Heated Relations Between U.S. and China
Sam Park - July 18, 2005
China's Fixed Exchange Rate Regime
The Chinese government has been fixing the Yuan, the base unit of the
Renminbi, at 8.28 Renminbi per dollar since 1995. By doing so, the Yuan has
been undervalued, thereby keeping Chinese exports relatively cheap compared
to U.S. products. This effect entices U.S. consumers to purchase cheaper
Chinese products. On the other hand, Chinese consumers face higher priced
American goods and many cannot afford to purchase them. This, along with
other reasons, has led to U.S. protectionists to tout unfair trade, as U.S.
Senators continue pressuring China to revalue the Yuan.
Such pressures will induce speculators, who bet that China would revalue the
Renminbi, to flow "hot money" into China. This short-term speculative flow
of capital further complicates China's ability to have its currency fixed to
the dollar. Despite these complications, China has shown little signs of
revaluing the Yuan. China currently refuses to immediately float its
currency because doing so would further exacerbate their problems with
unemployment (at 20 percent) and the fragile banking system.
Regardless of China's sticky situation, U.S. senators continue to push China
into a corner and blame China for the U.S. current account and trade
deficits. According to the U.S. International Trade Commission (USITC)
DataWeb 2004 figures, U.S. imported $196 billion worth of goods from China,
which translates to 13.4 percent of total U.S. imports. Of this amount, more
than half of the total imported goods from China were nuclear reactors and
parts, mechanical appliances, electrical equipment and toys. Apparel, both
knitted and non-knitted, added up to just over 5 percent. According to
USITC's data, it appears that the media has exaggerated the impact Chinašs
textile imports have in the U.S.
Protecting the American Workers
By claiming unfair trade, senators are partly referring to the trade
imbalance between U.S. and China. U.S. imported $196 billion and exported
only $32 billion worth of goods to and from China. This calculates to U.S.
having imported 13.4 percent of its total imports from China, while the
authorities in Beijing permitted only 4.5 percent from U.S. exporters. This
hardly reveals a "balanced" trade relationship.
Given that China's share of U.S. imports represent approximately 13 percent
and assuming all else is held constant, a 27.5 percent appreciation of the
Renminbi would impact the trade-weighted dollar exchange value by a mere 3.7
percent. This suggests that the Yuan appreciation would do little to resolve
the U.S. current account deficit. Although China accounts for almost a
quarter of the U.S trade deficit, hypothetically and completely eliminating
all trade relation would not resolve the U.S. current account and trade
deficits. I had briefly touched on the U.S. current account deficit picture
in my previous report titled "Preparing for an Inverted Yield Curve."
Many senators have claimed that their reasons for pressuring China were not
for protectionist purposes. And according to the figures previously
mentioned, pressures to revalue the Yuan would have little impact on saving
the existing jobs in America. Most manufacturing jobs, particularly
electronics related, have gone across borders where labor costs remain lower
than they are domestically. In current times where business competition
remains fierce, mature corporations must cut costs to stay alive. Such
transitions are never easy and producers must make difficult sacrifices to
maintain their competitiveness.
However, Chinese authorities do not make such transitions easy for American
and other Western companies that decide to move to China. Major problems of
American firms conducting business in China include: opaque legal and
regulatory systems (particularly regarding the protection of intellectual
property) and Chinese bureaucracy favoring local firms (especially
state-owned). Another core problem in China remains in its complete lack of
labor rights. The widespread violations of labor rights exist in just about
every factory. No wonder China has been able to produce such low priced
products. U.S. politicians probably view these practices as unfair, as they
will likely retaliate further by denying the CNOOC merger with UNOCAL.
Will This Fight Become a Brawl?
Ignorance will cause a Chinese debacle, and "an eye for an eye will leave
everyone blind." The U.S. economy will also feel the burden as the trade war
with China gains momentum. Chinese authorities continue refusing to conform
to "fair" trade practices. Some senators claim that Beijing has done little
to resolve the intellectual property issues, discarded the idea of floating
the Yuan, and not voluntarily limiting exports. On May 20, China claimed
that it would raise duties on a number of their textile products. However on
May 30, China withdrew its planned tariff increases on textile exports to
U.S. and Europe.
This type of misdirecting behavior has seriously upset the big boys in
Washington. China's reluctance to comply with fair practices has led
senators to call for drastic measures. The Schumer-Graham bill calls for a
27.5 percent ad valorem tariff on Chinese imports 180 days after the billšs
passage if China does not appreciate the Yuan by 27.5 percent. This
percentage number represents the average of 15 and 40 percent, which is the
estimated amount that the Yuan has been devalued.
Any economist would think this bill solves little, if nothing. Many would
also say that this highest tariff proposal since the notorious 1930
Hawley-Smooth bill would probably exacerbate the problem. However, the
current situation is different and more complex than that of the 1930's.
While this tariff may cause the snowball to roll faster, causing a downhill
economy, Washington will not sit around and let people get away with foul
play. Sometimes punishment is necessary to teach a lesson. China has been
testing its limits, has gone too far, and a small slap on the wrist does not
Although the tariff makes little economic sense, perhaps it is needed to
make China a well-respected trading partner in the future if they learn from
their mistakes. However, this also comes at a cost to the U.S. consumer who
would likely face flying inflation rates if the bill were to pass. A look at
the Hawley-Smoot bill passed in 1930 will provide some insight.
To see how this bill came to life, one should consider Hoover's promise to
the farmers during his 1928 campaign. International trade, particularly with
Canada, had brought prices down and had especially hurt the U.S. farmers'
competitiveness. Unemployment in farming had plagued America years before
the Great Depression. Hoover had promised to protect U.S. farmers, and thus
the Hawley-Smoot tariff was the result. The Hawley-Smoot Tariff Act
increased tariffs on over 20,000 items to record levels. One must keep in
mind that the bill was passed after the notorious 1929 market crash. However
some believe the bill was responsible for prolonging the Great Depression.
Some books have pointed out that other nations such as Canada had retaliated
to Hawley-Smoot. Nevertheless, some studies show that the tariff's impact on
real GDP may have actually been less than expected. Furthermore, current
situations and reasons for the Schumer-Graham bill are different than those
for the Hawley-Smoot bill.
First of all, the tariffs on the Hawley-Smoot bill were "specific"
(predetermined price per good) whereas those of the Schumer-Graham bill are
"ad valorem" (percentage of the value of goods). Americans in early 1900's
days faced a different situation where monetary and fiscal policies were not
employed, the U.S. had fewer trading partners, and information flowed much
more slowly. Since 1930 the Federal Reserve's role has greatly changed, far
more indeed than from its inception in 1913 until 1930. As we know, the Fed
now actively engages in monetary policies and will act when it sees warning
The U.S. currently has more trading partners, thus more trade options. While
China represents a large trading partner, U.S. consumers and producers will
increase trade relations with other lower-cost-providing nations if Chinese
relations remain unfavorable. At the same time, China with its 1.3 billion
population represents a marketplace that should not be ignored, even though
it currently does not import nearly as much as it exports. Forcing them back
into isolation would present unfavorable conditions for all and would not
Previously inefficient information flows may have also added to the
stagnation of the major economies during the Great Depression era. With the
rise of the Internet, we have come closer to efficient markets where prices
reflect almost real-time information. Prices will correct themselves almost
instantly. If China does not comply with U.S. Congress' appeal, market
participants will position themselves accordingly. And businesses will
effectively find more reliable trading partners. The U.S. Senate recently
passed the Central American Free Trade Agreement (CAFTA) as America
continues to look towards favorable trading relations. Additionally, the G-8
looks to help stabilize situations in Africa who is a promising trading
partner in the future.
Still, it is in the best interest to China and U.S. to conclude their
negotiation amicably. Hostile relations will only leave both with bruises
and injuries. We would hate to see a Mike Tyson move, like biting off an ear
by either party. Sure the ear could be sawn back on, but it will still leave
a deep scar. China has shown some progress toward floating the Yuan, which
will delay the immediacy of passing the Schumer-Graham bill. If China does
not act accordingly, someone is bound to lose an ear.
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