The Sydney Morning Herald

By Geoffrey Garrett

A strange thing has happened in the wake of the Greek-cum-European debt crisis - the second wave of the born-in-America global financial crisis. After two years of talk about the demise of the United States and its economic model, the world's investors are flooding back into dollars.

This is not because America has put its own parlous fiscal house in order. Far from it. US public debt is projected to become Greek-like over the course of this decade.

Rather, the flight back to the dollar as the preferred port in the latest global storm is recognition that, warts and all, the US is still the world's leading economy and will be so for the foreseeable future. And it is now clear what US leadership will look like as the world starts down the precarious path back to stability and prosperity.

America's response to the global financial crisis has less to do with calming global markets or assuaging foreign critics than with political and economic realities at home. The results go only part way to what the world hoped for, but as much as the world could reasonably expect.

The US will do three things. First, it will rein in the excesses of Wall Street while trying not to suffocate its innovation and productivity. Second, the US will plead with China in private rather than berate it in public over trade, investment and exchange rates because it needs China to keep funding American debt and hopes Chinese demand will soon be a major driver of American growth. Third, the US will create incentives for job-creating American exports but hold off on free trade deals that would demand politically difficult concessions at home.

It was only the American public's anger that made financial reform possible. When the financial rules are finalised, probably next month, Middle America will get the two things it wanted above all else - a mechanism for government to take over but not bail out failing financial institutions and a new agency to protect consumers from the fallout.

The world will get much of what it wanted, too. There will be restrictions on proprietary trading by banks and on how they run their derivatives businesses. Shadow banking institutions and practices will be brought under the financial regulatory tent. American reform will in turn make possible co-ordinated global action at the G20 summits in Canada next month and South Korea later in the year.

During the first phase of the crisis, the US tried to use the Group of 20 as a forum for lecturing if not hectoring China about unfair trade, closed markets and an undervalued currency, knowing that China needed American markets as much as the US needed China to buy its government bonds.

The crisis has changed the tenor of China-US relations, with China more confident than ever before and the US uncharacteristically unsure of itself. The US still wants China to let the yuan rise, to open up its markets from retail finance to public procurement and to protect the intellectual property of American firms operating in China. But the financial crisis has only reinforced the two-decade old US approach of keeping its major disagreements with China behind closed doors, with only the occasional public flare-up when a pressure release is needed.

The US knows freer global trade is in both its and the world's long run interests. But Barack Obama and congressional Democrats know trying to force through free trade deals would be a bloody losing battle when unemployment is near double digits and underemployment is closer to 15 per cent.

Pledging to double American exports over five years and creating incentives to help the process along is a much safer bet. Forcing tough congressional votes on trade deals that would be characterised as job killers will have to wait, certainly until after November's midterm elections and quite possibly not until an Obama second term.

Being a leader on free trade and tackling head-on the mounting fiscal crisis was beyond George Bush. With the financial crisis casting long shadows over all aspects of American life, it would be unrealistic to expect any better from a first-term Obama administration.

The US will someday have to swallow the bitter medicine of tax increases and spending cuts. But its surprising resilience as the world's leading economy is helping to put off that day of reckoning.

Professor Geoffrey Garrett is chief executive of the US Studies Centre at the University of Sydney.