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Lucky for the United States, all this surplus cash has been deposited in U.S. banks, though this has created another set of problems for the U.S. economy. The current subprime mortgage crisis in the United States had its beginning in the surplus cash the banks accrued a few years back -- also related to China.
Chinese influence in world financial markets has grown so much that if not contained now, China will begin to dominate world financial markets in the next ten years.
Despite all Western efforts, the Chinese dollar horde is still growing by leaps and bounds. No easy means have been found to tame this growth. China's currency revaluation in the last two years, which raised the yuan by about 10 percent, has not curbed the trend.
A number of ugly trade crises have been unleashed on China on behalf of U.S. consumers. Toxic substances in toys, toothpaste, food and medical products have all brought consumer backlash against Chinese goods. But none of this seems to have tamed the voracious appetite for cheap -- though less durable and less safe -- products coming out of China.
At present China keeps its currency reserves in U.S. dollars. China has earned all these dollars with ever higher levels of merchandise exports, while importing very little from the United States. In 2006, for example, China exported US$288 billion worth of goods to the United States and imported only $55 billion in return. Merchandise in every store in the United States is made in China. Almost all clothing, toys, furniture and consumer items are made in China.
In return China buys only food grain, technology and commercial aircraft from the United States.
The U.S. trade deficit with China first appeared in 1985. At that time it was a measly US$1 billion. Since then it has taken off exponentially. This was partly because former U.S. presidents Ronald Reagan and George Bush Sr. thought that to encircle the Soviet Union, China was their best bet. Hence they lent the Chinese large amounts of money to build infrastructure and set up new factories. Imports into the United States were allowed duty free, which turned out to be detrimental to U.S. economic health. The trade deficit in China's favor ballooned to $50 billion in 1997, $100 billion in 2002 and $233 billion in 2006.
It is not China's fault that U.S. businessmen are buying everything made in China. They find it cheaper, which boosts their profits. One thing the U.S. policymakers seem to have forgotten is that all these benefits are due to the heavy subsidies the Chinese give their industries and the low exchange rate they enjoy. If any other nation were to attempt to duplicate the Chinese model, the United States would invoke dumping laws or establish a quota system or impose trade barriers to keep its products out. China has been an exception.
It is almost as if the U.S. administration has fallen asleep at the wheel.
The U.S. consumer is not well off with Chinese merchandise. It is of low quality; it is cheap and requires replacement more often, costing more in the long run. Worst of all it takes away U.S. jobs without creating equivalent work for the local population.
With this large trade surplus the Chinese have created their very large cash reserves, far beyond their needs for trade and finance. With so much surplus cash around, everybody in the West has become dependent upon it. Even the current war in Iraq is partly funded by Chinese money via the U.S. Treasury.
The Chinese have no say as to how the Americans spend this money. It is the Americans who call the shots. But this is not going to last forever. Very soon the Chinese will ask to be informed as to how their money is spent.
China is not without risks with so much cash. The Chinese never imagined they would build up such a huge reserve, hence never gave a thought to its disposition. The United States told them their cash would serve as security for all the foreign direct investment that has gone into China. The total FDI invested in China over the last 25 years is about US$1 trillion, roughly equal to the cash reserves. So, for the Americans it is security and for the Chinese it is a pile of cash for a rainy day.
What should the United States do about this problem?
The solution to this problem will take about 20 years to implement, roughly the same time period it took for the cash reserves to build up. First and foremost, the United States has to curb its appetite for Chinese goods. It has to recover a few million jobs from China by rebuilding its industry, which has disappeared from the United States.
Second, the United States should revisit the dollar/yuan relationship in trade and finance. The minor 10 percent adjustment of the yuan in the last two years is not enough. The original exchange rate was set in the early 1980s, when China's gross national product was US$300 billion. It is now $2 trillion. Hence the concessions given in 1981 should be taken back and the new realities factored in.
Third, the United States should revisit the issue of hidden Chinese subsidies to its manufacturing sector. These are as much as 20 to 40 percent, depending on the product, and are invisible under Western accounting practices. They exist in the form of cheap land, fixed-price labor over long periods of time, low rates for utilities and other factory input as well as direct export incentives.
If the Chinese currency were revalued at a rate 30 percent higher, and at least 50 percent of government subsidies were removed, Chinese products would be 70 percent more expensive in the U.S. market than they are today. That would place China-made products on a par with U.S., European, Japanese or Korean goods. The hidden benefit to the United States would be that it would no longer be economical for U.S. businesses to import. They might decide to build factories in the United States and recover some of the jobs lost over the last 25 years.
This may take time to accomplish, but it would be well worth it. If the Chinese do not listen to reason and continue their current practices unabated, then a case for import duties and a quota system exists. These would limit market access and more balanced trade would follow.
What could the Chinese do to retaliate if the United States took such actions? As a matter of fact, they could not do very much. They import a measly US$55 billion from the United States. Any trade retaliation would be against their interest. Other nations could not fill the void left by a breakdown in trade with the United States.
Alternatively, the Chinese could take their cash reserves and go elsewhere, though it is doubtful any other nation could take this much cash and flourish. Hence China's choices are limited.
Then what is the right thing to do?
The right thing for China to do is to begin importing U.S. goods in a big way. Also China should voluntarily limit its exports. Both the United States and China should take time and think through the process, but a balancing of their trade is long overdue. Any delay will be detrimental to both Chinese and U.S. interests. Working together is the only option.
To summarize and prioritize, the necessary U.S. actions are: to kill the voracious U.S. appetite for cheap, low quality Chinese goods; to tackle the currency issues; and to study the subsidy mechanisms in China. China should co-operate; if it fails then duties and quotas should be implemented on all Chinese imports.
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(Hari Sud is a retired vice president of C-I-L Inc., a former investment strategies analyst and international relations manager. A graduate of Punjab University and the University of Missouri, he has lived in Canada for the past 34 years. ©Copyright Hari Sud.)
