US-China Tensions

The fault lines in the US-China relationships have been increasingly exposed in recent weeks, rising from rhetorical barbs exchanged on trade, the treatment of foreign companies in China, strategic issues such as US support of Taiwan, Tibet’s Dalai Lama to possible trade wars between two countries, leading to April 15’s report by US Treasury on China’s status on currency front. Domestic pressure in the US Congress on the need for action with regard to the pegged Renminbi (RMB) is growing and on the other side of the equation, Chinese leaders, including Premier Wen Jiabao, have recently hit back at the US for what they characterized as interference in China’s security and economic affairs.

Arguably that way back in 1971 when the US dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10% surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. Way back then, the Japanese yen was around 350 to the dollar. It is mentioned by Paul Krugman in his recent writing in New York Times ‘Taking on China’ that unless China is facing with the threat of similar action, except that this time the surcharge would have to be much larger, say 25%, it is hard to see China changing its policies.

One thing that I note than despite the changes in Yen, now at around 90 – the Japanese are still producing massive trade surpluses, about half the size of Chinese surpluses with less than one-tenth of the people. That is an almost 75% devaluation and yet the world keeps buying Japanese products.

The Chinese could raise the value of its currency over the next year and they would still run a surplus because like Japanese, they make good stuff that we want at prices we like. And it would also introduce inflationary increases in our imports and higher prices for lower income families.

The US deficit stood at US$40bn, but that is down from the US$70bn it was only a few years ago. Over half that deficit is oil and energy. The US trade deficit is due to a lack of savings in the US. But on the other hand, America sounds increasingly determined to push its exports and its attitude to China has hardened. Mr Obama has set a goal of doubling exports in five years.

A stronger RMB would not suddenly bring back millions of jobs to America and it would not be a magic bullet either within China or outside. Rebalancing China’s economy will require big structural reforms towards domestic spending by boosting Chinese consumers’ purchasing power, discouraging excessive investment in manufacturing and squeezing corporate profits.

Cool and calm multilateral leadership will achieve more than a Sino-American currency spat.