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A ‘Fall of Discontent’ for U.S.-China Trade Relations.

Global economic developments this year, along with the impact of safe-haven investment flows have led to the appreciation of the dollar in global markets, contributed to the high level of unemployment in the U.S. and increased the chances for a double-dip recession in America.  All these developments have further highlighted the international tensions over exchange rates, with the value of the Chinese renminbi (RMB) and U.S.-China bilateral trade taking center stage this fall.

In the U.S., the unfortunate economic development of the past decade has been the explosion of the trade deficit.  Returning the U.S. economy to economic health would be much easier if the country was not spending $500 billion more (then exports) each year on imported goods and services.  To bring the U.S. trade deficit down, American products need to become more competitive internationally, which in practice means that the value of the dollar must fall in terms of other currencies.  This notion that a weaker currency leads to a stronger economy is of course a strategy employed by many other governments, most notably China.

Fall Developments by the Administration –

This fall we saw a number of moves by both the U.S. executive and the legislative branch to pressure China to change its mercantilist trade policy and artificially undervalued currency.

On September 20, the U.S. Trade Representative Ron Kirk announced that the U.S. has filed a case against China before the World Trade Organization (WTO) to protect up to 300,000 American agricultural jobs that are being threatened by China’s imposition of duties on imports of American chicken products.

On October 6, Ambassador Kirk announced that the U.S. was submitting information to the WTO, identifying nearly 200 subsidy programs that China has failed to notify as required (and 50 subsidy programs by India) under WTO rules.  Through this action at the WTO, the U.S. is seeking the prompt provision of detailed information and data from China, in order to ascertain whether Beijing is violating its WTO obligations.  China is required to provide information on domestic subsidies programs every year, something that it has done only once since joining the WTO ten years ago.

On October 19, Ambassador Kirk announced that the U.S. is seeking detailed information (under WTO consultation provisions) on the trade impact of Chinese policies that may block U.S. companies’ websites in China, creating commercial barriers that especially hurt America’s small business.  What is of concern to the U.S. government is that businesses based outside of China face challenges when offering services to Chinese consumers when their websites are blocked by China’s national firewall.

Next month (end of November) signatories of the Government Procurement Agreement (GPA) are hoping to finally receive China’s long-awaited revised offer for accession to the GPA.  This would address a major demand by the U.S. and other GPA parties, who had criticized China’s initial offer in 2007 and a revised one in July 2010 for being not only incomplete (only covering central government procurement, and not also including sub-central entities such as provincial and local authorities), but also being grossly overdue (China promised to join the GPA as part of its WTO accession – some 10 years ago).

The Senate Currency Bill –

Meanwhile, the U.S. Senate approved S. 1619 on October 11 by a bipartisan 63-35 margin.  This currency legislation will make it harder for the U.S. executive branch to avoid taking action to counteract the trade effects of undervalued currencies such as the Chinese RMB.  In particular, the Senate bill will remove the question of ‘intent’ from Treasury’s bi-annual analysis of the exchange rate policies of major trading partners, and trigger retaliatory tariffs if the Treasury finds any country’s currency to be ‘misaligned.’

The legislation also instructs the Commerce Department that it cannot dismiss allegations that undervalued currency serves as an export subsidy in trade remedy cases simply because the benefits of currency undervaluation don’t extend only to exporters.  Currently, the Commerce Department considers countervailing duties when a country targets a specific industry or product, such as steel or shrimp or bedroom furniture.  The bill will require the Commerce Department to use estimates of currency undervaluation when calculating ‘countervailing duties,’ imposed against imports deemed to be state-subsidized (effectively treating the undervalued RMB as a subsidy offered by the Chinese government).

Therefore, the Senate bill will make it more difficult for the Commerce and Treasury departments to ignore currency manipulations and sidestep retaliatory measures against countries like China.

The Devil of the Details –

This is clearly a significant push by both branches of the U.S. government to force China to be more accountable with its trade policy.  Unfortunately, the acts are rather symbolic and the impact will be fairly small!

First, WTO cases take forever (at least 3 years), and China has learned how to ‘litigate’ at the WTO.  Although the Obama Administration has been much more active in the WTO then the Bush Administration, the precedent in which China drags its feet and even brings counter-cases (see China’s request for the establishment of WTO panel on the use of zeroing in U.S. trade remedy cases) has been set.

Second, the currency bill will only be significant on subsidies cases, and considering that trade remedies cases cover less than 4% of all U.S. imports it’s hard to see how it will have a major impact on Chinese exports (see past article by this author).  Also, many trade policy experts believe that the currency bill is vulnerable to a WTO challenge, because a benefit offered by the government to all domestic producers (like an undervalued currency) is not quite a subsidy under the WTO Subsidies Agreement.  Finally, the Senate bill will have to be approved by the House and signed by the President as well, both of which right now are looking very uncertain.

Third, according to many analysts, the appreciation of the RMB will not change the current U.S.-China trade imbalance.  This is because many items made in China are usually just assembled in China.  Although China exports a number of indigenous low value-added products, the majority of high-tech goods coming out of China are usually designed and developed in Japan, South Korea and Taiwan, and are only assembled in China.  Also, if Chinese exports become less competitive, jobs are more likely to move to other low-wage countries of south-east Asia and less likely to move to the U.S.

However, the U.S. is not alone in its frustration with China.  According to Steven Mufson of the Washington Post, Brazil has taken a variety of measures to combat imports from China.  Brazil changed government procurement rules to favor locally made products.  It boosted by 30% a tax on imported cars, which have been gaining market share.  It revived an old law restricting the amount of farmland that foreigners can purchase.  And, Brazil recently suggested that WTO laws be changed to permit tariffs to be imposed against imports from countries with undervalued exchange rates.

Changes in China’s Domestic Economy –

China’s currency has been rising in value, and along with inflation in China it is putting an extra burden on Chinese manufactures and the Chinese economy.  Growing wages and a demand for more cheap labor mean that China is no longer the world’s top cheap producers.  Inflation is a real problem within the Chinese economy, rising to at least 6.5% this year.  Along with 7% appreciation of the RMB since June of 2010, doing business in China is almost 14% more expensive than a year ago, and consequently so are exports to the rest of the world.

Therefore, according to an article by Keith Richburg of the Washington Post, China’s trade surplus is now less than 3% of the country’s gross domestic product, down from 11% in 2007.  China has actually cut its trade surplus relative to the size of its economy, although this could be due to the global recession.

Finally, according to the Peterson Institute for International Economics, it is currently costing the Chinese central bank about $240 billion per year to hold down the value of the Chinese currency relative to other currencies, and this cost is growing rapidly.  To put this cost in perspective, $240 billion is considerably larger than China’s trade surplus of $183 billion in 2010.  Based on calculations by the Peterson Institute, the cost is about 4% of China’s GDP in 2010.  Moreover, this cost does not include the implicit tax on the banking system associated with China’s reserve holdings which are passed on to Chinese households in the form of depressed rates of interest on savings deposits.

The Bigger Picture –

Robert Samuelson of the Washington Post reported recently that what’s at stake is not just the U.S. trade balance with China but the nature of the global trading system, according to a recent book by economist Arvind Subramanian of the Peterson Institute (“Eclipse: Living in the Shadow of China’s Economic Dominance”).  Since World War II, the United States has presided over an open, non-discriminatory global trading system, which has been a big success.  However, that has only served the needs of the U.S., with its comparative advantage over the rest of the world in capital, technological innovation, and the largest protected domestic market.

According to Mr. Subramanian, China might supplant this system with one focused on its needs.  It might pursue preferential access to needed raw materials (oil, grains, minerals); it might discriminate in favor of its friends and against adversaries; it might subsidize its exports and seek protected markets for them.  It already does all these things — and as its power grows, it may do more.  Just as the U.S. enjoyed the economic benefits that come with having the world’s reserve currency, now China is using its undervalued currency to shape the world economic system to serve its needs.  (see also: China’s Efforts to Internationalize its Currency)

In Conclusion –

The two ways out of the current U.S.-China trade/currency war could not be more divergent.  On the one hand, many experts (including this author) have proposed an across the board 25% to 40% tariff on all imports from China.  This indiscriminate measure could put real pressure on China to dramatically change its currency policy, and shift its economic growth model from export led growth to domestic consumption.  On the other hand, Yao Yang of the Center for Economic Research at Peking University advocates for a Free Trade Agreement between the U.S. and China, arguing that it could be better for both sides than currency revaluation.  Chinese tariffs for imports of consumer goods are fairly high (thus making up only 3% of China’s $1.4 billion imports last year), and an FTA between the U.S. and China could only benefit U.S. exports of consumer goods to China.

Unfortunately, once again, incrementalism trumped substance… Currency issues (from manipulation, to exchange, to sustainability) are vitally important to the global market and economic growth around the world.  They should be the main focus of America’s trade policy, to be considered in a grand debate of how to fix the global economy.  Instead, America’s politicians are stuck in the mock, deliberating on minutia that promises ‘revenge’ but fails to address the bigger issues!

 

Author

Nasos Mihalakas
Nasos Mihalakas

Nasos Mihalakas has over nine years of experience with the U.S. government as a trade policy analyst, covering U.S trade policy, globalization, U.S.-China trade relations, and economic growth through trade. Mr. Mihalakas holds an LLM from University College London, and a JD from the University of Pittsburgh, with a BS in Economics from the University of Illinois. He has worked for both a Congressional Commission advising Congress on the impact of trade with China and for the U.S. Department of Commerce investigating unfair trade practices. Mr. Mihalakas expertise's also include international trade law, international economic law and comparative constitutional law, subjects which he has taught as an adjunct professor during the past couple of year. Currently, he is an Assistant Professor of International Business at SUNY Brockport.

Areas of focus: China, International Trade, Globalization, Global Governance, Constitutional Developments.
Contact: [email protected]

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