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Tuesday, August 26, 2003

THE SHORT-TERM IMPACT OF CHINA'S SOARING TRADE SURPLUS WITH THE USA: Updated Final Version

On August 2nd, the buggy prof had a long article --- with one more installment to come --- on the impact of the Chinese economy on the US: China's Growing Economy, A Threat to the US or An Opportunity. It tried to distinguish between the current impact on the US economy --- more and more dislocating to many US industries (mainly low-tech ones), thanks to a huge export drive --- and its long-term promise as a huge, rapidly growing market for which the exports of US high-tech industries will be able to find more and more customers. The short-term problem, recall, has four facets.

* The size and rate of Chinese imports into the US economy. In 1997, those imports totaled $62 billion; last year they had more than doubled to $125 billion; this year, the influx has been even faster so far. In the same interval since 1997, $US exports rose from only $13 billion to $17 billion (2002). This year, the US deficit with China will almost certainly top $100 billion.

* The huge import surge is concentrated in certain industries: textiles, wood furniture, steel, plastics, and a few others, almost all low- or mid-tech in nature. That is causing big problems for employment in those industries at a time when the US job market has markedly worsened over the last two years, ever since the 2001 recession officially ended. It's one thing to encourage an economy's less technologically advanced industries to adapt to international competition through free trade, particularly if the declining competitiveness of these industries is underscored by a steady but predictable and limited growth rate of import competition, and at a time when the rest of the US economy is growing rapidly and creating lots of new jobs. It's another thing to let industries be overwhelmed by a flood of imports, and especially when the job market has been gloomy. (Note that integrated steel mills in this country are finally getting relief, in part from the dollar's falling against the euro, but even more from the protection that the Bush administration put around the industry last year. Imports tumbled 35% in July compared to the same month a year ago.)
* The big export drive out of China to here is being fueled by an increasingly undervalued currency, probably on the order of 20-40%, with the Yuan pegged to the US $ at 8.3. To maintain it, the Chinese government has been spending billions dollars worth of Yuan, up to $300 million daily, to buy dollars and keep the Yuan from rising as Americans buy more and more Chinese exports. (Remember, a rise of the Yuan in dollar terms would mean that it would fall from 8.3 toward 6.0 or 5.0 per dollar, * making Chinese goods that much more expensive for American customers.) By comparison, the Japanese Yen --- which floats against the dollar (despite the Japanese government's efforts to keep the Yen from rising against the dollar by selling large quantities of Yen daily and weekly too to buy dollars) --- rose about 7-8% between the spring of 2002 and this last spring. The result? Japan's trade surplus with the US has been falling steadily: from around $80 in 2002 to around an annual rate this year so far of less than $60 billion . . . a drop of about 25%. Note that each one Yen rise in dollar terms reduces the profits of major Japanese export-oriented companies by about 1% too: the reason why Nissan and Toyota have been accelerating their multinational transfer of their production to this country.

Note: a good article detailing the persistent efforts of the Japanese to keep the Yen weak against the dollar --- which led the Japanese government to spend $75 billion worth of Yen alone to buy dollars this last May and June (!) --- is in the New York Times for August 27th. One Japanese official had confided to a US expert that the currency interventions by the government in Tokyo had kept the Yen about 12% weaker than otherwise against the dollar. The article, note further, also explains that currency speculation --- which usually helps to work against a government's efforts to keep its currency at some level (or within a desired range) --- had been spooked off by the Japanese government's determination to spend and spend Yen to fight against a rising Yen/dollar rate.

* Finally, a political backlash is being generated by the dislocating impact of China's imports to the US, concentrated as it is in certain industries, themselves regionally grouped (mainly the South, to an extent the steel belt of the integrated companies in the Mid-West). This was predictable. No country can absorb such an influx of imports on limited industries without a political fall-out of this sort. For a good detailed analysis of this backlash, see today's New York Times.

What will likely ensue?

The Two-Way Tug in Bush's Political-Economic Calculus



Four Kinds of Measures Recommended:

As some benchmarks for assessing the Bush administration's options, it will be helpful to recall the four recommended buggy ways for our government --- whether the current one or any other in the future --- to deal with these kinds of problems:



[1] Import Relief.

Protecting an industry being swamped by a flood of imports is allowed under WTO rules for safeguards . . . provided these safeguard measures include a scheme to make the industry or industries affected more competitive by streamlining and restructuring the industry in question. There seems to be a case for this in textiles and wood furniture, maybe one or two others. Any import tariffs would have to be conditioned on a clear scheme of effective adjustment and should last 24 -36 months. Keep in mind that there are clear criteria that the WTO for the safeguards to be applied. For instance, it found that the Bush safeguard measures and high tariffs around steel imposed in the summer of 2002 violated these criteria.

[2] Help for Laid-off Workers.

We can also increase our trade-adjustment assistance to beleaguered industries and the laid-off workers affected. Fortunately --- as a recent buggy article here noted --- we've learned some things since the origins of this policy back in the mid-1970s to make it more efficient: above all, instead of press-ganging laid-off workers into government-sponsored or government-subsidized training programs that go nowhere, paying for 18-24 months the difference between new wages for the formerly laid-off workers in new jobs and what they were earning before. A large number opt for their own retraining and upgraded education, with beneficial results.

[3] Generating More US Economic Growth and Job-Creation.

Above all, there's a need --- it can't be exaggerated --- to boost Aggregate Demand to increase GDP growth and bring unemployment down to somewhere around 5.0% in the next 18 months. A booming economy and booming job-market are, in the end, indispensable antidotes to job-pessimism and growing pressures for protection.

[4] Pressure on China To Revalue or Float the Yuan Fixed at 8.3 Yuan/$.

The Chinese currency would automatically rise markedly in value if the currency were allowed to float or at least be formally revalued 20-40%. Right now, China seems to be spending about $300 million of Yuan daily to keep the exchange rate at that 8.3 level. That artificially low value of the Yuan keeps the export spigot to the US running excessively with ever greater force. Equally bad for many US hard--pressed industries, the rest of the Pacific Asian countries then sell their own currencies to keep their exchange rate vis-a-vis the dollar (and the Yuan) from rising too. Obviously, if it had its own way, the Chinese government isn't about to let the Yuan rise; its low value is what's helping fuel its huge export surge here. For a good article on this, see Business Week.

 

What Are Bush's Options:

1) Do nothing:

iIn effect, if he chose this option, he and his advisers would be hoping that the now faster US economic growth in the works would reduce the protectionist backlash in the industries affected by the huge inflow of Chinese imports, creating three or four million new jobs in the next year or so . . . itself a tough order, and most unlikely anyway. This option might be tempting --- given all the problems with the other alternatives laid out here --- but it's not cost-free, just the contrary. Above all won't relieve the direct pressure on certain US industries, regionally grouped, which would badly hurt his re-election potential in next year's election . . . in short, probably a form of political suicide. (The latest revision by the Bureau of Economic Affairs shows that GDP growth was advancing at 3.1% an annual rate in the spring quarter --- a revision upward from the original preliminary estimate of 2.4%. Almost all the signs in the US economy augur for a very strong growth the rest of year and into 2004. See "Economy Shows Surprising Strength.")

 

2) Outright long-term protection:

That might be tempting too, but it's illegal under WTO rules --- China now a member, recall --- and would encourage other industries to apply for such protection too. It would also conflict with Bush's commitment to work for an all-America's Free Trade treaty that he hopes to nail down, assuming he's re-elected.

 

3) Short-term relief, in line with WTO safeguard measures, to stem an import surge in affected industries . . . coupled with an acceleration of the new trade adjustment assistance being flirted with.

This is more promising from an economic viewpoint, and combined with faster GDP growth and new jobs, in other industries (most likely in different regions of the country), it might relieve the political pressures on local and state government and improve Bush's re-election prospects. Note that this new assistance being tested is dependent on a laid-off worker who loses his job owing to trade competition has to find another job to receive it: it then would compensate for the difference in income for 18-24 months say.

The problems here? They're several, alas.

For one thing, any safeguard measure requires that there be a credible restructuring program to show that the industry being temporarily protected will be able at the end to be competitive once the brunt of foreign competition materializes again. That might not be easy in textiles or wood furniture; it isn't even easy in integrated steel production --- as opposed to specialized steels (about 35-40% of the US market, where US mini-mills are internationally the pace-setters in productivity, and by a long shot) --- despite levels of productivity these days that are equal to any around the world. The hitch here for the integrated mills? They're stuck with very costly pension burdens, which increase the price of the steel they try to sell . . . in the US and abroad. (The steel safeguard measures initiated last year call for a 20% reduction over five years, and the US government did submit a restructuring program to the WTO.)

For another thing, the US government itself is under fire in the WTO from the EU and others over the latest round of US protection, imposed last summer by the Bush administration . . . clearly to generate Republican support in the industries and regions affected. It might not be easy to win a case for import relief if other countries contested it in a WTO investigation of the merits of the US case --- exactly what has happened this month over US steel protection ---- where some of the complaints lodged by others were upheld by an WTO panel. Its report found the US had violated the organization's trade rules --- a finding the administration contested, and anyway seems to be ignoring . . . something the EU and others have done on other cases of interest to them. See this article. (What can legally ensue when such a finding by a WTO panel occurs? If the country in question doesn't remove the protection, other countries have a right to retaliate with protection of their own. That's the legal reality. The political reality is different. In practice, the offending country's government --- the US in this case --- is likely to engage in negotiations with the complaining countries and see if they can't reach a mutually satisfactory arrangement, with concessions offered by the offender. The US already exempted some developing countries last year like Brazil from the full brunt of the new steel protection.)

As a third thing, even though the new trade adjustment assistance being tested looks promising, it is, still not what existing US assistance amounts to. The current program, while helpful, is less generous and also far less geared to getting laid-off workers finding a new job as quickly as they can. Remember, the proposed changes would compensate a worker for a lower wage, up to two years, on the condition that he or she found another job. The current assistance offers support "for placement assistance, career counseling, up to two years of occupational training and trade readjustment search and relocation allowances "--- this, after unemployment benefits are used up. (For a good readable summary --- believe me, far easier to master than the gabbledy-gook at the Dept. of Labor --- see this article) .

 

4) Exert pressure on China to re-evalue the Yuan, say by 20-40%.

The Bush administration has already talked about this, and the promise here, if Beijing complied, is manifold: the Yuan, after all, is clearly undervalued, with the Chinese government striving to keep it fixed at 8.3 to the dollar by selling hundreds of millions of dollars worth of Yuan daily the last few months. If we could stop the Chinese government from fighting an appreciation, the Yuan would rise above its aritifically pegged level to somewhere around 5-6 Yuan/ dollar. That would immediately make Chinese imports more expensive in the US market --- within months, by a large rise in their price. If, as a twist, Beijing feared letting the Yuan rise thanks to market forces --- worried, possibly, that the Yuan might be driven upward to 4 Yuan / dollar or higher --- then it could pell-mell announce that it was revaluing its currency to 6.0 or slightly higher and see what happened

All that is theoretical, mind you.

In reality, there's almost no likelihood that China's government would do this voluntarily even if we formally requested it day and night for the next month or two or years. It has too much at stake in the country's current export-led growth, heavily tilted above all toward its huge trade surplus with the US . . . over $100 billion annually now. Export growth has risen steadily there the last few years at an astonishing 35% a year (doubling every two years or so). Nor is that all. A higher Yuan would also hurt Chinese exports in the rest of Asia, whose currencies wouldn't rise against the dollar at all --- even though they're probably undervalued considerably too --- and no doubt hurt Chinese exports in Europe too since middle-men speculators in currency markets alone would lead the euro to rise against the Yuan once the latter was raised against the dollar.

 

More Muscle Then?

That would leave the Bush administration with a more muscle-laden approach, reinforced --- keep in mind -- by a political urgency in Washington: the Bush re-election prospects next year.

Unfortunately, there are opposing national interests and counter-pressures that the President and his advisers have to weigh:

First, the US government has been actively seeking Chinese help to deal with North Korea, and Beijing has been shepherding a new multi-national conference on the North Korean nuclear program, now in session. (Whether or not North Korea's government turns out to have a nuclear weapon and tests it soon as it just announced would still leave plenty of room for negotiations with Pyongyang over the nature of the program, its size, international inspections, arms control, and weapons-transfers . . . all in return for diplomatic and economic concessions.) Obviously, in such circumstances, trying to force Beijing to do something of pivotal importance to its economic growth and program won't be easy. US pressure over trade might be damagingly more widely still. Our diplomatic relationship with China is one of the three or four most important in the world. Our long-run aim is to coax China's government --- as Chinese wealth and military power grow --- to see the country's future as bound up with the stability and promise of the existing rule-governed global economy and arm-control system that we have so much a stake in, and regarding which we're the main manager. Bejing's joining the WTO has already integrated it deeply into the global trade and monetary systems, and it is slowly being required to overhaul its economy --- no small challenge --- in ways that conform with the organization's rules.

Second, China's GDP growth has been one of the few engines of the world economy the last few years . . . the US the only other mighty engine (and far more consequential). Japan is still stagnant, despite more promise of improvement economic growth; and the EU is stuck in the doldrums, barely growing last year or this one so far, with little hope for much vigor next year either. The result? If Beijing were pressured --- say, by threats of US trade protection --- and succumbed (however likely), the Chinese economy might itself grind to a halt.

Third, Beijing would no doubt contest any new US protection.

And fourth, when governments like those in Beijing or Tokyo spend tens of billions of dollars worth of their currency to buy dollars in currency markets --- and hence keep the price of the dollar high --- they don't stick the huge dollar reserves under their mattresses. Almost all is re-invested abroad, usually in safe government bonds --- mostly in the US, but possibly (depending on what interest rates are and likely exchange rates of the dollar and euro in the future) in the euro-area. (Japan's interest rates on bonds are too low for foreign investors to be attracted to them.) Hence, if China were to revalue the Yuan and eventually accept a lower trade surplus with the US ---- which is the equivalent of our having a lower trade deficit in general --- then there would be less foreign investment in the US and interest rates might rise. Note: might rise. The fact is we can't be certain. Back in the late 1980s, an unusually high dollar and huge bursting current account deficits in the US were both shrinking rapidly, and there was no rise in long-term US interest rates. In fact, they declined somewhat. Why? It's not clear. National saving rates didn't rise, as the chart by Benjamin Friedman shows. (See p. 18, figure 2.)

Keep in mind here, to elaborate on the significance of Chinese re-investment of surplus dollars in this country, that Asian Central Banks --- piling up dollar reserves thanks to large current account surpluses with the US in the trade of goods and services, plus constantly buying dollars to keep their own currencies cheaper in dollar terms --- now own 70% of the world's central bank reserves in foreign exchange. Just a decade ago, that figure was 30%; in the early 1970s, just 21%. The total of these foreign exchange reserves in Asia, according to a recent Financial Times article, is $1.6 trillion, the vast percentage of which is kept in dollars: either US currency and of course as US financial assets, mainly US treasury bonds. In short, almost all of Pacific Asia is addicted to export-led growth, which means mainly keeping open access to the US market (though intra-Asian trade is also growing rapidly), and the Central Banks that then pile up reserves of dollars when the US runs current account deficits with them re-invests those dollars in the US. It's a mutually beneficial exchange. They get what they want: export-led growth, and solid investments in the US for their surplus dollars; and we get what we want --- a steady inflow of dollars from abroad that help close the gap between US net savings and net investments. (This shows up in lower interest rates, at least in principle. As the last sentence shows, the dollar's decline in the late 1980s and the corresponding sharp decline in US current account deficits didn't manifest themselves in declining US interest rates, even though net national savings declined.) And the Asian Central Banks and their governments seem prepared to spend endless amounts of their currencies to buy dollars in order to keep their exchange rates from rising in dollar terms. (The Financial Times article mentioned earlier, alas, requires a subscription to acquire.)

So yes, the US economy benefits from continued high-levels of capital inflows from abroad . . . not least from Asia. Does that mean Washington can't start pressuring Beijing to revalue the Yuan and lessen the flood of Chinese exports to the US?

No; not really. As the last sentence in the paragraph before the last one noted, interest rates just didn't rise noticeably at all between 1985 and 1992 --- in fact, they declined for the most part. Come to that --- contrary to standard economic analysis that foresees inflationary pressures let loose when a currency falls markedly in value as the dollar did after 1985 --- were any such pressures noticeable in the US economy either.

 

The Conclusion?

All of which leaves the Bush administration with no clear problem-free set of policies. Doing nothing, however, would look like political suicide next year. So expect something to be done . . . possibly some combination of these latter two options (3 and 4). Of course, creative minds in Washington D.C. might come up with more promising, less troubled options that the buggy prof can't conjure up himself, but right now, it's hard to see what these might be.











Replies: 1 Comment

What about the alternative of twisting China's arm to open up more markets in China to US goods. Especially markets for goods a little higher on the tech food chain.. digital cameras for example. This would serve the mutual interest of keeping the US economically heathy and provide jobs in the US. SWS

Posted by SWS @ 09/18/2003 10:33 AM PST