The U.S. Trade Deficit with China & the Exchange Rate

83% of the U.S. non-oil trade deficit is with China.

EPI:  China trade deficit
src: Economic Policy Institute

Right now, we have the Obama administration seemingly hell bent on furthering that new country, ChimericaTM. All are wrought in fear as it is realized China is the biggest holder of U.S. Treasuries.

In the blog piece, The problem with relying on the dollar to produce a real appreciation in China …, we have a fairly in depth analysis on the Renminbi currency peg to the dollar and the massive trade deficit.

there is now plenty of evidence that a weak RMB does have an impact on the pattern of global trade. A big impact.

The boom in China’s exports that characterized this decade came after the dollar’s 2002-2004 depreciation produced a significant real depreciation of China’s RMB — a depreciation that came just as a host of internal reforms pushed China’s own productivity up. The net result: a huge export boom.

China exports vs. exchange rate

src: Council on Foreign Relations blog

Econbrowser has an exceptional analysis piece, Three Pictures: China's Exchange Rate and Trade Balances. While believing the China trade deficit has more to do with price elasticities that are small, he too is noticing the exchange rate with respect to the total China trade imbalance has an astounding correlation.

The Chinese CA surplus was forecasted for 10.3 ppts of GDP in 2009, and 9.3 in 2010. The most recent Public Information Notice for China (released 5 days ago) forecasts 9.5 for 2009, so clearly events are fast overtaking forecasts.

Here, of course, I'm talking about short term trends, and these are dominated by the financial crisis and recession [7]. My Eswar Prasad writes on prospects and policy implications for China while Bertaut, Kamin and Thomas write about what happens after the recession to the US external accounts, based upon pre-crisis trade elasticites. Whether those estimated trade elasticities will be the right ones in the longer term is up for debate

dollar exchange rate vs. yuan
src: Econbrowser

The above graph shows the exchange rate of the dollar vs. the Chinese real trade weighted CNY.

Chinn also reviews the Peterson Institute for International Economics' new book, The Future of China's Exchange Rate Policy and concludes:

They argue -- from a back-of-the-envelope calculation -- that a 45% appreciation would have eliminated the 2007 trade surplus of 11 percentage points of GDP.

If this back of the envelope calculation is valid, as I read it, implies one could solve the trade deficit with China by just addressing currency manipulation.

Policy recommendations from PIIE goes into great statistical detail, but they clearly illustrate China is manipulating it's currency to keep them at a competitive advantage in manufacturing. PIIE also implies enabling the China currency to float is tricky. One key element to this is precisely what the Obama administration discussed with China, for China to grow it's own consumer economy to replace the lost export dominance that would occur if the Yuan was allowed to appreciate.

So, it appears those pushing for China to stop it's currency manipulation, claiming such legislation would help greatly in reducing the beyond belief trade imbalance with China, are getting analysis from top economists backing up their claims.

Another reason to read the Peterson study, they discuss at length China's VAT, or value added tax manipulation.



Simon Johnson has another view, restrict capital inflows

I thought this was interesting. Simon Johnson over at the baseline scenario is taking about curbing capital inflows to feed growth, particular in China.

Much more likely is what is now being whispered about in the corridors of financial power – begin to consider ways to tighten capital controls, i.e., limit the amount of capital that can come into a country, or force investors to commit to stay in the country for longer periods of time.

Such capital controls are unlikely to be announced explicitly, but watch for tightening the rules around inflows. And expect discussion increasingly at the level of the G20 about the extent to which various kinds of capital controls can now be considered “best practice.”

I'm glad you found Johnson on capital controls

but I think it should be an independent diary on its own, because limiting cross-border capital flows strikes at the very heart of the economic neo-liberalism that has been the reigning economic paradigm for the past three decades. There is also this important in Johnson's article: The US has historically pushed the view that all capital controls are bad and should be abolished – in fact, this was a major international policy initiative of the Clinton administration, led in this regard by Messrs. Summers and Geithner (who both came up through the international side of Treasury).

Ian Walsh has some interesting things to say about US-China economic relations on his blog this past week:

The China Syndrome: what the current talks with China tell us about America’s situation

. . . . Both America and China did a stimulus.  China’s stimulus is already working.  It had 7.1% GDP growth.  The US is still mired in recession.

Why?  Two main reasons.

   * China did its stimulus right.  It wasn’t 40% bullshit tax cuts with almost no stimulative effect.
   * China, as a creditor rather than debtor nation with huge savings, can credibly be expected to continue its stimulus, while the US can’t.  

. . . . Americans also want the Chinese to move to greater domestic demand,, to open up the Chinese market to US investment (because American companies desperately want to be able to invest in a country with real growth prospects, rather than the US) and to start buying more US goods.  This requires letting the Chinese currency appreciate against the US dollars and is needed long run for American health.  But in the shorter term it leads to a fiscal crisis.  If America doesn’t want to increase taxes to pay for its own spending, how can China buy less treasuries and US assets and thus allow the Yuan to appreciate?  And why should they, when right now in exchange for money the Chinese can afford to lose and crappy consumer goods, the US is exporting its industrial base to China?  An industrial base is worth any price.  Americans, with their unwillingness to tax themselves, aren’t willing to pay for the American industrial base.  The Chinese are.

Why can’t we get a good healthcare bill?

Because the US is a debtor nation, and China isn’t willing to pay for Americans to have healthcare.  

 Walsh concludes that

. . . one side of the relationship is getting a lot more out of it than the other one and every year the Chinese need America less, and America needs China more.

And in a comment, Walsh writes;

Americans are going to find that the rest of the world is not willing to lend to them forever, just until they’ve extracted as much value as they can get and until the Chinese economy hits internal demand ignition.

At that point, the US gets to experience what the Russians did in the 90’s, but won’t handle it nearly as well.


well, one thing I find ridiculous

is sacrificing the U.S. production economy simply because oh tisk, tisk, they are worried about crashing the China economy...ya gotta wonder who do these politicians represent? and on top of it, come on, "all we need to do" is change the culture of 1.3 billion people who are a bunch of savers?

We simply should not worry about what China is doing and start worrying about what America is doing. Let China worry about China.

Chaos and a lack of willingness to limit trade

While I believe that the exchange rate is a problem, the real problem is that the United States has a lack of willingness to restrict trade to the public good instead of to private profit.

There are a lot of winners right here in the United States who depend on that trade imbalance- including a few companies whose trade with China exceeds that of many other nations.

The only real way to stop this is to insist on balanced trade agreements; no imports without exports in 100% equal amounts. And that means removing international trade from the free market; every trade must be applied for and approved by US Customs instead. Importers will have to buy from US Customs, Exporters will have to sell to US Customs, foreign businesses will have to deal with US Customs, ONLY.
Maximum jobs, not maximum profits.

Maximum jobs, not maximum profits.

While I am not as well

While I am not as well versed in these issues, I have always been interested in seeing how gold, the main asset class that the US government does not want to see higher, acts during these volatile economic times. I do find it interesting that the volatility of the Gold Price
has declined so much this year. I guess it is just difficult to predict the short term movements and relationships of gold and currencies.