Avoiding fireworks in China

A "dream team" of US Cabinet secretaries are in Beijing this week to coax China into further economic reform – before Democrats in Congress try to do it for them. The US has been here before. In 1985, a team led by none other than James Baker tried to tame a juggernaut Japan. That mission's lessons are instructive.

Then-Treasury Secretary Baker brokered a deal 21 years ago to raise the value of the yen by a massive 50 percent, making Japanese exports immediately more expensive. The aim was to buy time for US industry – mainly automakers – to shape up.

Japan overreacted, however, and overpumped its economy with cheap loans to compensate for slower exports. When that inflation bubble burst, Japan entered a long slump. Only a few American industries, meanwhile, met the Japanese challenge. Many, such as GM and Ford, didn't shape up soon enough to foreign competition, forcing massive layoffs.

That quick, drastic currency-rate fix turned out not to be the magic bullet for the world's top two economies.

The US and Japan often made clumsy moves to remove trade frictions. After the creation of the World Trade Organization in the 1990s, they now often solve their few disputes there in quiet litigation.

China, on the other hand, has been in the WTO for only five years, fulfilling many of its initial obligations to open markets. It has quickly become the fourth-largest economy, relying heavily on exports to the US that, as with Japan, have been made more inexpensive by a controlled currency rate. The US is now trying fix that currency manipulation and other trade issues through high-level bilateral talks. But it must be careful not to force drastic moves that would backfire or simply not achieve their intended ends.

It's fortunate, then, that this large US delegation is led by Treasury Secretary Henry Paulson, who understands China well from dozens of trips there as a Wall Street executive. His powers of persuasion will be up against a rising economic nationalism in Beijing. Its leaders are driven to prevent worker and peasant unrest from challenging their authority. They operate with a mercantile mentality that wants a heavy government hand in key sectors, especially basic industries and finance.

Despite Mr. Paulson's "good cop" role, some in Congress want to raise tariffs on Chinese goods if Beijing doesn't free up its currency, making exports more expensive and thus helping many US industries. And in a report Monday, the US trade office accused China of not fully embracing WTO principles "of market access, nondiscrimination, ... and transparency."

This push-pull US approach to China must be kept with yin-yang balance. The two economies are now highly dependent on each other. Most of China's exports are made by US and other foreign firms, for instance, and China owns a huge chunk of US debt that finances US consumers.

At best, the US can only influence Beijing's internal debates over how much to make further reforms and open markets. China has adjusted its currency 5 percent over the past year. Its more enlightened leaders know it must do more. The US needs to keep a middle ground in its tough-soft dealings with the Middle Kingdom.