Obama and the China Syndrome
DEVELOPMENTS
President-elect Barack Obama already has considerable reason to worry about America's trade relationship with China. In November, China ran up a record-breaking $40 billion USD monthly trade surplus, and the country's top economic planning agency reported that this year's annual trade surplus of USD 280 billion is set to surpass last year's record. These staggering figures, however, mask the fact that China's trade numbers have fallen steeply, raising substantial concern about the Chinese economy's viability. On December 13th, Central bank governor Zhou Xiaochuan and other top economists told a forum that China may well be slipping into deflation. China, which relies on exports for as much as 40% of gross domestic product (GDP), must preserve its export regime, either through subsidizing industries or devaluing its currency, if it is to maintain the 8% annual GDP growth its leaders believe is necessary to preserve social stability. But if it either protects its export industries or devalues its currency, the world risks a trade war. Some export companies have already received value-added tax breaks and others may be expected.
BACKGROUND
The mercantilist regime on which China built its prosperity over the last two decades is in serious trouble. Imports fell from a healthy 15.6% in October to -17.9% in November as China's consumers put the brakes on spending. Exports growth collapsed as well, to -2.2% year-on-year, the first time since June of 2001 that exports had gone negative. According to government figures, exports account for as much as 40% of China's GDP, up from 20% in 2001.
This is only a snapshot of what is going on inside the country. And the key to the full picture–rebuilding the export regime–risks a trade war with the United States and the Eurozone, both of which are increasingly inclined to save their own industries through protectionism. According to the U.S. Department of Commerce, total October trade figures showed a trade deficit in a goods and services of $57.2 billion. Of that, $28 billion was with China alone.
That makes China a particular bête noir in the halls of the U.S. Congress. China's first devaluation, of 0.79 % of its currency against the U.S. dollar, got U.S. Treasury Secretary Henry Paulson onto an airplane for Beijing to try to talk them out of further devaluations.
Certainly, China poses a huge trade problem. The country has been amassing the biggest surplus in world history for most of the last two decades, the latest and by far the biggest to join a parade of export-oriented economies that began with the Japanese in the 1960s, extending through to the so-called tiger economies in a progression that included South Korea and Taiwan on to Singapore, Malaysia and Thailand, and substantially enriched the region while luring manufacturing from the U.S.
But China had a vast export advantage built on a huge labor force and average per-capita GDP of only $339 USD in 1990, according to the China Statistical Yearbook. Once the paramount leader Deng Xiaoping opened the country to western investment, Taiwanese and Hong Kong companies flooded into the Pearl River and Yangtze River Deltas to take advantage of the cheap labor, and China quickly became the workshop to the world. The Taiwanese and Hong Kong factories were quickly followed by Americans and Europeans who wanted to take advantage of lax labor conditions and cheap per-hour costs. Accordingly, manufacturing in particular began to flee the United States, falling as a share of domestic employment from 28% in 1960 to 10% in 2006.
As alarm continued to grow in the U.S. over the trade deficit, the Americans continued to push the Chinese to raise the value of their currency against the U.S. dollar. The Chinese two years ago adopted a so-called "crawling peg," with the renminbi (Chinese currency) creeping up from 8.68 yuan: $1USD to 6.83 in late November. Despite the vast trade volumes, the renminbi is still not a convertible currency, except for some Hong Kong dollar deposits, which as we will see turned into a river.
The creep stopped as the Chinese became alarmed at the performance of their own economy, which appears to be in worse shape than most of the world's economists were aware of. Reports in October 2008 disproved with a vengeance much of the brave talk over the last two years that Asia had de-coupled from the West and was able to stand on its own economically.
Against that backdrop, China probably cannot afford to devalue its currency any further despite some predictions that the renminbi could come down by another 5-10% against the U.S.dollar. In addition to retaliatory measures, it also risks capital flight. China doesn't want a currency crisis on top of a steeply descending economy.
If the currency is going to remain stable, it is up to the U.S.to do something about its own economy. And the worst thing it could do–and one that is increasingly possible–is opt for protectionism. The incoming U.S. Congress is overwhelmingly Democratic, and the Democrats got through the 2008 elections with the help of organized labor, and organized labor is antipathetic to free trade. Nancy Pelosi, the San Francisco Democrat who rules as House Speaker, is not only pro-labor but has, in the past, been hostile to China. With the U.S. economy descending towards the harshest landing since the Great Depression of the 1930s, protectionist sentiment is almost certain to rise.
As former President Bill Clinton did in the past, Obama comes into office showing a certain amount of public antagonism to free trade, and not just to China. He voted against a bilateral trade pact with Colombia, and has made strong statements about renegotiating the North American Free Trade Act (NAFTA), although those statements have been characterized privately by aides as political posturing prior to the election. His threat to name China a currency manipulator has also caused unease. It remains to be seen if he means it.
Like Clinton, Obama's top economic and trade advisors include, for instance, Rahm Emmanuel, his chief of staff, a Clinton administration alumnus who played a crucial role in gaining congressional approval of NAFTA. Head of Obama's White House economic team Lawrence Summers and Treasury secretary Timothy Geithner are linked to Robert Rubin, who as former President Bill Clinton's top economic adviser, pushed the North American Free Trade Agreement, which labor opposed. The question now is whether Obama will find a way out of his comments about China. He has delivered volte-face after volte-face so far, including naming Hilary Clinton Secretary of State after criticizing her heavily during the presidential race, for instance, and seems to have got away with it.
ANALYSIS
On June 17, 1930, U.S. Rep. Willis C. Hawley and U.S. Sen. Reed Smoot pushed through the Smoot Hawley Tariff Act, one of the most notorious blunders in U.S. legislative history. It raised tariffs on some 20,000-odd imported goods to record levels, kicking off a retaliatory trade war that is widely held to be the catalyst for the Great Depression. Whatever China's leaders or the U.S. Congress do, one assumes they will not dare another round of retaliatory tariff and other trade measures. America's labor unions, battered by three decades of diminishing power, played a crucial role in electing Barack Obama. They want what they consider to be their due, and they see China as the source of many of their troubles, from cheap shoes to cheap toys to cheap precision parts that have drastically cut the standard of living of the American worker.
In China, on the other hand, the confidence with which the country's leaders initially greeted the global slowdown has largely disappeared as they have discovered how interconnected they are to world markets, particularly to the United States and the Eurozone. But they face a growing dilemma –stability. China has famously been likened to a man on a bicycle. If the bicycle stops moving, the man falls over. GDP growth of 8% is the figure the country's leaders have repeatedly cited as the point at which the bicycle might fall over. Already, there have been scores of reports of riots in the Pearl River and Yangtze River Deltas as factories have closed and left workers high and dry. To attempt to alleviate the problems, China's leaders hurriedly pushed through a 4 trillion Rmb stimulus package, equivalent to about 4% of GDP. It is questionable if it will be enough.
What the United States and China obviously need over the coming months is close consultation. One of the few bright spots in George W Bush's dismal administration is the attention U.S. Treasury Secretary Paulson has shown towards China. It is essential that Obama continue that relationship, ideally with a powerful ambassadorial appointment and visits to the Middle Kingdom by his top economic advisors, if not the new President himself. And his bigger problem will be to keep the protectionist hawks in his own administration at bay while the global economic convulsion works its way through the system and the two countries achieve equilibrium again.
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John Berthelsen is editor of Asia Sentinel. Prior to Asia Sentinel, he was managing editor of The Standard newspaper in Hong Kong. Mr. Berthelsen was also a correspondent for Newsweek Magazine, the Asian Wall Street Journal and the Sacramento Bee. He has lived in and reported from five different countries in Asia.