Can This Marriage Be Saved?

China and the US are the power couple of the modern economics, but there are some clouds on the marital horizon. Michael Pettis, filling in on Brad Setser's Blog takes a look at the immediate future of this co-dependent relationship:

It is hard to overestimate the importance to China's near-term and longer-term prospects of the 17th Plenum in two weeks. These meetings, held every five years, are the main events of China’s political cycles and it is during these meetings that the big promotions to senior positions within the Party and, juiciest of all, membership in the Standing Committee of the Politburo are made. The Standing Committee consists of the nine men (previously seven, and there are not completely credible rumors that it may be reduced to seven again – the decision has everything to do with factional fighting) who are the ultimate source of power in China today, and is headed by President Hu Jintao and Prime Minister Wen Jiabao.

Although the deliberations are secret, the months leading to the congress are rife with factional infighting, sweetheart deals, attacks on frontrunners, corruption scandals, and the all-important maneuvering for promotion. Unfortunately, on the assumption that that any serious contender must at all costs avoid doing anything that may give rise to criticism before the promotions are decided, the period before the meetings tends to be a time in which very little, no matter how urgent, gets done. For this reason, although the government is watching with terror China's rising inflation, after the last interest rate move little has been done except to freeze a number of prices, and this latter is rumored to have been done almost solely to prevent rising prices from ruining the feel-good ambience that is always required to permeate the national congress meetings.

Some suspect that the imbalances of the relationship, which require China to take, take, take American debt while the US takes, takes, takes Chinese trade good are unsustainable. The monetary consequences of this asymnmetric flow, which is maintained by China's artificial peg of the RMB to the dollar seem finally to be resulting in the long predicted inflation.

China based Pettis has a not-quite an insider's look at how it could play out and some of the pitfalls involved.

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