U.S.-China Trade: Prepare for Continued Imbalance

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Barges wait to collect shipping containers at Victoria Harbour in Hong Kong

On Friday, as President Obama crossed the Pacific to begin his first trip to Asia, the Census Bureau released its monthly trade tally. The headline was that the U.S. trade deficit grew to $36.5 billion in September, more than forecasters expected and the biggest such figure since January. But the really dramatic number was that 60.5% of the deficit, or $22.1 billion, was with just one country: China.

Obama arrived in Beijing Monday, but don't expect anything to get resolved. The U.S.-China economic relationship has become way too complicated and contradictory for simple solutions.

Within the U.S., the imbalance is mainly seen as the product of protectionist policies by China, in particular China's refusal to let its currency, the yuan, appreciate against the dollar. There's certainly something to this — it's now universally agreed just about everywhere but China that a freely floating yuan would be worth significantly more than the 15 cents it currently goes for. By keeping its currency's value artificially low, China makes its products cheaper in the U.S., thus encouraging imbalanced trade.

But when China linked its currency to the dollar in the early 1990s, it was out not to create trade surpluses but to carve out a bit of stability in turbulent global currency markets. During the emerging-market currency crises of 1997 and 1998, China's success in keeping the yuan fixed at 8.3 yuan to the dollar was applauded in the West as a major contribution to averting financial chaos. Since 2005, China has been willing to allow the yuan to appreciate a bit (the current exchange rate is 6.8 yuan to the dollar). It just hasn't been willing to do this on any but its own extremely conservative terms.

In China, meanwhile, it is fashionable to blame U.S. trade deficits on the debt-addicted ways of American citizens and their government. There's an element of truth to this too. If the U.S. borrowed and spent less, its trade imbalances would be smaller. But China has been enabling this profligate behavior for years by buying trillions of dollars in U.S. government debt and mortgage securities as part of its continuing effort to — you got it — keep the yuan from appreciating too much against the dollar.

It's a bit reminiscent of the seemingly endless wrangles in the late 1980s and early 1990s with Japan, which accounted for the bulk of the U.S. trade deficit in those days. The trade deficit with Japan never shrank much in dollar terms, but it became smaller as a share of GDP starting in the mid-1990s, and was eclipsed by the trade imbalance with China in 2000 (in September the U.S. trade deficit with Japan was $4.1 billion, compared to $22.1 billion with China). The issue was never resolved, but it ceased to seem so important. Could that happen with China?

Probably not. There are two crucial differences. One is that much of today's U.S. trade deficit comes from U.S.-based corporations selling products at home that were partly or entirely made in China. As a result, the trade relationship with China has become far more ingrained in the economic fabric of the U.S. than that with Japan ever was. Some evidence: in the first nine months of 2009, the global economic slowdown cut the U.S. deficit with Japan 47% compared with the first nine months of 2008. The deficit with China dropped just 16%.

An even more important difference is that the stakes are higher with China. Japan seemed like a fearsome economic rival a quarter-century ago, but it wasn't really a political rival and, with a population less than half that of the U.S., it was unlikely ever to surpass the U.S. as an economic power. China, with its billion-plus population, seems destined to surpass the U.S. in economic clout, and it appears to have designs on rivaling the U.S. as a political and military power. Which means there's no easy way out of the U.S.-China trade impasse.