China and Destabilizing Deficits
China is now running a trade deficit — not a surplus. This might be a surprise to those of you who faithfully follow the Opinion pages of The New York Times.
On New Year’s Eve, Paul Krugman came out swinging: “China’s currency is pegged by official policy at about 6.8 yuan to the dollar. At this exchange rate, Chinese manufacturing has a large cost advantage over its rivals, leading to huge trade surpluses…The bottom line is that Chinese mercantilism is a growing problem, and the victims of that mercantilism have little to lose from a trade confrontation.”
The following month, Krugman basically hit the publish button again, though with more provocative language. And not three days later a New York Times editorial, Will China Listen? [presumably to Krugman], offered a strikingly similar condemnation: “China’s decision to base its economic growth on exporting deliberately undervalued goods is threatening economies around the world. It is fueling huge trade deficits in the United States and Europe.”
So what happened? How did the coronated world-leader in predatory trade practices become a net consumer? The answer is partly way down under , as China’s appetite for commodities and energy continues to soar. But if the financial crisis taught us anything it’s that China’s economy is not export-dependent, and it probably hasn’t been for some time. In late 2008 and early 2009, as the global consumer began stashing cash under her foreclosed-upon tool shed, doomsday media headlines predicted economic and social catastrophe in China. Here are some of the choice headlines: Rising Desperation as China’s Exports Drop (NYT), China’s Hard Landing (Fortune), and The Last Pillar of China’s Economy Falls (Time). Ouch. The basic assumption – which some still defend – was that China’s economy couldn’t survive a precipitous drop in its exports. Apparently no one was convinced by Jonathan Anderson’s thorough assessment way back in 2007 on the diminished role of exports in China’s economy. In 2009, outflows fell by 16.4% and the country’s account surplus with the US narrowed by about 35%, yet total economic activity (GDP) in China remained remarkably bullish, growing by more than 8%. So much for export dependence.
Back to the here and now. Is the RMB undervalued? Probably somewhat. It was undergoing a steady appreciation against the USD before Beijing threw on the brakes, not moments before the markets took a dive. And recently the RMB has depreciated along with the dollar against most other currencies, though that may say more about the dollar than it does about the RMB. Regardless, Beijing has a great deal of interest in a stronger RMB – as China-based companies buy up foreign commodities and brands (a la Volvo) – which is why we will likely soon see just that.
There are a few things that people don’t often recognize about trade with China. First, about 55% of China’s exports are actually produced by foreign companies with international investors. That number goes up above 80% in high-tech industries. For many businesses, China serves as a final assembly center for components and materials sourced from countries around the world. For example , Apple’s iPod is manufactured in China, but less than 5% of its end value is actually created by Chinese citizens or resources. For the difference we must look elsewhere, such as Australian metals or well-paid creative service jobs in the US. Those well-paying US jobs wouldn’t exist unless companies like Apple are allowed to source different parts of the production process to different markets. China is just one stop among many production hubs in an intricate commerce network that drives efficiency and lowers prices for end consumers. This global economic restructuring should be welcomed so long as more value is being created than lost. Unfortunately, wealth in the US is less evenly distributed now than it was, and that’s a problem, but China didn’t tell us to spend our credit line dropping bombs and neglecting schools. That one’s on us.
At the same time, more than 70% of US-based companies are operating in China not for labor but for the consumer market. China has become a major highlight on otherwise depressing balance sheets for scores of US-based companies. For example, it looks like GM will sell more cars in China this year than in the US. And they are not alone. Look at Boeing, Nokia, Volkswagen, or Coca-Cola. Or basically any luxury brand you can think of. To be sure, there are disconcerting challenges for foreign companies operating in China, such as ambiguous legal frameworks, IPR theft, information censorship, and limited market access in sensitive industries, among others. But China is an unparalleled long-term business opportunity, already paying out USD and EUR dividends for many, as 71% of the US-based businesses reported profitability in their China operations for 2009, which, if you didn’t notice, wasn’t exactly a boon year for the global economy.
Don’t get caught up believing that all of this could make or break the US. Because then, tragically, it just might. China’s exports are not prominently responsible for recent economic woes – particularly unemployment – in the US. At most, China and other major developing economies are just begging a lot of tough questions for Americans about global economic activity in the 21st century. Turning back the clock is not a good option. And painting China as the villain in our economic tragedy is a debilitating mistake, because it actually leads people to believe that for some reason forces within the US are not responsible for economic conditions in the US.
The US economy is in trouble, and confronting China on currency practices is like blaming the bat boy for striking out. The very thought betrays a sickening, corrosive sense of entitlement and disgusting priorities. You see it in record fiscal deficits, accumulated to fight wars while high-school graduation rates are below 80%; you see it in Easy Street bailouts that don’t allow the failures of profligate do-nothings to fail; you see it in protectionist legislation designed to prevent Americans from ever having to compete in a global market; and you see it in headlines running on the country’s most well-respected newspaper such as Will China Listen?.
Maybe it is time for the US to listen. Or just go back to work.
NOTE & INTRODUCTION: A few excerpts of this post appeared on my previous blog, chirony.com, which has since been ‘harmonized’ by the great firewall. And I thought I was being pretty good to China… For those of you who don’t know me, and for full disclosure, I recently moved to Shanghai from Beijing, and now work in one of those comparatively well-paying creative service jobs, within the energy industry, that probably wouldn’t exist were it not for free markets and international commerce.
Mr. Frost,
Welcome to “The Scene”. This was a great first post. My only objection is that you seeem to identify “dropping bombs and neglecting schools” as the cause for our uneven distribution of wealth which makes me chuckle and wonder how someone who could write such an intelligent post about free trade and international commerce be so clueless about both military spending and the relationship between spending money and school performance. If you have some down time, I’d recommend Charles Murray’s latest little book called “Real Education” which won’t take more than a couple of days and should cure you of your education romanticism.
Otherwise, keep up the good work.
— Arminius · Apr 13, 02:56 PM · #
Are you related to Matt?
— Freddie · Apr 13, 03:37 PM · #
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— Matt Frost · Apr 13, 05:54 PM · #
The trade deficit is probably partially seasonal: http://chovanec.wordpress.com/2010/04/10/chinas-march-trade-deficit-what-does-it-mean/
As to the broader question, whether or not Chinese exports are responsible for American economic woes, I think that’s not quite focusing on the right issue: the issue is about whether Chinese undervaluation of the RMB is at least partially responsible for American economic woes. Seeing as the undervaluation of the RMB is related to China’s financing of American debt, whether public or private, then yes, it would seem to be related, at least a little bit, no? Where you assign most of the blame is quite another issue, but I think the Chinese-American economic relationship is inextricable, with each move on one side being mirrored by another one on the other.
— dth · Apr 13, 06:02 PM · #
Dear Sir:
I do not believe your argument really tackles that of Krugman. Krugman is focused, as I understand it, on the trade deficit between the US and China. You are talking about the trade deficit between China and all its trade partners. Krugman’s argument is straightforward; he has shown how China’s pegging the renminbi boosts Chinese exports at the expense of US employment. Other economists have come to similar conclusions. What’s the simple upshot? China is practicing harmful protectionism. Talking about value added in Australia, or even in the US, misses the point; we (i.e., America) have an important interest in encouraging the renminbi to float.
Mack
— Mack · Apr 13, 09:12 PM · #
Arminius, thanks for the kind welcome. My military spending jab, which was admittedly unsubstantiated in this post, was just to draw attention to the marginal costs of war. In other words, we could have spent the same resources doing a lot of other things, such as recruiting more and better teachers or promoting renewable energy. Regardless, I will look into your recommendation and it put it on my next vacation reading list.
Freddie, yes.
Dth, it is tough to extricate certain aspects of the trade relationship as being more predatory or harmful than others. There are definitely restructuring costs associated with international trade, and those at times, and in specific industries, could be exacerbated by China’s currency practices. But I think it is important that we stop viewing the US as a victim in this trade relationship. The US chose what to do with the money China bankrolled, and US companies and consumers get a lot of value out of the trade environment in China. So my point is more that this isn’t a one-way street. Until Krugman recognizes the benefits it is hard to take his arguments seriously about the net balance.
Mack, similar to above, the problem is that Krugman is only looking at one side of the trade relationship, and not even the whole side. There is no question that Chinese exports detract from US manufacturing jobs (manufacturing productivity in the US has doubled over last 30 years), so do Mexico’s and India’s. The important question is whether our trade relationship with China detracts from total US wealth. The US can’t hold China responsible for what the US does with the money.
— walker frost · Apr 13, 10:01 PM · #
Mr. Frost writes in regard to the iPod:
“Those well-paying US jobs wouldn’t exist unless companies like Apple are allowed to source different parts of the production process to different markets. … Unfortunately, wealth in the US is less evenly distributed now than it was, and that’s a problem, but China didn’t tell us to spend our credit line dropping bombs and neglecting schools. That one’s on us.”
I don’t follow this logic.
If the final assembly of iPods were done in, say, Mississippi rather than in China, surely the direct effects would be to slightly lessen economic inequality in the U.S. The people with the “good jobs” in Silicon Valley would make slightly less money, American consumers would pay slightly more for iPods, and working class people in Mississippi would be a little better off.
— Steve Sailer · Apr 14, 12:23 AM · #
“…we could have spent the same resources doing a lot of other things, such as recruiting more and better teachers or promoting renewable energy.”
What about fighting obesity? We could have been hectoring fat kids with that money.
— Matt Frost · Apr 14, 01:57 AM · #
Steve, I think everything you said is exactly right. Except there are some other effects that you, and Krugman, are not accounting for. There would possibly be more wealth equality, but less total wealth (market prices rise, business profits decrease, investments decrease). And if China responded in kind we would then lose jobs, too. I agree that extreme wealth inequality is a destabilizing issue, but I would rather address it by using the extra cash on education and creating a bigger, better pie.
Matt, you don’t have to be rich to pick on fat kids. Just cold hearted… But maybe that’s better than being clogged-hearted.
— wfrost · Apr 14, 02:39 AM · #
Sir:
I see where you’re coming from; economic developments in other countries are sometimes not in our interest, and we can’t hold those countries accountable for the fact that things don’t play out the way we want. We have no special, general override on other countries’ economic state-of-being. We can’t mandate productivity or business cycles.
But here’s the difference. The renminbi’s peg isn’t an unfavorable economic development; it is a policy action. China, unlike India or Mexico, is engaging in protectionism to a degree that it is causing us material harm. That sort of action explicitly violates our longstanding trade policy. We have an obligation to address it.
The problem isn’t how US consumers spend their money; the problem is how the Chinese government is manipulating its currency.
Mack
— Mack · Apr 14, 03:35 AM · #
The Chinese elite think protectionism is a sensible policy. The American elite hates protectionism.
Which elite is right?
Yes, I know all about Ricardo’s theory of comparative advantage, just as the Chinese technocrats do, too.
Which elite has a better track record in recent decades?
— Steve Sailer · Apr 14, 07:43 AM · #
Yes, I know all about Ricardo’s theory of comparative advantage, just as the Chinese technocrats do, too.
— christian louboutin · Apr 14, 11:27 AM · #
Dear Steve:
I believe your argument boils down to ‘experts disagree’, with ‘elites’ replacing experts (which of course makes them less credible).
But the fact is that they agree on comparative advantage – it’s not really up for debate, as far as economic theories go. The reason they’re pegging the renminbi is because it helps them. The problem, however, is that it hurts us, and harmful protectionism is officially non-kosher between big economic powers.
It’s not about “who’s done better,” but how they’ve done better. In this case, Chinese methods are violating international agreements.
Mack
— Mack · Apr 14, 01:23 PM · #
Mack, when you say “it hurts us,” do you just mean that more low-cost manufacturing jobs are outsourced at a marginally faster rate?
The RMB is undervalued and it does have a somewhat negative impact (though way over-stated). The more important questions are: “Does the totality of this trade relationship help or hurt the US economy? And what could we do to improve it?”
For the first question, you have to consider everything. If we force an appreciation, how would you account for the profits lost by the US-based companies who manufacture in China? How would you account for the costs of higher consumer prices? Higher interest rates? How would you account for the potential costs of a trade war? What about the long-term costs of decreased market access for US companies in China?
For the latter question, I believe that a slightly undervalued RMB, that has been fairly steadily appreciating for five years (against USD, EUR, MXN, INR), is not a priority issue. China market access and legal protections for US companies is the real value opportunity.
Trade wars are just a bad way to create jobs.
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