Economic Imbalance between China and the United States
If Sen. John McCain, Republican from the State of Arizona was confident that China was willing to pay the “price” for normalization, Sen. Ernest Rollings, Democrat from South Carolina, was not convinced. In his testimony and written statement, Hollings rehearsed the case for free trade and focused upon the costs and consequences of that policy for the welfare of U.S. communities dependent upon labor-intensive industries (such as textiles in South Carolina). He noted that the standard free trade argument assumes the composition of trade changes as the low-skill labor- intensive industries of developed economies (U.S.) shift off shore, replaced by highly skilled capital intensive industries that claim their share of the global marketplace. With increased economic growth due to the efficiency-premium on the geographical dispersal of production and exchange, employment growth should compensate for local job losses. For Hollings, the plausibility of this process depends on developing countries being willing to take up their share of exports from the developed world—something he doubted.6 Invoking the Japanese case, he believed China would not honor their side of the deal. He forecast that the Chinese trade surplus with the United States of US$68 billion would “spiral out of control” should the permanent normal trade relations (PNTR) initiative be accepted.7
It turns out that Hollings was correct. After 2001 the terms of trade exploded in China’s favor, with exports to the United States accelerating far beyond expectations, reaching nearly US$300 billion in 2007 (just before the onset of the global financial crisis) (see figure 7.1). Reasons for the explosion in Chinese exports over the first decade of the twenty-first century are many and varied.8 Most obviously, growth in the volume of exports reflected official Chinese development policy mimicking, in part, the earlier success of the Asian newly industrialized economies (NIEs) of Hong Kong, Korea, Singapore, and Taiwan in using exports to the West as the engine of growth (see Chow and Kellman 1993; IMF 1993). However, in a study of the economic forces shaping the success of the Asian NIEs, Webber (1996) argues that the initial massive imbalance between exports and imports that marked the first phase of NIE growth would soon pass. In the second phase of development, imports essential to production should rise to match exports; equally, as labor resources become increasingly scarce, increasing real wages should prompt increasing demand for Western consumption goods.
Figure 7.1 shows the development of massive imbalances. However, two other factors should also be taken into account. Sustaining the growth in exports to the United States was the Chinese government’s policy of pegging the local currency (RMB) to the U.S. dollar with a fixed exchange rate. In figure 7.2, we display the temporal pattern of the major currencies against the U.S. dollar since 1994. For the most part, governments’ willingness to let currency
Figure 7.1. U.S. trade with People's Republic of China 1984-2008 (US dollars). Source: Authors' calculations of iMF and the People's Bank of China data
markets set currency rates is reflected in the volatility and trends in currencies against the U.S. dollar. For the RMB, however, the Chinese government has sought to fix the U.S. dollar exchange rate (see 1995-2005) and sought to manage currency appreciation against a basket of currencies, in particular as exports to the United States exploded in volume and value after 2005. In effect, China’s currency regime has been used to enhance its claim on U.S. consumer markets against Europe and Japan while holding firm the price advantage enjoyed by exporters to the United States relative to U.S. domestic producers.9 As such, it has been a policy designed to hold in abeyance the immutable forces of economic correction inherent in the export-led model of growth (see Stiglitz 2009, 228-29).
Not only did this policy accelerate the growth in the trade surplus with the United States, in the context of the global financial crisis, holding firm to such an absolute trade advantage, China risked protectionism or even a trade war with the West. Goldstein and Lardy (2006) suggest that this policy has contributed to internal problems of macroeconomic stability in China, including wage-price and property-price inflation. By limiting currency appreciation in the context of the burgeoning demand for imports of raw materials from countries such as Australia, China has lost an opportunity to discount the costs of those commodities, as the Australian dollar (among a number of other country currencies) appreciated against the U.S. dollar.10 They also suggest that this policy has been pursued to protect the domestic banking system from the possible consequences of currency revaluation for fixed asset values, exchange-rate speculation, and capital flight. We return to this issue in the next section. Through its domestically focused subsidiary, Central Huijin
Figure 7.2. U.S. dollar exchange rates (normalized to base 1, 1994). Source: Authors calculations' of iMF and the People's Bank of China data
Investment Ltd, CIC has made significant investments to support the domestic banking system.
Commentators have been split on whether the dollar-peg is sustainable, whether it has significantly distorted the Chinese economy, and whether it is likely to persist. Further, it has been noted that China is hardly the only country to have pursued such a growth strategy (Reinhart, Rogoff, and Savas- tano 2003). Dooley et al. (1996, 2004) suggest that, following the Second World War in reconstruction, Germany and Japan also pursued a dollar-peg economic growth policy aided and abetted by the U.S. government. More generally, Dooley et al. suggest that this policy tends to run its course such that established dollar-peg economies will eventually move from the periphery of the world economy to the core of the world economy, wherein their own currencies become partners with the U.S. dollar in underwriting foreign trade and exchange. In Dooley et al.’s history of the post-1945 economy, it is assumed that dollar-peg economies buy U.S. securities, in part, to manage official currency exchange rates and in part to underwrite the resulting gross imbalances in trade between dollar-peg economies and the United States. There is, then, a reciprocal relationship between Dooley et al.’s core and periphery model of neo-mercantilism, which is congruent with Aizenman and Lee’s (2008) mercantilism applied to SWFs as a twenty-first-century mechanism for hoarding capital. However, this reciprocity between China and the United States was thrown out of equilibrium due to the imbalances that grew through the first decade of the twenty-first century.
The massive growth of Chinese exports to the U.S. economy after 2000 began to affect the capacity of the U.S. government to control aspects of its own economy—compared to Germany and Japan immediately after the Second World War, the rapid growth of the Chinese economy threatened to overturn the core-periphery relationship before the periphery was economically mature and willing and able (in a regulatory sense) to float its own currency. Expansionary macroeconomic policy combined with the unrestrained growth in household indebtedness produced a surge in U.S. demand for consumer goods that China was only too willing to meet, whatever the shortterm costs in terms of its own macroeconomic stability. Therefore, the surge in imports could be seen both as a reflection of U.S. monetary policy and household indebtedness (Taylor 2009) and a willingness to postpone on both sides of the Pacific the inevitable readjustment for short-term political purposes (Bordo 2005; Truman 2005; L. H. Summers 2006).11