announced at the APEC) is billed as a precursor to a broad pan-pacific free trade zone. However, it appears to the Chinese as an American-led effort to isolate China among its Southeast Asian neighbors by (again) setting the rules of trade and commerce.

The Chinese consider the announcement that the U.S. will station military aircraft and up to 2,500 troops in Australia as offensive and tangible evidence that the U.S. wants to weaken Chinese influence in the region, even though the proposed military presence is 5,500 miles from China. Part of the unspoken reasoning is China's claim of sovereignty over the entire South China Sea, which is in conflict with many other Southeast Asian nations' claims. From a strategic perspective, by continuing its military presence in Japan and South Korea and by establishing a military presence in Australia, the U.S. may be able to keep China's military preoccupied and pinned down in its own backyard.

Yet despite the heated rhetoric in public and maneuvering behind the scenes, both nations in fact need each other in multiple ways in order to advance. For example, an easy way for the Chinese to let the yuan strengthen against the U.S. dollar is for the People's Bank of China to reduce its buying of U.S. Treasury (UST) securities. By just not lending as much or by simply failing to rollover all UST debt that matures, the Chinese would cause significant strengthening of the yuan because the demand for U.S. dollars would be dramatically reduced. However, there would be significant consequences in such a move.

First, the U.S. government would have to pay much more for any new debt and for the debt it already has. This would significantly impact all federal spending programs because the U.S. budget would be much tighter than it already is. Next, the monetary policy laid out by the U.S. Federal Reserve to keep interest rates very low through 2013 would be in total disarray. Third, more expensive Chinese products in American markets would put upward pressure of consumer prices in the U.S. These three aspects of a stronger yuan, by virtue of less Chinese lending, would all but certain cause negative economic growth in the U.S. There is a fourth point to consider: a stronger yuan would allow China to buy raw materials (process trade) from foreign sources cheaper; therefore, some Chinese finished goods might actually be cheaper in U.S. dollars.

In China, a stronger yuan would make American products cheaper, and foreign exports would surely be reduced – causing higher Chinese unemployment. Higher unemployment in China could very well increase civil unrest that is already on the rise. A less stable China is certainly not in the best interest of the U.S.

So, both sides have much at stake in the current stage of the ongoing dialogue. As Warren Buffet said in a Nov. 14 interview: "it's not in our interest to start getting really furious with each other. And there will be tensions. We'll want to play the game our way. They'll want to play the game their way and we'll both have to give in some cases." With all of this being said, it appears the U.S. and China should engage in serious and continuous negotiating sessions behind closed doors – if they are not already doing so. In the meantime, both parties should try their best to understand as much of the background reality as possible. This too is in all likelihood already occurring.

The Chinese have an old saying: "No mountain is big enough for two tigers." Today, the world seems to be the mountain and the two tigers China and the U.S. The two tigers need to treat each other as litter mates.

The author is a columnist with China.org.cn. For more information please visit: http://www.ccgp-fushun.com/opinion/tylorclaggett.htm

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