Avoiding bravado

A US-China trade war would hurt global recovery

The US has done well to pause and reflect on the consequences of a proposed legislation that would penalise China for keeping its currency artificially low. The ‘Currency Bill’, if passed, would allow the US to impose tariffs on Chinese goods, by way of retaliation for China keeping its currency artificially undervalued. The Chinese riposte would surely be in the form of counter-sanctions on US imports into China. A trade war between the world’s two pre-eminent economies is the last thing the tottering global economy needs at this time! The move to impose sanctions comes against the backdrop of a faltering US economy characterised by anaemic growth (the Federal Reserve’s forecasts for 2011 and 2012 are 1.7 per cent and 1.2 per cent, respectively), stubbornly high unemployment (officially estimated at 9.1 per cent), staggering public debt and a high trade deficit ($500 billion in 2010). The combination of a high fiscal and a trade deficit (the classic ‘twin pillars’ problem) ensures the US continues to be dependent on infusions of foreign capital. Under such conditions, the temptation to find a scapegoat is understandable, but bereft of economic logic and a clear comprehension of the steps China has taken to rationalise its currency’s value.

The Yuan has appreciated 6.5 per cent against the dollar in just over a year. A combination of Chinese capital controls and the ‘flight to safety’ appeal of the dollar for investors has helped. In letting the Yuan gradually appreciate, China is not merely responding to US pressure, but also trying to reset the composition of domestic aggregate demand. This involves raising the share of domestic consumption and a concomitant fall in the share of investment and exports, the current drivers of China’s economy. Progress in doing so has been limited, mainly because non-housing credit markets have not taken off as expected. Thus, in the foreseeable future, exports will continue to play an important role in China’s economy, which means the appreciation of the Yuan will be gradual.

The reasoning that a declining trade deficit with China will reduce domestic unemployment in the US is overly optimistic. For one, a significant proportion of the chronically unemployed in the US do not have the professional wherewithal (read skill sets) to participate in a modern knowledge economy. Second, ceteris paribus, a strengthening yuan will move manufacturing to other countries in Southeast Asia, a process already underway as surging labour costs in China make it less competitive. A revival of the US manufacturing sector, that has hollowed out since the 1980s, except in some niche high tech sectors, will come from innovation-led higher marginal productivity, a traditional US strength.

A US-China trade war would be ill-advised from the US standpoint because US exports to China are growing at 17 per cent, far more rapidly than exports in the other direction. China’s strategic independence of the US makes a Plaza Accord type of commitment by China hard to visualise. Ironically, the key to both economic revival in the United States and rebalancing in China lies in both countries talking what are self-serving decisions in the short term. The global economy will be the surprising beneficiary.