China: Trade Relations

8/6/2019 China: Trade Relations

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nited tates and hina:

Trade Relations

Brooke A. Gallagher

Economics 561

Professor MendozaDecember 16, 2008


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elations between the United States and China have a tumultuous history

of ups and downs. As of recently, the story is no different. The United States current dismal

economic position and trade deficit in comparison with Chinas booming economy and

trade surplus proves to be a reasonable worry for Americans. But are these concerns

reasonable enough to assume a potential overtaking of economic power by the Chinese

Market? To accurately answer this question, it is important to look at the Chinese economy

from every angle and through a variety of telescopes. The following is a discussion on the

United States current economic relationship with China and what the future may hold for

both economies.

There are countless underlying factors that make up Chinas economic policy. Many

of these factors were created through Chinas unwillingness to conform to near universal

economic standards; consequently this has created a distorted economy. This type of

distortion makes it nearly impossible to truly measure the depth or success of an

economy. When economists study a nations welfare, it is a necessity to know how much

the national currency is worth. China has a managed flexible currency which is an

inefficient way to measure net worth in comparison to a flexible currency, hence, the

distorted economy.

To accurately find a solution to an economic dilemma, it is best to look at the

chronological history of a nation and carefully analyze and asses the process which has led

to the nations current state of despair or inadequacy. In doing so, one can take this analysis

and contrast it to that of other nations, thereby confirming a conclusive solution. The

following few paragraphs will give a brief analysis on the contemporary history of Chinas

Topic: Chinas fixed to managed currency will be discussed in greater

detail further in the paper.


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public and economic policy reforms; the topics will be narrowed down by what is deemed

most relevant to the United States.

Throughout the 1940s, China was in considerable political unrest (a frequent

position for Chinese politics). In 1941, the United States sent military and financial aid to

China in support of the Nationalist government. This further proved to the world that the

United States had a firm motive in dismantling communism. Not only did the United States

fight communism, the US sent troops to China in support of the treaty revisal of Tientsin.

This treaty allowed Japan to treat China unjustly through bilateral agreements.

Unfortunately, in 1949, the US efforts were lost and the communist party took over

establishing the Peoples Republic of China which relocated the Nationalist party to Taiwan.

The Korean War froze US- China trade and travel relations for over two decades in

the fifties. In 1971, Secretary of State, Henry Kissinger, made a surprise visit to China and

requested that trade be resumed within the next decade. This proved beneficial as

resistance to bilateral trade began to thaw (Stratfor, Timeline). Thus, the United States

loosened its trade embargo against China and the net trade worth began to grow from zero.

Success was noticed in 1979 when Washington and Beijing reestablished diplomatic

relations and bilateral trade was already up to a cumulative amount of $2.4 billion.

Subsequently, a Three-Year Trade Relations Agreement was signed. China thus opened

their first Special Economic Zones which offered unique treatment to the US and other

foreign investors, thereby reentering the World Bank and the International Monetary Fund.

In reaction to Chinas progress and the United States solid economic position in

1984, President Ronald Reagan signed an agreement to eliminate the dual taxation and ban

tax- evasion. Furthermore, Beijing opens itself up to the world by launching a conglomerate


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of programs aimed at economic reform. By 1988, one quarter of Chinas total $40 billion

export sector is sent to the United States. To sum the US- China relationship up at this

point, things were working, but things were stressful.

After China joined the World Trade Organization in 2001, international relations

should have become more stable. However Chinas economy is consistently changing and

thus policies are inconsistently compatible because of these reforms and fluctuations. The

three most recent complaints from the United States in regards to the trade relationship

with China are: the undervalued renminbi, Chinas slow progress in meeting World Trade

Organization commitments, and Chinas questionable standards for assessing

countervailing duties with concerns for national security (Bhattasali, Deepak).

Both nations have motives to keep relations stable, therefore it was vital that China

join the World Trade Organization. China depends on the US export market to generate

jobs for its citizens, while the United States creditors and businesses with investments in

China depend on continued Chinese economic growth and social stability for a multitude of

reasons.

As of the recent, specific sectors of Chinese exports, such as textiles and clothing,

have had ongoing disputes with the US industry especially after the expiration of the Multi-

Fiber Arrangement in 2005. US industry feared for good cause that an incoming flood of

cheap Chinese textiles would consume American markets after this quota on imports was

lifted. This fear led to a compromise and the two countries worked out a new bilateral

agreement to add quotas in order to put a cap on 21 categories of imported Chinese textiles

and clothing.

Renminbi- The formal currency of the Peoples Republic of China, also known as the

Yuan ().


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The main dispute at hand is how China keeps their prices so low. One major concern

concentrates on human rights and alleges that China utilizes unfair labor practices

providing its workers with the bare minimum necessities. China indeed encourages

minimal labor standards and may violate workers rights by suppressing strikes and

prohibiting labor unions which can potentially reduce businesss expenditures by well over

50% (Hufbauer, Gary). AFL-CIO calculated that on average, Chinese companies were

reducing costs by about 47%, thereby granting them comparative advantage over

American industry.

Another cause for disagreement between these two nations is Chinas seemingly

denial of market economy status, relevant to the nations disregard toward anti-dumping

duties on wood furniture and television sets which set back the US export industry and

estimated $4 billion. Some nations and companies use dumping to their advantage because

it creates a larger profit margin by selling commodities at a higher price overseas than they

do domestically, thus defeating the purpose of trade and creating another formal barrier to

trade. China had promised to end its tax discrimination against semiconductors (important

in electronic devices) but has failed to follow through which has set back US exports $0.3

billion. Once a solid resolution is reached on the auto parts dispute, the United States could

likely see an increase of $300 million to the export sector.

The most heated theme consistently debated between China and the United States

has been the renminbi exchange rate. The currency has recently been removed from the

fixed peg to a more manageable exchange rate with a central parity based on a central

currency basket. When the renminbi was fixed (1994 to 2005) the US trade deficit had

reached record highs and Chinas economy was growing at record highs at an average rate

During the time of the fixed currency, the Yuan was averaged at about 8.28 to $1


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of 8% per year. If China had a free floating currency, which is universally standard, the

Yuan would have appreciated thereby unveiling the true economic strength of the nation

and the true market buying power of the currency. Because the currency was so

tremendously undervalued (around 27.5%), over 3 million United States manufacturing

jobs were lost due to cheaper products being imported from overseas.

An undervalued currency can create a plethora of economic problems. In this case,

the US import sector is paying too much Yuan for the commodities they are importing. That

extra expense can act either as a subsidy on exports or a tax on imports; either way, the US

import industry is missing out on their share. For China, this undervalued currency means

that the Chinese Central Bank will lose money if the currency is ever revalued (which most

experts assume is inevitable).

United States senator Charles Schumer of New York and Lindsay Graham of South

Carolina created the bipartisan bill (2005) that led to the eventual managed floating

exchange rate. Schumer stated: "The Chinese want to have it both ways: On one hand they

want free trade and want membership in the WTO and other international trade

organizations. But on the other hand, they don't want to play by the rules of those

organizations. The Chinese actions endanger American and world commitment to free

trade and weaken the support in Congress for free trade. This legislation is a tough-love

effort to get the Chinese to stop playing games with their currency in order to level the

playing field for American companies trying to compete with goods and service coming

from China."

However, former chairman of the US Federal Reserve, Alan Greenspan, warned

against such pressure. He stated that the loosening of Chinese currency restraints would do


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little to increase employment in the United States job market and emphasized the

precarious nature of the Chinese banking system. He did explain that it would be in Chinas

best interest to do so for their economic benefit, and advised to do so in a slow and

controlled manor. "It is nonetheless the case that a more flexible RMB would be helpful to

China's economic stability, and hence, to world and US economic growth," he said. "Rapid

accumulation of foreign, largely dollar-reserve holdings by the People's Bank of China,

China's central bank, as a consequence of support for the RMB, would boost the growth of

the money stock with the accompanying risk of putting upward pressure on inflation and a

general overheating of the Chinese economy."

Greenspans main argument was that China does not have a system like ours and to

force our regulation ideals on them would be detrimental to both economies. Chinas

collective banking sheet contains a voluminous amount of nonperforming loans (an

estimated 40% of recent bank loans are NPLs). If a nation has this type of balance sheet, to

quickly take away a fixed currency could create an outward flood of capital to more secure

foreign banks, resulting in the destabilization of the Chinese economy. With such a large

economic player in disarray, this would be very detrimental to world growth.

Whether it was Greenspans words of wisdom or the threat of imposing a 27.5% tariff,

China decided to ultimately loosen the currency restraints. The basket proved effective (not

perfect) in revaluing the renminbi within a band constraint of daily fluctuations against the

dollar limited to 0.3% around the central parity number, announced daily and beginning at

8.2, and with a total narrow band of 2.1%.

Unfortunately this still creates a distorted market. Any form of market

manipulation to gain comparative advantage over another country violates the World

The logic of imposing a 27.5% tariff was to even out the playing field becausethe renminbi was undervalued at an estimated 15 to 40% (average


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Trade Organization and International Monetary Fund in which China has recently become a

part of (Bhattsali, Deepak). Politicians, economists, and other experts disagree

considerably on what the renminbi should be revalued at, but it is certainly the topic that

has been the gasoline on the fire for trade relations.

Looking at Chinas economic portfolio, around 50% of the GDP is in the segment of

investments: all investments including that of new real estate. The net exports are also at a

considerably high level at 7% of Chinas net GDP. Conversely, household consumption is

only 40% of the Gross Domestic Product. If we compare that to the United States at the

opposite end of the spectrum, 70%, we can see the large disparity between the two

portfolios. A nations true economic health and welfare is measured through the rate of

consumption rather than that of net exports or investments. Therefore, the United States

economic welfare is, by definition, actually in a healthier state.

Future government savings in China will likely be low because of the large unfunded

pension liabilities China continues to burden, those nonperforming loans and assets that

will eventually need to be refinanced, and the fact that their social welfare and health care

system relies heavily on the government which will call for large scale government support

(Perkins, Dwight). However, Chinas main bulk of savings remains in households. These

household savings are mainly intended for large consumer durables, but the new

privatization of housing has created an entirely new economic sector. Thus, expansion of

consumer credit and heftier mortgages may change the Chinese saving paradigm.

The point is this, as Chinas economy changes as seen in the model of Chinese saving

patterns, so too does aggregate demand. This shift in demand may cause a shift from

Chinas dependency on rapid export growth to domestic consumption and expansion,

All figures cited within this are sourced from: Hufbauer, Gary: US-China TradeDis utes


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thereby leading to an expanded consumer lending relationship. I feel this situation will be

attained because prior economic knowledge has displayed that large developing countries

with high growth rates continuously rake in high enterprise profits that remain high. As

stated above, Chinas economy is still dependent to a relatively strong degree on its

government and thus, it is my assumption that these profits will be put back into

investment activities in order to keep the political economy stable.

Throughout Chinas history, there has been a complete lack in the governments

fundamental desire to globalize the nation. The isolation dates back from the beginning.

China had and still continues to have the potential to become the leading world power but

what they do not have is the desire to incorporate the rest of the world. The falling behind

in the midst of the Industrial Revolution proved Chinas fear of unconventional ideas and,

in effect, innovation. Until China breaks free from these protectionist ideals they will

remain behind. With the popularizing of present technological innovation, globalization has

become especially important and it is nearly impossible for a business to survive if they are

not connected to the World Wide Web. So the real question at hand is: can China keep up?

I think that it is clear that China does have the potential to become the top economic

power, yet China has a way to go. Politics and Economics need to be formed together to

create a stable nation; and for a flourishing economy, there must be a well-formed

democracy. China is definitely headed in the right direction and is on the path of market-

preserving federalism. However, China has a volatile political past so it is not definite that a

democracy will last. As for Americas relationship with China they are codependent; thus

without their inflows of goods and investments and our outflow of products, neither nation

would be as large a success. As long as China and the United States work together in a joint


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effort to promote the expansion of world trade and investment, both nations will benefit,

and consequently, so too will the rest of the world.

Sources and Works Cited

y Bhattasali, Deepak. China and the WTO: Accession, Policy Reform, and PovertyReduction Strategies. The World Bank and Oxford University Press.Washington, DC. 2004.

y Hufbauer, Gary. US China Trade Disputes: Rising Tide, Rising Stakes.The Institute for International Economics. Washington, DC. 2008.

y Kynge, James. China Shakes the World. Houghton Mifflin Company.Boston, NY. 2006.

y Perkins, Dwight H. The Challenges of Chinas Growth. The American EnterpriseInstitute for Public Policy Research. Washington, DC. 2007.

y Prasad, Edward S. IMF Policy Discussion Paper: Modernizing Chinas GrowthParadigm. American Economic Review. American Economic Association andthe International Monetary Fund. Boston, MA. March 2006.

Documents

China: Trade Relations