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,, 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.