U.S.-China Trade: Too Much Talk?
Summits between heads of state always seem to come with set storylines that get recycled ad nauseam by the 24/7 global media. The arrival of Chinese President Hu Jintao in the U.S. on Apr. 20 will surely be no different. Expect plenty of fiery rhetoric by U.S. trade hawks about why China is a massive currency manipulator whose renegade trade practices are destroying jobs, incomes, and American prosperity.
The evidence they cite to back this up usually boils down to the fact that the yuan is undervalued by anywhere from 15% to 40% vs. the dollar, that Chinese monetary authorities have only let the currency budge 3% since they abandoned a peg to the dollar last July, and that the U.S. trade deficit with China was a scorching $201 billion in 2005.
Add in U.S. mid-term elections in November, and you have a very combustible mixture. Senators Charles Schumer and Lindsey Graham have sponsored legislation that would impose 27.5% tariffs on Chinese exports to the U.S. if Beijing doesn't let the yuan appreciate. And this spring, the Bush Administration may brand China as a "currency manipulator" when it issues a report on key trading partners.
All this will make great political theater, and the brinkmanship may even pay off with some minor concessions from Beijing. "From a U.S. perspective, the threat of protective action has been a useful tool in encouraging the Chinese government to take reform measures," Hong Kong-based UBS economist Jonathan Anderson points out. But the odds of a real trade war with China are pretty low -- because both sides have too much to lose. It is telling that Schumer and Graham have delayed until the fall an expected floor vote on their bill.
What U.S. trade hawks rarely point out is that a big reason China's global trade numbers have ballooned is that foreign companies are prospering on the mainland. About half the exports coming out of China are actually from multinationals producing there. In high-tech, the figure is closer to 90%, led by companies such as Motorola (MOT) and Nokia (NOK). Global auto companies such as General Motors (GM), Toyota (TM), Nissan (NSANY), and Honda (HMC) enjoy huge market share in the Chinese auto market.
And big global banks such as HSBC (HBC), Bank of America (BAC), Goldman Sachs (GS), and Citibank (C) are making serious inroads into China's rapidly expanding banking and financial services sectors (see BW Online, 1/18/06, "Don't Be Afraid of China").
So tariffs on Chinese exports would hit the earnings of big American companies and take their toll on U.S. stock markets. Morgan Stanley analyst Andy Xie figures a 27.5% tariff would cost companies exporting out of China about $69 billion, most of which would be shouldered by U.S. companies operating on the mainland.
And while progress on currency reform has undoubtedly been slow, it is hard to argue that the Chinese have done nothing. Over the past eight months, the Chinese have liberalized the market for currency swaps and forward contracts, and invited foreign banks to play a role as "market makers" who trade foreign currencies with Chinese banks to help set prices for the yuan. These market reform moves help pave the way for greater flexibility in the value of the yuan.
For now, though, China has no intention of adopting the kind of shock therapy some in the U.S. are calling for. Schumer and others want China to let the yuan float freely against foreign currencies rather than in a narrow band, as is the case today. Others think Beijing should lift capital controls that prevent most individual Chinese from investing their savings overseas.
Either move, if adopted abruptly, would be economic suicide for China. Its fragile banking system would face collapse if a wave of Chinese deposits headed offshore. And rapid appreciation of the yuan would depress exports and hurt a Chinese economy that has to grow at nearly 10% just to provide enough jobs for newcomers to the labor force. "China will only consider the gradualist reform approach that wins the trust of the masses of the Chinese people, rather than shock therapy," Gov. Zhou Xiaochuan of the People's Bank of China said in a Mar. 20 speech.
Gradual is the key word. Most economists think the yuan will be allowed to appreciate another 3% to 5% in 2006. That follows the roughly 3% appreciation since last July. This won't be enough to quiet China critics in the West, but it is a step in the right direction. Also, as Chinese living standards improve, consumers likely will start buying more foreign goods, which will also cut down its trade surplus.
Washington may have no alternative. If the U.S. slaps punitive tariffs on Chinese goods, Beijing will surely retaliate. These tariffs will eventually get passed along to consumers in both countries, and thereby depress growth. Should things really turn nasty, the Chinese could find other uses for the $200 billion or so worth of U.S. Treasury bonds and other long-term fixed investments its central bank holds. That would put upward pressure on U.S. interest rates.
Most economists think as China continues to prosper it will import more goods and lower its trade surpluses significantly. The U.S., meanwhile, must boost its savings and depress consumption of imports, a far tougher task.
So when Hu visits the U.S. this month, expect plenty of heated language and a bit of brinkmanship about unfair trade and Chinese mercantilism. But with any luck it will be just talk, with little real action that could ultimately inflict serious damage to both sides.