China-U.S. Economic and Trade Relations Face an Eventful Period

Jan 23 , 2017

China-US bilateral trade has shown a weaker momentum in recent years.

According to Chinese statistics, China-US trade totaled $558.3 billion in 2015, increasing slightly by 0.58% over 2014. China’s exports to the US reached $409.5 billion, a year-on-year increase of 3.4%. According to US statistics, US-China trade was $598.1 billion, a moderate growth of 1.25% compared with 2014. US exports to China totaled $116.2 billion, the first shrinkage (-6.3%) since 2009.

Bilateral trade totaled $418.03 billion from January to October 2016, falling by 9.1%, according to Chinese statistics. Chinese exports to the US were $312.57 billion, falling by 8%. Chinese imports from the US were $105.46 billion, dropping by 12.2%. China’s trade surplus with the US was $207.1 billion, decreasing by 5.6%. According to US statistics, US-China trade totaled US$488.49 billion from January to October 2016, down by 5.4%. US exports to China were $92.03 billion, dropping by 3.5%. US imports from China were $396.46 billion, down by 5.8%. The US trade deficit with China was $304.43 billion, down by 6.5%, slightly better than the first half of the year.

Trade Deficit with China

For many years, the US has run a big trade deficit with China. In 2014, that deficit was $342.6 billion, accounting for 50.6% of the total US trade deficit. In 2015, the US trade deficit with China $365.7 billion, accounting for 49.6% of the total US trade deficit of $737.1 billion. In the first half of 2016, the US had a deficit of $161 billion, accounting for 46.2% of its total trade deficit of $348.3 billion, which has come down slightly for the six-month period year-on-year.

The US trade deficit is composed of three parts. First, the competitive deficit. Japan’s automobiles and the Airbus aircraft from Europe constitute a threat to their counterpart industries in the US and must be handled carefully. Second, the resource deficit. The US imports a huge amount of crude oil from the Americas and Middle East and minerals from Africa and Asia. This is an important part of its trade deficit and cannot be resolved easily. Third, the supplementary deficit. The US imports daily consumer goods from China, East Asia and Southeast Asia as an important supplement to its economy, industrial structure and people’s life. This is nothing but beneficial to the US.

Most of China’s exports to the US are daily consumer goods of high quality yet low cost. This helps alleviate inflation in the US and benefits low and middle-income groups.

Traditional trade statistics cannot explain the current issue of trade imbalance.

First, since the start of reform and opening-up, about 70% of the foreign investment in China has come from East Asia. Products that used to create a deficit between other East Asian economies and the US have been made on the Chinese mainland, causing the “effect of trade balance transfer”. Most of the parts and components in these products are from East Asia. They are not “Made in China”, but “Made in East Asia”. The income from the exports is shared by East Asia, not solely by China. However, according to the principle of place of origin, all the value of the exports to the US is attributed to China. China-US trade cannot be simply characterized as bilateral trade. It is multilateral trade, trade between the US and East Asia.

Second, one prominent feature of China-US trade is that 60% of it is processing trade. China only gets a fraction of the profits from processing. The US importers, wholesalers and retailers get a far larger share of the profits than Chinese manufacturers and exporters. Hence the phenomenon of “surplus in China, profits in the US”. As US economist Charles Kadlec said, according to the principle of place of origin, the $178 manufacturing cost of an iPhone is put under China’s account, because China is the final assembly place. China, however, only gets $6.50 of the added value of each phone.

It has been 46 years since 1971, when the US started running a foreign trade deficit. According to the statistics of the US customs authorities, the US has trade deficits with more than 90 countries and regions. The blame should not be all put on the RMB exchange rate. Rather, it is a natural result of economic globalization, industrial adjustment and massive international division of labor. This is a structural issue that cannot be reversed.

The Issue of the RMB Exchange Rate

It has been the practice of the successive US governments over the years to force the currencies of their trading partners to significantly appreciate, so as to reduce trade deficits. The US did so to the Deutschemark in the early 1980s, to the Japanese yen in the mid-1980s, to the New Taiwan Dollar in the late 1980s, and to the ROK won in the early 1990s. Since the beginning of the new century, the US has pushed hard for significant RMB appreciation.
But what has been the result of these moves? Over the years, the US has maintained trade deficits with Germany, Japan, the Taiwan region, ROK and China. This has never been reversed. In 2015, the US ran trade deficits of $74.2 billion with Germany, $68.6 billion with Japan, $14.8 billion with the Taiwan region, $28.3 billion with the ROK and $365.7 billion with China.

Once again, take China for example. The RMB appreciated by 36% from July 2005 to early August 2016, while the US trade deficit with China increased from $201.6 billion to $365.7 billion in 2015, up by 81.4% since 2005.

These facts show that the trade surplus or deficit of a country or region does not have much to do with its exchange rate. The exchange rate is not the deciding factor. Rather, deficit or surplus is a trading activity. It is the result of comparative advantages on a market basis. The competitiveness of the products of a country or region is determined by a host of factors. Simply forcing the currency appreciation of the counterparty to reduce one’s own trade deficit is a traditional and narrow-minded thinking on international trade. Times have changed, and the situation is more complicated. Such conventional thinking must be adjusted and updated.

After 11 years of exchange-rate reform, the RMB exchange rate has basically become market driven. The band of the exchange rate fluctuation has increased from the original 0.3% to 0.5%, 1%, 2% and current 3%. In the past half-year, the RMB exchange rate has been once again pegged to a basket of currencies and basically maintained stability. Now, people are more focused on the depreciation of the RMB against the US dollar and neglect its appreciation to different degrees against the yen, euro and pound.

The main reason for the RMB’s depreciation against the dollar lies in the dollar itself, not the RMB. On Oct 10, 2016, the USDX exceeded 97, and the central parity rate of the RMB was 6.7098 the following day. On Nov 15, the USDX exceeded 100, and the central parity rate of the RMB was 6.8592 on Nov 16. On Dec 22, the USDX rose to 103.36, a 14-year high since 2002. The central parity rate of the RMB was 6.9463 the next day. In the face of the significant appreciation of the US dollar, the currencies of quite many developing countries have experienced relatively sharp depreciation. By comparison, the fluctuation of the RMB is comparatively moderate. This is a widely recognized fact that must not be distorted.

On Oct 1, 2016, the International Monetary Fund officially included the RMB into the SDR basket as one of its five reserve currencies. This is a recognition of the market-based reform of the RMB exchange rate and the global use of the RMB.

There is no reason that China should be labeled as a “currency manipulator”.

China-US economic and trade relations will enter an eventful period in 2017.

As the strongly protectionist Trump team takes office, they will inevitably push for trade protectionism globally, which will for sure meet with opposition and reprisals across the world. As a consequence, it will hurt all and benefit none, and the world economy will backslide. There are examples in history. In the 1930s when the US experienced the Great Depression, President Herbert Hoover raised import tariffs by a great margin to protect domestic industries. That was opposed by the rest of the world. When goods cannot move across borders freely, soldiers go beyond national borders. The Second World War thus broke out.

China has no intention to wage a trade war. Nor is it afraid of a trade war. In the 44 years of China-US economic exchanges, there has been only one trade war: the textile trade dispute in 1983. It ended with compromise made by the US government. It is worth noting that China’s GDP in 1983 was less than 5% of that of the US, while China’s GDP in 2015 was 61% of US GDP. Today’s China is not what it was 33 years ago. Any US administration should never belittle China. In 2015, China imported 22% of US cotton, 56% of US soy beans, 26% of Boeing aircraft and 33% of the GM vehicles sold overseas. Substitutes for these products can be found elsewhere in the world. The US is fully aware of that.

Dialogue is better than confrontation, and cooperation is better than friction. China and the US are each other’s big market. Since 2010, China has been the largest market for US agricultural products. Trump nominated the governor of an agricultural state to be the US ambassador to China in the hope of promoting agricultural exports to China.

China has become a vital trading partner for the US over a long period. US-China trade in 2015 was $598.1 billion, accounting for 16% of US foreign trade. If Hong Kong and Macao are included, US-China trade will be $642.6 billion, accounting for 17.2% of US foreign trade.

That said, the US is also a very important trading partner of China. In 2015, China-US trade was $558.3 billion, accounting for 14.3% of China’s foreign trade. China’s exports to the US were $409.5 billion, accounting for 18% of its total exports. If the $481.9 billion exports via Hong Kong are included, it will account for 21.2% of China’s total exports. Since 2012, the US has surpassed the EU as China’s largest export market.

China-US economic and trade cooperation faces broad prospects, with both major opportunities and daunting challenges. The two countries will lose from confrontation and gain from cooperation. The two governments should strengthen dialogue and cooperation in a win-win spirit. This will not only benefit the Chinese and American people, but also promote the development of the world economy.

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