The “China Problem” on the Economic Agenda

Along similar (trade-related) lines…

There’s is an interesting story in CBS MarketWatch about Snow’s trip to China, and the US-China economic relationship more generally.

On the surface, maybe it doesn’t seem that interesting to people who aren’t international economists, but there are several things contained in the article that I think are going to be of increasing significance over the next 2 to 4 years.

1. China’s trade gap with the US is huge and growing. (See chart.)

Just as Japan’s huge and growing trade imbalance caused a rising tide of protectionism in the late 1980s, I think this one is going to bolster a trend toward protectionism in the US over the coming few years. After all, it’s easier to sell protectionism when there is a clear target in everyone’s mind – especially one that doesn’t stir much sympathy among most Americans. (For some reason no one seems bothered by the US’s very large trade deficits with Canada or Germany.)

2. There’s growing discussion about the value of the Chinese yuan against the dollar:

“Snow needs to rattle the saber a bit here because members of Congress are speaking pretty loudly about the economic threat China is posing to the United States,” Matsukata said.

A growing chorus in Washington is alleging that the China trade gap is the result of rock-bottom labor costs, a relaxed regulatory environment, and most importantly, an unfair advantage — an undervalued currency. China’s currency — the renminbi or yuan — has been pegged to the dollar in a narrow range between 8.276 and 8.28 since 1994….

Analysts said they expected Snow to urge China to consider either revaluing the currency a little bit or expand the trading range a little bit.

More and more US manufacturing firms (at least those that don’t use inputs made in China) are clamoring for someone to pressure on the Chinese to let their currency appreciate. Some in Congress have been taking up the call. I predict that this pressure will increase substantially – and I bet at least a couple of the Presidential candidates will make pressuring the Chinese to revalue the yuan a part of their platform. The problem is, the Chinese have no incentive to do it, at least not right now. (I’d be happy to discuss why in more detail if anyone wants to.)

3. China’s reserves of US dollar assets:

“The United States has also benefited from the fixed peg because China has been a large buyer of U.S. debt securities, which funds the U.S. current account and keeps interest rates low. China has amassed $345 billion in dollar-denominated reserves, according to the International Monetary Fund.”

Actually it’s closer to $500 bn once you take Hong Kong’s reserves into account. I’ve been keeping track of this for some time, and what’s happened in the last 3 or 4 years is truly astonishing and unprecedented: China, Taiwan, Hong Kong, Japan, Korea, and Singapore together have collected nearly $900 billion in US securities.

This has enormous implications. The first is that it simply indicates that the US dollar is seriously overvalued. The second is that whenever those countries decide to start selling those assets, the dollar is going to take a gigantic plunge. The third is that these reserves actually give China a reasonable amount of leverage on the US; China could (I’m not saying they would ever even threaten this, but it’s a theoretical possibility) tell the US that they will drive US interest rates higher if they aren’t happy. $500 bn in assets is enough to do that.

My prediction: these issues are going be HUGE in the not-too-distant future.