The rising trade deficit with China

Author: Steve others.

While many politicians have proposed plans for reducing the rising trade deficit between the United States and the People’s Republic of China, Mendoza College Finance Department Chair Roger Huang believes that many of their remedies are misguided.

Huang notes that United States lawmakers have called on the Chinese to freely float the renminbi, or yuan, in an effort to aggressively counter the yawning trade gap. “We’ve heard calls for imposing tariffs on Chinese goods of up to 27.5 percent by some congressmen to force the Chinese to float the renminbi,” Huang says.

The U.S. trade deficit with China in 2005 was roughly $200 billion, which is about a quarter of the overall $800 billion trade deficit the U.S. carries with the world at large. But Huang says that doesn’t mean that the Chinese did not buy anything here with the $200 billion. “When we just focus on the trade deficit alone, we forget that the Chinese buy ( U.S.) Treasury bonds and other financial securities and make direct investment in the U.S.,” Huang explains.

Huang, who holds the Kenneth R. Meyer Chair in Global Investment Management, doubts that the Chinese are manipulating their currency solely to create a situation in which it is less expensive to manufacture in China than in the U.S. He observes that the Chinese can prevent their currency from appreciating even under a floating renminbi in the same manner as they currently do under the controlled system. Huang recalls that the floating Japanese yen is also perceived to be undervalued by the market, but that the Japanese government has been able to successfully control its appreciation by selling yen. He believes that despite China’s extraordinary economic expansion of the past two decades, it remains an emerging nation. The Chinese believe that they must keep the currency fixed to gain the confidence of investors.

“Emerging markets usually do not have the infrastructure to convince foreign investors that they will not lose the value of their investment overnight,” he says. “Foreigners usually do not trust, for example, emerging market countries’ currencies unless they’re fixed. China is developed for only about 200 million of its people in the coastal cities. The rest of China, approximately 1.2 billion people, is essentially quite poor. Also, the banks are rather fragile.”

While Huang says that the U.S. trade deficit with China might shrink with tariffs such as those proposed in Congress, there may be unintended consequences. Because China is still an emerging market, a freely floating renminbi may end up depreciating rather than appreciating against the dollar, thereby leading to an even bigger trade deficit with China—the opposite of what lawmakers hope for. And, even if the renminbi were to appreciate, it may not help the U.S. trade deficit with the world. Rather than paying more for American products, consumers may instead buy the same goods inexpensively elsewhere.

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