Washington ignorant of China's
importance to US By Jephraim P
Gundzik
The increasing politicization of
economic relations between Washington and Beijing
poses a significant threat to the US economy. A
series of protectionist measures against imports
of Chinese goods and capital have been imposed by
the Bush administration or are being threatened by
Congress. But rather than supporting the economy,
as intended, such measures are likely to push US
inflation and interest rates higher and economic
growth lower.
Embracing
protectionism For most of the past 25
years, the US has championed free trade globally
as the best means to support strong economic
growth worldwide. In this span Washington has
ratified numerous bilateral and multilateral free
trade deals. It has also supported global free
trade through the General Agreement on Tariffs and
Trade (GATT) and its successor, the World Trade
Organization (WTO). However, in the past two
years, US support for free trade has waned.
Washington's unwillingness to open the US
to agricultural import competition has effectively
destroyed the Bush administration's dream of
creating a Free Trade Area of the Americas (FTAA).
It has also impeded progress in the achingly slow
Doha Round of WTO Negotiations. In the last year,
this passive protectionism has been replaced with
active attempts to protect the US from Chinese
goods and capital imports.
Under WTO
agreements in place since 1995, global trade in
clothing and textiles became quota-free on January
1, 2005. This prompted a surge of clothing and
textile imports to both the EU and US from China,
which is the low-cost producer for many categories
of textile items. While Brussels chose to
negotiate an agreement with Beijing over limiting
clothing and textile imports, Washington slapped
new quotas on several categories of clothing and
textile imports from China in May 2005.
The Bush administration has been applying
increasing pressure on Beijing to revalue the yuan
over the past two years. The US Senate joined the
administration in applying pressure on Beijing for
an exchange rate adjustment. In April 2005, the
Senate voted 67-33 in favor of considering
legislation that would threaten Beijing with a
27.5% tariff on all Chinese exports to the US
unless the yuan was allowed to float.
A
second Senate vote on the tariff legislation was
scheduled for July 27. In early July, the sponsors
of this legislation, US Senators Lindsey Graham
and Charles Schumer delayed the second vote in
order to give Beijing more time to revalue the
yuan. However, should Beijing continue to avoid a
yuan revaluation, as expected, a vote on this
tariff legislation will return to the Senate's
agenda.
Officials in Beijing have
repeatedly expressed that the timing of a yuan
revaluation will not be decided in Washington.
European and Asian central bankers, as well as
many US commentators, support Beijing's position.
Meanwhile, China responded angrily to the new US
import quotas on clothing and textiles, accusing
the Bush administration of violating WTO rules.
Tempers in Beijing became further elevated
when, in July 2005, the US House of
Representatives approved a resolution by a 398-15
margin urging the Bush administration to block the
purchase of California-based Unocal Corporation by
the China National Offshore Oil Corporation
(CNOOC). The House resolution describes the
proposed Unocal-CNOOC transaction as a threat to
US national security. In a written statement,
China's Foreign Ministry responded to the
resolution demanding that "the US Congress correct
its mistaken ways of politicizing economic and
trade issues and stop interfering in the normal
commercial exchanges between enterprises of the
two countries".
China's goods
fundamental to low US inflation China is
the second-largest source of US imports: in 2004,
the US imported a record $200 billion in goods
from China. At only 14% of total US imports, China
appears to be only a small supplier to the vast US
market. However, the majority of US imports from
China are consumer goods, and Chinese firms
dominate this category of imports. In 2004 China
accounted for 81%, 68%, 42%, 22% and about 20% of
total US imports of sporting goods, footwear,
furniture, electronic equipment and clothing,
respectively.
As a key supplier of
consumer goods, Chinese imports directly account
for about 10% of total personal consumption
expenditure on clothing and footwear and 6% of
expenditure on furniture and household equipment
in the US. Clothing, footwear, furniture and
household equipment make up 10% of total personal
consumption expenditure, excluding food and
energy, in the US. Overall, imports from China
make up about 2% of total personal consumption
expenditure, excluding food and energy.
This low percentage of personal
consumption expenditure may appear to be an
underwhelming statistic; however it plays an
important role in determining the evolution of the
US Federal Reserve's preferred inflation
indicator, the core personal consumption
expenditure (PCE) deflator, which excludes food
and energy. Unlike the consumer price index (CPI),
the weightings of goods used in the PCE deflator
are adjusted to reflect changes in consumption
patterns. In other words, the PCE deflator is
derived from the weightings of actual personal
consumption expenditure in US national accounts
data.
In a straightforward calculation,
because Chinese goods account for 2% of total
personal consumption expenditure, excluding food
and energy, Chinese goods also account for 2% of
the core PCE deflator. However, China is the price
leader in US consumer goods. As a result, the
price of Chinese goods is a strong determinant of
the price of similar goods in the US market; this
is due to the nature of price competition.
Because of price competition, the impact
of Chinese goods on the core PCE deflator extends
far beyond its 2% weighting. Just how far would be
an interesting subject for Washington to examine.
Nonetheless, some examples of how different
weightings could impact the core PCE deflator are
enlightening. At its nominal weighting of 2%, a
20% increase in the price of Chinese imports would
push the PCE deflator up by 0.4%. As price
competition extends the influence of Chinese
prices, a 4% and 6% weighting and the same 20%
increase in the price of Chinese goods would push
the PCE deflator up by 0.8% and 1.2%,
respectively. Conversely, declining prices for
Chinese goods push the US core PCE deflator lower.
This is precisely what occurred in the
first quarter of 2005 as US imports of Chinese
clothing surged higher, prompting the Bush
administration to reimpose import quotas on these
goods. The PCE deflator for both women's and men's
clothing declined by 0.6% in the first quarter of
2005 compared to the same period in 2004. This
helped to hold the overall increase in the core
PCE deflator to 1.7% in the first quarter of 2005
as compared to the first quarter of 2004.
The imposition of quotas on imports of
Chinese clothing in June 2005 will push the core
PCE deflator back up in the second half of this
year. An across-the-board tariff on all Chinese
imports as proposed by the US Senate, or a
revaluation of the yuan, would also push the core
PCE deflator higher. How high US inflation goes
depends on the magnitude of the tariff or
revaluation.
Though other countries could
provide cheaper goods to the US than China, no
other country in the world has China's industrial
capacity. Capacity constraints in other countries,
and even in the US, for the production of goods
similar to goods now being produced by China would
force prices of these goods higher as well. The
facts are plain - China's imports are containing
US inflation, and any move to increase the cost of
these imports will push US inflation higher.
China's capital fundamental to low US
interest rates In February 2005, Federal
Reserve Chairman Alan Greenspan, in Congressional
testimony, called the decline of long-term US
interest rates in the face of rising short-term
interest rates a "conundrum". Actually, there is
no mystery here. China has played an increasingly
important role in US interest rate developments in
the past few years, including the decline of
long-term US interest rates in 2004.
Because US imports from China have
contained the growth of inflation, they have also
been a factor in lowering US interest rates. An
equally important factor in lowering rates has
been the recycling of China's massive foreign
exchange reserves - a byproduct of China's
oft-vilified trade surplus with the US - into US
Treasury securities.
According to Federal
Reserve and US Treasury data, about 47% of total
marketable Treasury securities were held by
foreign investors at the end of 2004. Stripping
out Treasury securities held by the Federal
Reserve and state and local government in the US
leaves foreigners accounting for 61% of all
privately held US Treasury securities. In December
2004, China's holdings of Treasury securities
amounted to $223 billion, equivalent to 7% of the
total amount of privately held US Treasury
securities.
At the end of 2004, 80% of the
Treasury securities held by foreign investors were
in the form of treasury notes and bonds, ie
long-term treasuries. Undoubtedly, China's
holdings of Treasuries do not vary much from this
maturity mix. China's purchases of US Treasuries,
along with purchases by other countries, have
pushed long-term US interest rates lower.
Washington's self-destructive
intervention Taken to its logical
conclusion, the politicization of economic
relations between Washington and Beijing poses a
significant threat to the US economy. Efforts to
push the price of China's imports higher with
quotas and tariffs will push US inflation higher.
Any revaluation of the yuan would have the same
effect on US inflation.
More problematic
for the US economy are the implications of
administrative controls on Chinese capital inflows
and yuan revaluation on long-term US interest
rates. By threatening China's proposed investment
in Unocal with US government intervention on
national security grounds, the US Congress is
simultaneously undermining US shareholder rights
and preventing China from realizing higher
investment returns than are available to it in
Treasury securities.
The threat of
government intervention destroys the right of
Unocal shareholders to maximize the value of their
investment by accepting the clearly superior bid
that CNOOC is offering. This threat, whether it is
realized or not, reduces the value of CNOOC's
offer by creating the perception that this offer
will be subject to close government scrutiny and
may ultimately fail under this scrutiny.
From Beijing's perspective, Washington's
interference in the CNOOC-Unocal transaction
raises the probability that similar interference
could prohibit other Chinese fixed investments in
the US. Such fixed investments, offering higher
returns than US Treasuries, could give China a way
to keep its capital in the US without taking a
huge hit when the yuan is eventually revalued.
Rather than embracing protectionism and placing
future US economic growth at risk, policymakers in
Washington must accept that China, Chinese imports
and the fixed value of the yuan are integral to
the health of the US economy.
Jephraim P Gundzik is president
of Condor Advisers, Inc. Condor Advisers provides
emerging markets investment risk analysis to
individuals and institutions globally. Please visit for further
information.
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