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US China Trade Imbalances - In the Shallow End of a Deep Pool

Economics / US Dollar May 30, 2007 - 12:58 PM GMT

By: Paul_Petillo


Recent talks with Chinese ended last week with the feeling that we have gained little ground. And with good reason. Only the US sees the growing trade deficits and the dollar-Yuan peg as a problem of growing importance. 

T he Chinese general/philosopher Sun Tzu once wrote “. . . If you know the enemy and know yourself, your victory will not stand in doubt, if you know Heaven and know Earth, you may make your victory complete”. He seemed to be offering rather pointed advice several thousand years removed on how negotiations with the US should proceed.

The topics on the table are important, at least to the US negotiators. But the issues seem less so to the Chinese who, represented by Vice Premier Wu Yi, left both the White House and Congress frustrated by the seeming lack of interest in the subject.

The US wants the same thing it has always wanted: concessions. The topics discussed at the most recent meeting by these two global giants have focused on the tight control the Chinese have kept on the Yuan and the ever burgeoning trade deficit the US believes is attributable to the perceived undervalue of that currency. 

Congress has made it clear that the situation is not tolerable and seeks to stem the imbalance by imposing duties on imported goods. This stance is seen as a vague attempt by the lawmakers to prompt the Chinese to allow their currency to adjust itself naturally on the open market.

The Yuan however is not the problem. There is no real proof that the sovereign regulation of a country's own currency has any impact on the balance of trade between other nations. The People's Bank of China prints money to control short-term interest rates within its borders. These rates help regulate their economy using them in the same fashion as the Federal Reserve.

These internal controls have little effect on trade deficits. The Chinese produce goods and the US buys – often on credit, over $233 billion worth. And this is where the members of Congress see the source of the problem.

The US contends that the PBOC prints money for a different purpose. They contend that the Chinese are using their cheaper currency to buy dollars and then buy dollar denominated assets. While this may be perceived as trade adverse, the Chinese and most economists see the problem differently.

It is important to remember that the Chinese view the US as a mature economy with a banking system with a strong network of banks whose link helps control the nation's economic health. This close association allows our institutions to make risk-adjusted decisions about credit. The Chinese do not yet have that sort of infrastructure in place. Their meteoric rise in the global marketplace has exposed some flaws when held against similar banking structures in other countries. Removing the dollar-Yuan peg will offer little in the way of an equitable fix especially from the Chinese point of view.

Pushing China to change is largely a waste of time. There are three reasons for this. China has a low-wage workforce at its disposal comparative to much more mature economies in the US and Europe. This is one of the most prominent reasons behind the trade imbalances.

I mention Europe at this point in the discussion for a good reason. Much to the dissatisfaction of the US, the Yuan is allowed to float against the Euro. The same type of trade imbalance exists there as well. If you were to do a side-by-side comparison over the last ten-years, you would notice that the amount of exports from China to Europe have grown almost in tandem with the US. 

The second reason the US should drop their zealous effort to fix this currency issue portrays a basic misunderstanding of where the Chinese are right now. The only link the PBOC has with the economy has comes with their attempt to regulate is what is called nominal prices.

Supply and demand regulates nominal prices by putting pressure on nominal exchange rates. Nominal prices are described as a monetary unit. When nominal prices are used as the PBOC does, the math becomes much simpler allowing currencies to be exchanged in a straightforward manner. Comparative advantage, the US should note, affects the rest.

And lastly, efforts by the US to force the Chinese to shift their policies could precipitate a possible currency collaboration with other Asian nations. This would benefit China's smaller neighbors, whose economies are equally immature and whose labor force may be seen as a threat to the competitive advantage the Chinese have internationally.

Such Euro like affiliations would not serve the US interests and would make Congressional pressures concerning duties and the Treasury department's repeated request to float their currency a moot point. 

By Paul Petillo
Managing Editor

Paul Petillo is the Managing Editor of the and the author of several books on personal finance including "Building Wealth in a Paycheck-to-Paycheck World" (McGraw-Hill 2004) and "Investing for the Utterly Confused (McGraw-Hill 2007). He can be reached for comment via:

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