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The U.S.–China Economic Relationship: In Need
of Counseling, Not Divorce
by Derek
Scissors, Ph.D.
January 27, 2009
WebMemo #2249

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The process of demonizing the U.S.-China economic relationship
has begun. It is being called out both as principally responsible
for our nation's economic turmoil and as driven largely by
devastating Chinese policies. There is certainly bad Chinese policy
to be found. The yuan is misaligned and, more important, the
People's Republic of China's (PRC's) tight controls on capital
movement caused global economic adjustment to be more violent than
it should have been.

Unfortunately, bad American economic policy made a proportionally
greater contribution to this crisis. It is vital to recall that
America's economy is much bigger than China's. The U.S. is the heart
of the global economy. Moreover, there are many core benefits of the
Sino-American economic relationship, benefits now being recognized
even by some of China's harshest critics. On the U.S. side, these
benefits include cheaper goods and still-cheap capital,
simultaneously, a rare and valuable combination.

Blaming China First

For his congressional confirmation hearings, Treasury
Secretary-designate Timothy Geithner submitted written testimony
indicating that President Obama considers China to be manipulating
its currency.[1] This testimony should be considered the first
shot in a trade battle that has been looming since the start of the
current economic crisis.[2]

Geithner's comments immediately sparked a debate over the role of
Chinese policy in U.S. economic performance, with assessments
ranging from principal blame for the PRC to no blame at all for the
PRC.[3] One of the reasons for the sharp divergence in
views is the availability of easy targets when attacking Chinese
economic policy.

From the end of 2004 to the end of 2008, the yuan climbed more
than 17 percent against the dollar and more than 14 percent against
the euro.[4] In the same period, however, China's overall
trade surplus went from $32 billion to $295 billion, an increase of
more than 800 percent.[5] The currency movement has been insufficient.[6]

Another source of confusion is the, sometimes belated,
recognition that the U.S. gains even from bad Chinese policy. One
reason for the dangerous explosion in easy credit in the U.S. was
the Chinese buying American bonds with proceeds from their massive
trade surplus. This recycling was forced ultimately by the PRC's
capital controls, whereby the foreign currency earned from exports
cannot be freely used within China. Such currency can only be spent
abroad and American bonds are the only market that can absorb $250
billion or more each year.

The closed-capital account has been trumpeted for years in
Beijing as a great contributor to stability. As with all state
attempts to control the market, it merely postponed the day of
reckoning. Rather than addressing the ongoing minor instability of
free capital movement across its borders, the closed-capital account
and forced recycling contributed to the biggest patch of instability
for the PRC since Tiananmen Square.

But Chinese politicians are not the only ones caught on their own
hook. The principal advocates of trade action against China may have
just recognized that the trade deficit the U.S. runs finances
Chinese purchases of American bonds. Consequently, such purchases
may now appear indispensable in light of plans to greatly expand the
U.S. budget deficit.[7]

Contradictions

There is rhetorical and policy inconsistency on both sides of the
Pacific because assigning blame runs headlong into the fact the U.S.
and China both want to enjoy the benefits of their
irresponsibility.

The inadequate American savings the PRC has harped on for years
effectively sustained millions of Chinese jobs--jobs Beijing is
desperate to keep.[8] In fact, despite its massive 2008 trade
surplus, China is looking to boost exports further, relying on
foreign consumption for still more help.[9]

On the U.S. side, Chinese purchases of American bonds will
support the "pump-priming" designed by the Obama Administration. But
American gains from the relationship go beyond that. Chinese exports
to the U.S. are led by consumer electronics--computers, phones, and
televisions. Clothing and textiles are the other major component.[10] Competition and products from the PRC have
yielded lower prices and higher quality for American consumers,
developments that are welcome when times are good and more urgent
now that household income is stagnant or dropping.

It is a mistake, though, to translate these gains for the U.S.
into a belief that China has disproportionate influence over the
American economy. In 2007, the PRC's exports to the U.S. were
equivalent to 2.3 percent of American GDP; they were 9.1 percent of
Chinese GDP.[11] China's holdings stood at 5.3 percent of
U.S. public debt securities on the most recent measure and much less
than that when private debt is included.[12]

Just as important is the nature of the bilateral economic
relationship. If Fannie Mae and Freddie Mac do not sell debt to
finance U.S. government intervention in the housing market, China
cannot buy that debt, no matter how many dollars Beijing holds. The
same is true of the bonds sold to finance U.S. federal deficit. If
Americans choose not to buy as many goods, the PRC cannot sell as
many, no matter how high production goes. There are plenty of
substitutes for Chinese goods and capital--even if they are priced
higher--but there is no substitute for the American bond market and
consumer.

The U.S. has benefited from Chinese over-saving, and China, from
American under-saving. Poor policies on both sides of the Pacific
led to excess and the current crisis. But it is inaccurate and
potentially dangerous to lay most of this at the feet of the
Chinese. Yes, the PRC shares blame for the global imbalance that is
now unwinding. Given the size and centrality of the American
economy, the problem and the solution start in the U.S. To determine
otherwise is to trust, mistakenly, our nation's economic fate to
others and risk a trade war in the bargain.

Derek
Scissors, Ph.D., is Research Fellow in Asia Economic Policy in
the Asian Studies Center at the Heritage Foundation.

[1]"China's Yuan
'Manipulation' an Issue--Geithner," Reuters, January 21, 2009, at
http://www.reuters.com/article/usDollarRpt/idUSN2148652720090121
(January 26, 2009).

[2]Derek Scissors,
"The Coming U.S.-China Trade Conflict," Heritage Foundation
WebMemo No. 2172, December 12, 2008, at http://www.heritage.org
/Research/AsiaandthePacific/wm2172.cfm
(January 26, 2009).

[3]Sebastian
Mallaby, "What OPEC Teaches China," The Washington Post,
January 25, 2009, at http://www.washingtonpost.com/wp-
dyn/content/article/2009/01/23/AR2009012303291.html
(January 26, 2009); Bret Swanson, "Geithner Is Exactly Wrong On
China Trade," The Wall Street Journal, January 26, 2009, at
http://online.wsj.com/article/SB123293057464414089.html
(January 26, 2009).

[4]"FXHistory:
Historical Currency Exchange Rates," Oanda.Com, at http://www.oanda.com/convert/fxhistory
(January 26, 2009).

[5]China
Monthly Statistics, Vol. 12, 2004.

[6]This is not the
same as manipulation. As with so many of its policies, China's
currency policy is dictated by obsession with stability. A
relatively minor shift in July 2005 aside, the yuan has not changed
since the 1994 devaluation. The stability obsession was very useful
to the U.S. during the Asian financial crisis. What has changed
since then is primarily U.S. goals for Chinese currency policy, not
the policy itself.

[7]Joseph J. Schatz,
"Geithner Signals Change in Policy on China Currency," Yahoo News,
January 22, 2009, at http://news.yahoo.co
m/s/cq/20090122/pl_cq_politics/politics3016257_1
(January 26, 2009).

[8]"Mood Not Bullish
as China Greats Year of the Ox," Google News, January 25, 2009, at
http://www.google.com/hostednews/afp/article/A
LeqM5ixfonH0Ud6wKGldX4fHpW1spnJxQ
(January 26, 2009).

[9]"More Textile
Export Rebates Soon," China Economic Net, November 21, 2008, at
http://en.ce.cn/Industries/Consumen-
Industries/200811/21/t20081121_17458415.shtml
(January 26, 2009).

[10]U.S. Census
Bureau, U.S. International Trade Statistics, see "China (mainland),"
at http://censtats.census.gov/sitc/sitc.shtml
(January 27, 2009).

[11]Eugene P. Sesky
and Shelly Smith, "Annual Revision of the National Income and
Product Accounts," U.S. Department of Commerce, Bureau of Economic
Analysis, August 2008, at http://www.bea.gov/scb/pdf/2008/08%
20August/0808_nipa_annrev.pdf
(January 26, 2009); and

"China 2007 GDP Growth Revised up to 13%," China
Daily, January 14, 2009, at http://www.chinadaily.com.cn/china/2009-01/14/content_7396604.htm
(January 26, 2009), and

U.S. Census Bureau, U.S. International Trade
Statistics, see: China (mainland), at http://censtats.census.gov/sitc/sitc.shtml
(January 27, 2009).

[12]Wayne M.
Morrison, et al., "China's Holdings of U.S. Securities:
Implications for the U.S. Economy," Congressional Research Service,
January 9, 2008, at http://fpc.state.gov/documents/organization/99496.pdf
(January 26,
2009).

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