Trade Deficit and Bonds Relationship Between China and the United States

From Dickinson College Wiki
Jump to navigationJump to search

Preview

http://www.ft.com/cms/b8c8387e-42e7-11d8-81c6-0820abe49a01.gif

Bilateral trade between China and the United States has grown rapidly in recent years. American exports to China have more than doubled since China joined the World Trade Organization (WTO) in 2001. Over the 2001-2005 periods, U.S. imports from China have increased from $102 billion to $243.5 billion. So far, China is the third-largest merchandise trading nation in the world. In 2005, China’s global trade surplus exceeded $100 billion and the United States took about 23% of China's exports. In 2005 the United States became China’s No.1 export market.

Although ongoing global trade liberalization has contributed to a major expansion of both exports and imports for the United States and most other countries, freeing trade from policy restrictions does not ensure that trade between China and the United State will be balanced. Aggregate trade deficits or surpluses reflect underlying macroeconomic conditions in the two countries. In short, China’s exports have grown faster than imports, resulting in an overall trade surplus. In contrast, the United States’ imports have grown faster than exports, resulting in an overall trade deficit. Figure 1 illustrates the recent increase in the merchandise trade deficit as a share of gross domestic product (GDP). Moreover, China has emerged as a major source of U.S. imports, leading to a widespread view that the record overall U.S. trade deficits of recent years are “made in China”.

The U.S. merchandise trade deficit with China alone accounted for about $162 billion in 2004, or nearly one-quarter of the total U.S. trade deficit, up from a negligible share in the mid-1980s. Figure 2 highlights the growing contribution of China to the overall deficit and the declining contribution of Japan over the same period.


In 2005, the United State ran a trade deficit with China of $201.6 billion. This is the largest bilateral trade deficit of the United State worldwide; it has become a source of friction. The deficit is due to a number of factors:

  • Undervaluation of Chinese Currency
  • Purchase of American Bonds

The detailed explanations are given below.

China

Overview

According to the report from China Customs[1], in 2005, the United States is China’s No.1 export market, accounting for roughly 30 percent of all Chinese exports. The total value of American purchasing reaches 162.9 billion US dollars.

File:China Top Trade Partner 2005.PNG

File:China Top Export Destination 2005.PNG

Undervaluation of Chinese Currency

  • Background
  • China’s official currency is renminbi, sometimes abbreviated as RMB, which is expressed in the unit of yuan.
  • The yuan had been pegged to the US dollar dates to May 1995. Prior to that the Chinese currency had undergone a series of devaluations — most recently at the start of 1994 when it lost one-third of its value, with the yuan depreciating from $0.1728 to $0.1152 and the dollar appreciating from 5.7855 yuan to 8.6783.
  • Since the East Asian finance crisis, Chinese had maintained the exchange rate at 8.28 yuan to a dollar. The market value of yuan is permitted to fluctuate only 0.3% around fixed rate.
  • Economists have estimated that the Chinese are undervaluing their currency by as much as 40%.
  • The World Bank's World Development Indicators 2005 estimated that one United States dollar is equivalent to approximately 1.8 Renminbi by purchasing power parity in 2003.[2].

http://www.rmbguide.com/images/rmb_Against_dollar1985-2004.gif, http://www.econreview.com/events/images/exchus.png

  • Reason
  • Pro-growth monetary stability
Chinese consumer price inflation has been docile, averaging just 1 percent year-on-year from January 2000 through March 2005 (versus a 2.6% U.S. average over the same period). Consequently, Chinese interest rates — both real and nominal — are also low.
  • Encourage exports
Artificially make Chinese exports cheaper for a long time
  • Stability
China also seeks stability in a country that has more internal stability problems than meets the eye. In 2004 the military police force had to deal with thousands of protests. China’s government reported that in 2004 there were over 74,000 protests of 100 people or more, many of which became violent. This number was up from 53,000 in 2003, a 39% increase. [3] Dealing with these turbulent domestic issues is China’s main focus. By focusing on economic growth China believes that increasing the overall wealth of the country is one of the best ways to maintain internal stability. By keeping inflation lower and increasing exports China has made foreign countries dependent on economic goods. Therefore through this economic growth China also has the reasurance that the well being of other countries economies is dependent on the wellbeing of the Chinese economy and the stablility of their government. So if they were to face an economic crisis they can count on such countries as the U.S. to go to great lengths to make sure that stability is maintained in their country.


  • American Reaction
From the perspective of Capital Hill, Chinese alleged manipulation on its currency, which gave mainland-made goods an unfair price advantage in the global competition, is a reason for China’s $160 billion-plus trade surplus with the United States. Bush Administration pushed so hard on demanding Beijing to revalue Chinese currency. American Senator Charles E. Schumer (D-N.Y.) and Lindsey O. Graham (R-S.C.) once had been pressing a bill that would impose across-the-board punitive tariffs of 27.5 percent against Chinese imports if China does not substantially raise the value of the yuan.
  • Policy
From July 21 2005, China’s central bank announced it would increase the value of its currency, the yuan, and abandon its decade-old fixed exchange rate to the U.S. dollar in favor of a link to a basket of world currencies. By the end of September 2006, Chinese currency was pushed through 7.9 to the US dollar, an annualized rate of 10 percent, comparing with an annual appreciation of less than 2.5 percent for most of the year after China's small revaluation in July 2005.
  • Impact
  • be another market-oriented restraint tool to keep the Chinese economy from overheating.
  • help deflect potential imposition of trade barriers by customs, including the U.S., where the growing bilateral trade deficit with China has touched off protectionist criticism in Congress.
  • be probably necessary in order to allow many of the other Asian economies to tolerate some further appreciation vs. the dollar.
  • Different Opinion
Many other economists disagree that revaluation of Chinese currency will help to narrow the trade deficit between China and the United States. The reason that the revaluation (or even tariff changes) won't impact trade flows is because, in general, very little of any such change gets passed through to consumer prices. That's been true of changes in the euro, the yen, the peso and the pound. It would be no different for the yuan, because consumer prices of most internationally traded goods are largely a reflection of "local value-added," or the costs incurred in the importing market right up to the point of purchase. In the United States, as elsewhere, these costs include labor, rent and utilities, as well as marketing, distribution and transportation -- none of which is affected by international exchange rates. Only the initial component -- the import price -- is affected by exchange rates, and that component is often a small piece of a product's final cost.

Purchase of American Bonds

File:Formulation.PNG

  • The Facts
By the end of October 2006, China's foreign-exchange reserves are likely to top $1 trillion, twice their level two years ago and more than one-fifth of global reserves. China's reserves are equivalent to 15 months of imports and are six times bigger than its short-term debt. Currently China is the world’s second largest buyer of American Treasury Securities, exceeded only by Japan. Furthermore, China’s purchases of U.S. government securities rose 20% over the first half of this year and have exploded by more than 105%, increasing by a massive $850 billion in the past five years. About 72% of China’s reserve assets are denominated in US dollars.

File:China\'s Foreign Reserve.PNG File:China\'s Purchase of American Treasury Securities.PNG

  • Impact
Currently, US external debt now is equal to more than 25 percent of GDP, which continues to be added at an extraordinary pace. China’s central bank’s intervention in the treasury market has helped to finance the rising US budget and trade deficits. It has also propped up the dollar and reduced American bond yields—by up to 1.5 percentage points according to some estimates. A big shift out of dollars could therefore push up bond yields and hence mortgage rates, damaging America's already crumbling housing market.
Furthermore, Roubini and some other economists estimated that a 20 percent increase in the value of the yuan against the dollar would reduce the value of China's roughly $450 billion in dollar reserves by about $100 billion -- 6 percent of China's GDP. In four years, if nothing changes, Chinese dollar reserves could reach $1.4 trillion, raising the costs of a falling dollar to $300 billion -- some 12 percent of China's GDP. In short, the longer China continues to finance U.S. deficits, the larger its ultimate losses.
However, if China stops buying American debts, that will cause long-term bond prices to drop, interest rate to rise and the dollar to fall. For instance, despite rising short-term interest rates, longer-term debt yields in the United States are exceptionally low by historical standards. Any move by China to sell some of its massive debt holdings could drive up long-term rates, which ultimately could make it costlier for Americans to take out home mortgages.

the United States

  • History
  • Over the past 28 years China has become a great assest for American businesses as well as a great threat for many American jobs. America looks at China as a great opportunity economically and potential partner. But America is also hesitant of the risks of doing business with such a rapidly expanding power. Two main camps have formed in the U.S. those in favor of globalization and those opposed to it. As a result the United States is divided over contiuing the good economic relationship that it has with China today.
  • The United States has been one of the main players in developing trade throughout the world today. In 1946 at the Bretton Woods Conference the United States and 46 other countries set up the World Bank and the International Monetary Fund. These organizations have since then helped to facilitate an increase in international trade in countries all around the world. In relation to China, since 1978 with the opening up of China's economy under Deng Xiaoping, the United States has sought to improve trade relations between our two countries. Since then trade between are two countries has increased seemingly eponentially.
  • Since 1978 China faced major problems and had to set the value of the yuan at a fixed rate to the value of the dollar. This resulted in an unfair advantage of Chinese domestic goods over imported American goods. This kind of trade policy was unacceptable to the United States. It helped to create a huge trade deficit for the United States to China. It should be noted though that China has not been the only country ever to set up the market in such a way to protect and help develop domestic firms. Traditionally speaking, the United States has actually been opposed to free trade. During the early 1800's the government provided subsidies and placed tariffs on imported goods so that domestic companies could develop and face stronger foreign competitors in a free trade market.


http://www.mbginfosvcs.com/images/us-china.gif, File:GDP of countries 2005.PNG


During this time China's GDP has seen an unheard of annual growth rate averaging around 10%. When compared to the rest of the world the United States has done reasonably well and kept an annual growth rate around 4-5% for the past 15 years. When the two are compared though it is obvious that China has been surguing ahead and leaving the rest of the world in the dust.

Underevaluation of the Chinese Currency

http://money.cnn.com/2005/07/21/news/international/china_yuan/mind_the_gap.gif

  • The Trade Deficit from the American perspective
  • In 2001 China was admitted to the World Trade Organization and soon thereafter given favored nation status by the United States, eliminating many trade and tariff barriers but the underevaluation of the RenMinBi still lead to trading difficulties between the U.S. and China.
  • The main problem for the United States has been the huge trade defecit that it has accumulated over the past 30 years. The United States has not had a trade surplus since 1975 and the annual trade defecit is at the largest it has ever been. The defecit for 2005 was $725.8 billion, a 17.5 percent increase from 2004's previous record of $617.6 billion. Out of that 725.8 billion in 2005, 201.5 billion of the trade defecit was going to China. So in 2005 27.7% of the United States trade defecit was with China. [4]
  • Some have argued that in recent years the rising trade defeicit is a result of our increasing trade defecit with China. Within the U.S. some hold the viewpoint that the underevaluation of the yuan has been a contributor in recent years to these record setting annual defecits. They argue that if China were to decrease the value of the yuan against the dollar then this could help to bring the increasing trade defecit under control. As of November 21, 2006 the value of the Chinese yuan to the dollar was 7.871, down ten percent from 2005. Some have argued though that China needs to bring down the value of the yuan against the dollar by as much as 25%. The belief is that, as a result, more Americans imports would be sold in China and fewer domestic purchases of goods. This would help to stablize the huge trade defecit between the U.S. and China.
  • Opponents argue that in reality U.S.-China trading only makes up 10% of U.S. trade. And reducing the the value of the yuan by 25% would only partially offset the U.S.'s overall trade defecit.
  • On July 21 2005, China’s central bank announced it would increase the value of its currency, the yuan, and abandon its decade-old fixed exchange rate to the U.S. dollar in favor of a link to a basket of world currencies. This change in policy has lead to improved relations between the United States and China.


http://www.oftwominds.com/blog-photos/US-china-trade.gif, http://www.washingtonpost.com/wp-dyn/content/graphic/2005/05/11/GR2005051100164.gif


  • What has in part lead to this huge trade defecit to China is that products and jobs that used to be in the United States have been exported to China. As a result the United States suffers losses in exports that it would have had but no longer does since China now has then jobs. In addition the United States is still buying the same goods but that money is now going to China instead of domestic companies. What this results in is fewer exports for the United States and more imports. This further serves to aggravate the trade deficit between China and the U.S.

Impacts of Bond Relationship on the U.S.

Brad Setser, head of global research at Roubini Global Economics, has estimated that around 70% of China’s $1 trillion of reserves is invested in dollars, mainly U.S. Treasury securities. This has propped up the dollar and in turn reduced American bond yields—by as much as 1.5% points according to certain estimates. If China decided to make a big shift out of dollars it would push up bond yields and hence mortgage rates. This would further damage America's already hurting housing market. [5]


China's reserves have reached a size where any shift in funds can have great impacts on markets all around the world. If China were to move its reserves to either Euros or local Asian currencies then this would push the value of the dollar down. However, as a result of moving these reserves China would suffer loses on its remaining dollar reserves.

China is suffering from a problem that any other country in the world would like to have: They have more money than they know what to do with.

Proposals for what China should do:

"The only real solution to the poor return on China's reserves is to stop accumulating them. That requires policy reforms to reduce China's massive saving, which drives its current-account surplus, and a more flexible exchange-rate system. But before that happens, China's reserves could well hit $2 trillion."

Conclusion

Is the U.S. trade deficit caused by China? So far, it is has been hard to find a final and concrete answer for that. For the people who support the “yes” answer, they are concerned that China’s currency is undervalued and that this injures the U.S. economy. Many charge that China is manipulating the value of its currency in order to gain an unfair trade advantage. The basic arguements that they use are:

  • The U.S. savings rate is relatively low compared to that of other countries, such as China and other Asian countries, yet its need for capital and its opportunities for the productive use of capital are greater than those of other countries.
  • The United States must borrow from abroad in order to finance their preferred levels of consumption and investment and also to deal with their federal budget deficit.
  • It is a core principle of economic analysis that a country which is a net importer of capital from abroad must also be a net importer of foreign goods.
  • Consequently, so long as the United States borrows from abroad and encourages foreign investment in its economy, they will continue to have a trade deficit and an overvalued currency.

They expect if the yuan increased substantially in value, imports from China and the flow of loans from China would decline.

For China’s part, Chinese officials say that they have not fixed the exchange rate of the yuan against the dollar in order to gain trade advantages. Rather, they say the fixed rate promotes economic stability. Without this, they say, fluctuations in the yuan’s value could cause serious dislocations in China’s domestic economy. Thus the consequence is China’s central bank sells yuan in order to maintain the value of its currency. In the process, it has accumulated foreign exchange reserves that now total more than $840 billion (including Hong Kong and Macau).

Roubini and Setser say that

  • The United States cannot keep borrowing indefinitely at its current rate and that China cannot continue accumulating reserves or exporting at its current rate without doing serious damage to its economy.
  • If policy makers take action both to reduce the level of U.S. borrowing and to diminish the Chinese levels of exports and reserve accumulation, an orderly and smooth adjustment to the current situation will result.

Consequently this had led to reform and action being taken by the two countries recently.

  • The United States:
  • Congress is considering several bills that would put economic pressure on China if it does not revaluate its currency, such as Senators Graham and Schumer mandated a 27% special tariff on Chinese goods if the yuan is not increased in value.
  • China:
  • On July 21, 2005, China’s central bank announced a new exchange rate system for China’s currency.


For the people who support the “no” answer, they argue:

  • In recent years U.S. bilateral trade deficits have been increasing not only vis-à-vis China but most other trading partners as well
  • The imbalance on bilateral trade with China, though large, still accounts for less than one-quarter of the total.


This wiki is created and maintained by
Shumei Chen
Zhuoran Li
John Richards

Retrieved from "https://wiki.dickinson.edu/index.php?title=Trade_Deficit_and_Bonds_Relationship_Between_China_and_the_United_States&oldid=22824"