Assignment

On US Trade Deficit with China

Submitted To:
Humaira Parvin
Southeast University

Submitted By:
Name Tanvir Mazhar Shafiqul Islam Md. Nahid Ali Mosleh Mr. Ashraf Ali Khan Batch Section Program : 6th :D : MBA (Friday) ID 2011110005120 2011110005122 2011110005126 2011110005128

Introduction:
Economic and trade reforms (begun in 1979) have helped transform China into one of the worlds fastest-growing economies. Chinas economic growth and trade liberalization, including comprehensive trade commitments made upon entering the World Trade Organization (WTO) in 2001, have led to a sharp expansion in U.S.-China commercial ties. U.S.-China trade rose rapidly after the two nations reestablished diplomatic relations (in January 1979), signed a bilateral trade agreement (July 1979), and provided mutual most-favored-nation (MFN) treatment beginning in 1980. The rapid pace of economic integration between China and the United States, while benefiting both sides overall, has made the trade relationship increasingly complex. Yet, bilateral trade relations have become increasingly strained in recent years over a number of issues, including a large and growing U.S. trade deficit with China, resistance by China to reform its currency policy, U.S. concerns over Chinas mixed record on implementing its WTO obligations, and numerous Chinese industrial policies that appear to impose new restrictions on foreign firms.

U.S. Trade with China

U.S.-China economic ties have expanded substantially over the past three decades. Total U.S. - China trade rose from $2 billion in 1979 to $457 billion in 2010. China is currently the second largest U.S. trading partner, its third-largest export market, and its biggest source of imports. In recent years, China has been one of the fastest-growing U.S. export markets, and the importance of this market is expected to grow even further, given the pace of Chinas economic growth, and as Chinese living standards continue to improve and a sizable Chinese middle class emerges. The U.S. trade deficit with China has surged over the past two decades, as U.S. imports from China have grown much faster than U.S. exports to China. In 2011, the U.S. trade deficit with China was $272 billion. This was down a bit from the year before, when the trade deficit was $273 billion. Both were higher than any prior year. The U.S. has a trade deficit with China despite the fact that its exports to that country were the highest in history. In 2011, the U.S. exported $94 billion in goods, an all-time record. (Exports in 2010 were only $92 billion.) However, imports from China also set a record i.e. $367 billion, more than the $364 billion imported in 2010. The U.S. imports consumer electronics, clothing and machinery from China. A lot of the imports are from U.S. based companies that send raw materials to China for cheap assembly. When they are shipped back to the U.S., they are called imports even though they are profiting American-owned companies.

Statistics of US-China Trade:

Major U.S. Exports to China: 2005-2010

Over the past few years, China has been among the fastest-growing U.S. export markets, as canbe seen in Table 3. In 2010, China was the second-fastest-growing export market (after SouthKorea). From 2001 to 2010, U.S. exports to China increased by about 379%, which was significantly faster than U.S. exports to other major U.S. exports markets.

Major U.S. Imports from China

China was the largest source of U.S. imports in 2010, at $365 billion. U.S. imports from China increased by 23.1% in 2010 over the previous year.14 China accounted for 19.1% of U.S. imports in 2010 (compared to 8.2% in 2000). The importance (ranking) of China as a source of U.S. imports has risen dramatically, from eighth-largest in 1990, to fourth in 2000, to second in 2004-2006, to first in 2007-2010. The top five U.S. imports from China in 20010 were computers and parts, miscellaneous manufactured articles (such as toys, games, etc.), communications equipment and parts, apparel, and audio and video equipment (see Table 4). U.S. imports from China from January-July 2011 rose by 12.5% on a year-on-year basis.

Reasons for Trade Deficit with China

China is able to produce goods that Americans want at a low cost. Despite the loss in jobs, this is unlikely to change. That's because most people would rather pay as little as possible for computers, electronics and clothing -- even if it means other Americans lose their jobs. That's why the situation is unlikely to change, despite recurrent bills by legislators to impose tariffs or other forms of trade protectionism with China. Most economists agree that China's competitive pricing is a result of two factors: A lower standard of living, which allows companies in China to pay lower wages to workers. China's economy is the third largest in the world. In 2010, its Gross Domestic Product (GDP) was $10.9 trillion in goods and services. However, China has more people than any other country. It has to divide this production up among 1.3 trillion residents. In other words, its GDP per capita is $7,600. Imagine trying to live in the United States on only $7,600 a year. No wonder China's leaders are desperately trying to get the economy to grow faster. They remember the Chinese Revolution all too well, and know that the Chinese people won't accept a lower standard of living forever.

An exchange rate that is partially set to be always priced lower than the dollar. China sets the value of its currency, the Yuan, to always equal a set amount of a basket of currencies which includes the dollar. In other words, China pegs its currency to the dollar using a fixed exchange rate. When the dollar loses value, China buys dollars through U.S. Treasuries to support it. In this way, the Yuans value is always within its targeted range. As long as the Yuans value is lower than the dollar, China's goods are cheaper in comparison.

How it affects in U.S. Economy

China must continually buy so many U.S. Treasury notes that it is now the largest lender to the U.S. Government. As of November 2011, the U.S. debt to China was $1.13 trillion, 25% of the total public debt. Many are concerned that this gives China political leverage over U.S. fiscal policy, since it could theoretically call in its loan. (Source: U.S. Treasury, Major Foreign Holdings of Treasury Securities) By buying Treasuries, China helped keep U.S. interest rates low. Until the Subprime Mortgage Crisis, this helped fuel the U.S. housing boom. If China were to stop buying Treasuries, interest rates would rise, delaying any recovery from the recession. This isn't in China's best interests, as U.S. shoppers would buy fewer Chinese exports. However, China is buying fewer Treasuries than in June 2011, when it owned $1.165 trillion. China has been diversifying its holdings into other currencies, such as the euro. The U.S. trade deficit with China means that U.S. companies that can't compete with cheap Chinese goods must either lower their costs or go out of business. To lower their costs, many companies have started outsourcing jobs to India and China, adding to U.S. unemployment. Other industries have simply dried up. U.S. manufacturing, as measured by the number of jobs, declined 34% between 1998 and 2010. As these industries declined, so has U.S. competitiveness in the global marketplace.

Conclusion and recommendations

A trade deficit is not necessarily bad. It is most useful to see it as a vehicle to achieve an economic end, conferring some benefit at some cost. Whether the trade deficit is good or bad will hinge on a weighing of these benefits and costs. The overriding benefit is the ability to borrow internationally so as to push current spending beyond current production. Trade deficits in the 1990s have been a means to help finance an elevated level of domestic investment. Investment augments the nations future productive possibilities and is a boon to long-term economic welfare. In contrast, the large trade deficits of the 2000s have been used to finance greater public and private consumption. In this situation, the benefit of an increase in current consumption must be weighed against the cost of a reduction of future consumption. The cost of the trade deficit is the debt service that must be paid on the associated borrowing from the rest of the world. The U.S. debt service has grown steadily and will soon reach a size that could impose a significant decrement to the rate of growth of its living standard. It is a burden that is still well within the U.S. means to pay, but some might argue it is a burden that needs to be curtailed. Certainly true that standard trade policy tools such as tariffs, quotas, and subsidies will not significantly change saving or investment behavior and, therefore, will not reduce the trade deficit. But in most cases will create distortions that reduce national economic welfare. Macroeconomic policy can affect the saving-investment balance and can change the trade deficit, but how to do so by rising domestic saving rather than reducing domestic investment remains unclear. The government budget deficit and government saving have improved in recent years, but a much more sizable increase would be needed to eliminate the trade deficit by this means alone. Over the long-term, many economists see the budget balance moving in the opposite direction under the pressures of rising entitlement spending. However, the prospect of more vigorous economic growth in the euro area and Japan could cause greater opportunities for investment in those economies, slowing their saving outflow to the United States, and working to shrink the U.S. trade deficit. Generating a sustained increase in the U.S. economys rate of saving by reversing the steadily sagging rate of household saving would reduce the trade deficit, but how to raise that rate is uncertain. It is possible that the trade deficit could correct itself without any inducement by economic policy. There are good reasons to expect that economic forces will work to sate the demand for foreign borrowing as well as reduce the supply of foreign funds being offered. A significant acceleration of the rate of growth abroad relative to that of the United States (raising domestic investment relative to domestic saving abroad) would likely initiate such a process. A change in relative growth rates would most likely alter rates of return between the United States and the rest of the world, redirect a larger share of international investment flows towards destinations other than the United States, and shrink the U.S. trade deficit. This correction does not necessarily have to lead to an elimination of the trade deficit. It might only fall enough to assure a more sustainable rate of accumulation of foreign debt that stabilizes the ratio of external debt to GDP. Nevertheless, a smaller trade deficit, lacking an increase in the rate of U.S. domestic saving, will mean that the reduced saving inflow from abroad will have shrunk without any offsetting increase in domestic saving. This will increase U.S. interest rates and force a reduction of domestic investment to the level of the smaller flow of saving available to finance it.

Reference: 1. www.google.com 2. Congressional research service- China-U.S. Trade Issues: Wayne M. Morrison, Specialist in Asian Trade and Finance