The American president heads into the G20 meeting having been told by his top advisers that the US economy is showing signs of recovery. Sales of new homes rose 4.7% last month, durable-goods orders were up, the stock market is at least sitting up in its sick bed, and applications for mortgages soared as mortgage rates fell to a low of about 4.5% for 30-year fixed-rate loans. Many of these applications are aimed at refinancing existing, higher-rate mortgages, but as one administration economist put it to me, that is the equivalent of a tax cut, as homeowners who pay less interest have more to spend in the shops. But he is nevertheless warning his boss that these positive signs just might be the real economy’s equivalent of the dead-cat bounce that occurs in bear markets — share prices rise, only to fall back again.

Barack Obama is also being advised to play down expectations of what might come out of the G20 meeting, lest disappointed investors run for cover at its conclusion. After all, the Europeans will not go along with his request for a co-ordinated stimulus, and he will not go along with all their demands for heavy-handed regulation of financial markets. The problem is that Gordon Brown, who sees this meeting as his ticket to victory in his first general election, is raising expectations faster than Obama and others can lower them.

Obama is confident that his budget, which adds trillions to the government deficit over the next decade, tripling the national debt, will not drive down the dollar. This, despite the immense borrowing that will be required to fund both his stimulus package and his wish list — extending healthcare coverage to 50m more Americans, constructing a “smart” grid powered by renewable energy, and improving access to superior education from kindergarten to college.

Republicans are not alone in claiming that we should be worried about a budget deficit that hits 13% of GDP next year and never falls much below 5% in the next decade, according to the non-partisan Congressional Budget Office. Even the Democrats in Congress are baulking at some of the president’s proposals.

But their trimmings-around-the- edges will not satisfy China, which fears that Obama-level deficits will leave it with vaults full of depreciated dollars. After Chinese premier Wen Jiabao announced that he was “a little bit worried” that his country would be paid back in dollars that don’t buy very much, Zhou Xiaochuan, governor of the People’s Bank of China, went further. He wants to replace the dollar as the world’s main reserve currency with a quasi- currency managed by the International Monetary Fund (IMF) — or says he does.

Obama was quick to give the thumbs down on any such move, and sources at foreign embassies knowledgeable in the ways of the Chinese tell me that they were merely flexing their muscles.

They feel under-represented in the international economic forums and institutions, and know they will be asked to make a big contribution to increase the IMF’s ability to cope with the current recession and future financial crises. They are letting it be known that he who pays the piper should get to call the policy tune.

The Americans also head for London confident that Treasury secretary Timothy Geithner’s plan to set up public-private partnerships to take toxic assets — renamed “legacy assets” — off the books of the banks will further ease the credit markets. The taxpayer will provide most of the money and guarantee the debt, and the private sector will reap a disproportionate share of the profits. Sounds good, but the investors I talk to are frightened by the populist backlash against the bonuses paid to some AIG executives.

Obama’s economic advisers are well aware of this problem, and advised the president to tone down his rhetoric and give his personal assurances to leading bankers — which he did at a White House meeting on Friday. The Geithner plan does include clauses to stop retrospective attacks on the profits of private-sector participants. But we won’t know until the plan becomes operational in May whether that protection will be sufficient to reassure investors that they will not end up under the spotlight in a congressional hearing room, or with busloads of protesters on the doorsteps of their homes.

The Geithner plan is running into another potential problem. “I don’t see how they are going to get the banks to sell,” an executive at a large bank told the press. The banks value these assets on their books at something like 90 cents on the dollar — and are likely to be offered 60 cents for some and perhaps 30 cents on the dollar for others. If they sell these assets, the banks would have to record the resulting losses on their books, which would reduce their ability to pass the “stress tests” now being run by the Treasury to determine whether they can withstand a worsening of the recession. Failure would result in a government takeover.

The most important development at the G20 meeting will not find its way into the communiqué. Members of the American delegation are not alone in believing that Europe is in a state of denial, and that the worst is yet to befall its economies. Europe continues to look back, one participant told me, to protectionism in the case of France, and to the devastating effects of inflation in the case of Germany, which makes chancellor Angela Merkel reluctant to sign on to a real stimulus package.

China and America, privately dubbed the G2, know they must look ahead, and create a workable new world economic order by eliminating their trade imbalance. The Chinese will have to let their currency rise to stem the tide of goods flowing from China to Wal-Mart, and create a domestic safety net so that Chinese citizens can stimulate the world economy by spending more instead of saving 25% of their incomes. America will have to provide assurances that it will not print so much money that the dollar drops in value. There is a deal to be made in the interest of both the present superpower and the emerging one. It will take time but, say the optimists in the G20 crowd, it will be done.

Irwin Stelzer is a business adviser and director of economic policy studies at the Hudson Institute

stelzer@aol.com

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