China and the Global Recession - Part II - Relations With the United States

In 2001, the Bush Administration characterized China				Fed Chair and current head of the Obama
as a "strategic competitor" to the United States. This				Administration's President's Economic Recovery
may still be an accurate depiction of U.S. - Sino				Advisory Board, Paul Volker, recently stated that
relations, at least as it applies to certain aspects of				China has accumulated a large amount of USD
the multifarious relationship between the two nations.				because they do not want to appreciate their
Financially, China and the U.S. have long been				currency, so they are "crying foul".
symbiotic. Despite the mutual benefits attained from				The Obama administration is in a complicated position.
this situation, there have been numerous points of				Obama often says he does not want to governor
contention, issues that have only been aggravated				out of fear or anger, but the American populous is
by the global financial crisis. The U.S. and China will				doing what oft happens in a financial downturn,
have to find politically palatable ways to work though				becoming increasingly xenophobic in regard to free
some of these differences, because the future				trade. Pew Research Center found that there has
economic viability of both nations depends on it.				been a significant drop in support for free trade
The People's Republic of China (PRC) is the world's				within the United State.
largest single holder of U.S. Treasury Securities, which				The reality is that the average unemployment from
total about $700 billion U.S. dollars (USD). China also				1999-2006 was 5 percent, a decrease from the 6
purchases U.S debt through third countries, which				percent in 1991-1998. The total compensation for
could bring the total closer to $1 trillion as of January				blue-collar workers rose during the same period.
2009. Much of these securities are held by China to				Chinese exports to the U.S. rose over 3 fold since
regulate the Yuan against the dollar in order to ease				2000 to $338 billion in 2008, while imports rose from
the flow of the massive amount of trade between				$16 billion to $71 billion. The actual percentage of
the two nations. In 1979, China - U.S. trade was				China's exports going to the U.S. has declined over
valued at $2.5 billion as compared to over $400 billion				the same period, from about 22 percent in 2000 to
in 2008.				19 percent in 2007 and 17% by August 2008. The EU
Today, America is China's single largest national				surpassed the United States as China's largest export
trading partner and Americans invest in over 50,000				market in 2007. Still, China's bilateral trade surplus with
Chinese enterprises in the amount of $57 billion. Still,				the U.S. continues to rise. It has moved from $84
bilateral foreign direct investment (FDI) from the U.S.				billion in 2000 to over $266 billion in 2008, about 1.9
to China declined from its peak of $5.4 billion in 2002				percent of U.S. GDP. Even if the overall volume of
to $2.6 billion in 2007, but this trend is not reflective				U.S.-Sino trade decreases that will only the current
of overall inflows, as China saw a total of $92 billion in				parallel the sharp fall in global trade as a whole. The
2008, about a 23.58 percent increase from the				U.S. trade deficit with China could still be as much as
previous year.				$200 billion in 2009.
In sharp contrast, flows from China to the U.S. have				No amount of statistical realism has tempered the
surged in recent years. This largely reflects large				calls from the U.S. Congress for large levies on
Chinese central bank purchases of U.S. treasury				Chinese imports or other such acts of legislative
bonds. Due to current account surpluses created by				retaliation if China does not allow the Reminbi (RMB,
exporting to the U.S. and other developed markets,				also known as the Yuan) to float. This great
China has little alternative but to buy U.S. treasuries				acrimony continues in some political quarters despite
to manage its exchange rate. In fact, in 2008 about				China having allowed its exchange rate to appreciate
half of China's total reserves went towards net				by 21 percent relative to the U.S. dollar since 2005.
purchases of U.S. treasuries. In the wake of the U.S.				This is not seen as enough; especially since it is
Financial Crisis of late 2008, these facts have created				obvious China continues to accumulate foreign
great concern in the Chinese government.				reserves at a rapid rate, even after mid-2005. This
Following statements earlier this month by Premier				indicates the continued intervention by China's central
Wen, which voiced apprehension concerning the				bank in the foreign exchange market. Senior IMF
future stability of the USD, the head of the PRC's				officials have also recently noted that the RMB
central bank, Zhou Xiaochuan called for a new				remains substantially undervalued.
international reserve to replace the U.S. dollar, a truly				Some American analysts even argue that the
global currency, which is independent of "economic				Chinese government aided in creating the current
conditions and sovereign interests of any single				global financial crisis. The argument is that the large
country". This reserve would be an enhanced version				current account deficits only occurred because it was
of the International Monetary Fund's (IMF) Special				financed by China (and other Asian and oil producing
Drawing Rights (SDR).				nations). The "excess" savings in these nations were
SDRs are valued based on a basket of currencies,				invested in America because most of them do not
the USD; Euro; Japanese Yen; and British Pound				have the financial capacity to allocate large amounts
Sterling. They were originally proposed to replace the				of capital. The result was artificially low interest rates
Bretton Wood's "gold standard". The SDR has never				in the U.S. that lead to risky lending behavior for a
gained the popularity of the U.S. dollar; only a handful				prolonged period.
of nations peg their currency against SDRs. Since				Other China critics complain that the trade imbalance
Bretton Woods ended in 1971, the global market has				is fundamentally due to unfair competition, citing the
set currency prices of "floating" exchange rates. This				protectionism present in the Chinese market and the
put more power in the hands of national central				pervasive subsidation the Chinese government gives
banks, such as the U.S. Federal Reserve. Due to the				its corporations. Much of this was outlined in "China
economic downturn it is tempting for nations to				and the Global Recession: Part I", but there are also
devalue their currency to make their exports more				subsidies for land and fuel, which reduce the total
competitive, which could spark a trade war. This				production cost of Chinese industries. These
goes to the heart of Chinese Premier Wen Jiabao's				appropriations, when combined with the economy of
concern over the safety of Chinese investments.				scale and low labor costs, result in a major
China does not completely trust the government and				competitive advantage in international markets. This
Federal Reserve to do what is best for the world				argument is somewhat weakened by the various
economy over what is in America's best interest. The				recent financial bailouts of the U.S. governments, but
various bailouts and liquidity schemes that the U.S.				these bailouts pale in comparison to the depth and
government and the Federal Reserve have promoted				scope of the Chinese system.
appear to China as an attempt by America to pay				The current global financial crisis has not changed the
for financial stimulus by "printing money". This could				calculus; it is still mutually beneficial for both parties to
create inflation which will weaken the value of China's				maintain their symbiotic relationship. To do this the
assets.				U.S. government will need to avoid making any
One problem with Zhou's proposal is that the IMF				provocative financial moves that will cause the U.S.
would determine the value of the SDR, a multinational				dollar to rapidly depreciate and specifically address its
institution where there would be much political				deficit spending and public debt. The extent to which
pressure from major contributing nations to bend the				this is likely to happen and the threshold at which the
exchange rates in a given nation's favor. When the				Chinese government will be placated remains in
IMF does allocate SDRs, countries exchange them for				question. The U.S. may be at a political disadvantage
local currencies at domestic central banks. The				due to the current economic situation, which would
country then uses it to buy capital assets which				require some additional concessions, such as
often inflate domestic currency, which is also				increasing China's role in international financial
problematic. Such a proposal has been suggested				institutions, such as the IMF. This is something China
before by Russia and other lesser developed nations,				feels its current stature entitles it too. In the end,
but the United States has always been wary that				China will continue to purchase U.S. reserves at a rate
this could be inflationary and affect the central role				that will fund the American stimulus and war
of the USD.				spending.
Recently, Treasury Secretary Timothy Geithner said				For China's part, it is not likely to rapidly adjust the
he was "quite open" to an "international reserve				value of the RMB in a global recession, let alone, allow
currency" to replace the dollar, but then quickly				it to float. The common wisdom among neoclassical
reversed, trumpeting the dollar's dominance as the				economic adherents is that China should allow for a
USD and various stocks market values begin to drop.				larger float and improve their domestic economy. The
The U.S. will likely work to reduce currency fluctuation				resulting investment abroad as capital flows out of
and ease world trade where politically possible in the				China will cause the Yuan to naturally drop in value.
current climate, not find a means to remove the				China's dollar holdings must be considered here,
special status the dollar holds in the world economy.				re-equilibration of the Yuan to the dollar could result in
This was not the first time an Obama cabinet				a 20 percent capital loss or roughly 10 % of Chinese
member has made controversial remarks concerning				GDP, which is about one year of average Chinese
China. Geithner also accused the Chinese government				GDP growth.
of currency manipulation. China angrily responded that				To compound this, if the domestic economy can not
the U.S. needs to fix its own financial issues, especially				make up the difference of a reduction in exports
since they have affected most of the world.				caused by an appreciated Yuan the economy could
President Obama quickly moved to quail rising tension;				contract. As discussed in "China and the Global
any further stimulus spending will require Chinese				Recession: Part I", China's domestic market is weak,
financing. U.S. borrowing costs could rise if China				especially for a nation of its size, in the best possible
starts divesting at the same time that America is				situation, this would be a risky slow growth formula.
trying to stabilize its financial market. China did say it				China is not as socially stable as popularly believed in
would continue to buy U.S. bonds. It is in their best				the West and still needs significant economic
interest to avoid any rapid market fluctuations.				investment from outside its borders to continue to
Despite this, Energy Secretary, Steven Chu, stated				progress technologically. The Chinese government is
that if China did not sign an agreement for the				well advised to continue its current economic growth
mandatory reductions in greenhouse gas emissions he				model, because it more than offsets the potential
would favor import tariffs on Chinese imports. A				cost of getting caught with holding deprecating U.S.
trade war with China in the middle of a global				dollars.
economic crisis definitely not prudent. Then, Former

Global Trade

China and the Global Recession - Part II - Relations With the United States