The Bush Administration imposed duties on some goods from China yesterday. While the duties are only for high gloss paper, it sets a precedent in our China trade relationship and changes direction away from the free trade policies which have been the hallmark of the US government. While some may have a knee jerk reaction for or against free trade, these issues are complex. This particular issue surrounds whether the Chinese government subsidies paper manufacturing through tax breaks, debt forgiveness, or low cost loans. Additionally, there are issues with the form of subsidy allowed for a state owned enterprise which may significantly reduce their costs relative to US manufacturers.
The trade issue is heating up in a number of directions. Two leading US Senate critics of China’s currency policy – Sen. Charles Schumer, a New York Democrat, and Sen. Lindsey Graham, a South Carolina Republican – said on Wednesday that they expected Congress to pass a ”veto-proof” bill forcing Beijing to raise the value of the yuan. An interesting piece of legislation is when the Congress decides to change the value of a currency.
What is especially problematic about the current legislation is that is cosponsored by both Democrats and Republicans. The normal party of free trade, the Republicans, is being united with Democrats to move trade policy in a new direction. Constraints on trade cause a reduction of overall trade flow which will hurt what may be the fastest growing area of the US economy now that the housing sector is languishing. The importance of trade is even greater if we believe that growth in Europe and Asia will exceed the United States in the coming year. Most economists suggest stronger growth outside the United States in 2007.Global constraints on US exports in retaliation to US action will especially hurt now that the decline in the dollar may actually allow for an increase in exports.
Nevertheless, increases in exports will not occur overnight. This is why avoiding trade constraints at this time is important. There is the well-known J-curve effect whereby trade will further deteriorate even if there is a decline in a country’s currency. Imports will be booked at current prices and exports signed for purchase may not be paid and not be displayed in trade statistics until later.
China is now our second largest trading partner with just under 15% of all trade. It has a trade deficit with the US of over $200 billion in 2006. It is the fourth largest trade partner with the United States. In exchange for all of these traded goods, China holds over $1 trillion in US debt as accumulated reserves. We export debt in exchange for goods. (See http://www.fas.org/sgp/crs/row/RL31403.pdf for a thorough review of the China-United States trade relationship.)
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