9/8/2010
By Conley Turner, Research Analyst

China was granted Most Favored Nation (MFN) status with the US on a permanent basis in 2000.  This came after decades of that country having to endure a cumbersome annual review process by the sitting president with the promise of ongoing mutual benefit.   Flash forward to present day and things have not worked out exactly as imagined.  China is now the beneficiary of an immense trade imbalance with the US and thus far, all efforts by US authorities have proved ineffective in resolving the situation.

The MFN designation essentially assures normalized trading relations between partners. With the U.S. and China, the latter had that status restored (after having been suspended in 1951) in 1980.  However, it was subject to an annual review because China did not allow the freedom of emigration as mandated by the 1974 Jackson-Vanik Amendment.   The country received permanent status in 2000 under the promise of job creation for American workers, more free trade and an overall decline in the then significant trade imbalance.

In 2000, that trade deficit with China stood at approximately $84 billion.   However by 2009, that figure had ballooned to $227 billion and continues to climb. According to the International Monetary Fund (IMF), China is anticipated to have a trade surplus of more than $400 billion by the end of 2010.

With manufacturing now accounting for as much as 23 percent of China's total GDP, that country's government is clearly unwilling to relinquish that advantage. The imbalance in trade is now at critical mass and is prompting a growing number of lawmakers in the U.S. to call for stricter measures to resolve the situation.  This does not exclude the actual revocation of China's MFN status. 

By and large, it appears that both countries are headed for some kind of trade related showdown.
Among the charges levied by U.S. officials against China is the condoning of a significant number of practices that fall outside the parameters of fair trade. These include among other things, the piracy of technology and the stealing of intellectual property. In this regard, some western companies in general and US companies in particular have expressed concern that China is employing arcane industrial policies and other mechanisms with the clear purpose of transferring technology and innovative capacity to that country. There is more than a little concern among non indigenous Chinese companies about the theft of intellectual property and the disastrous impact of product counterfeiting.  These actions signal to many that China is actually retreating from the initial steps it took in order to open its economy to foreign players.

Be that as it may, the most egregious action by China according to many in industrial, economic and political circles is the artificially low value at which the country's currency is being held. The current value of the renminbi as it is known provides what is widely considered to be an unfair competitive advantage for Chinese made goods and products versus goods made elsewhere.  By doing so, the country has been able to orchestrate a trade surplus with the rest of the world.

The international community is at consensus in the view that the Chinese government manipulates the value the renminbi.  This feat is being achieved by the government selling the renminbi while in turn purchasing other currencies including the dollar.  This action ensures that the renminbi remains weak and that China's exports stay competitive. A recent report by the IMF concluded that China's currency continues to be undervalued in a range of between 5 and 27 percent according to the methodology employed.  As it pertains to the U.S. dollar, estimates put the currency as being undervalued within a range of 25 to 40 percent.  

It follows that U.S. products sold in China are as much as 40 percent too expensive.  Conversely, goods manufactured in China are artificially cheap by as much as 40 percent. The discrepancy in currency values makes products made in the U.S. very expensive for the Chinese market and vice versa. The imbalance has resulted in China now holding approximately $2.4 trillion in U.S. dollars. 

Despite numerous calls by the US authorities for the China to allow the currency to float naturally on the global currency market, nothing sufficiently substantive has been done.  On June 19, China did nonetheless take a constructive step and announced the establishment of a more flexible exchange rate policy for the renminbi.   The result was a temporary 1 percent increase in the currency which was hardly sufficient to offset the value gap with the dollar. 

The loss of American jobs in the past few years as a result of diminishing US manufacturing capacity has caused more than a little in the way of political repercussions. The current trade imbalance with China has the effect of imposing a de facto anti-stimulus mechanism on the economy that is desperately in need of one. 

The implementation of any punitive tariff or other measures on Chinese made goods buy the US would likely lead to a comparable reaction to US goods. With emotions now bubbling to the surface, this can cause a trade dispute that no one really wants or can afford.

It is clear that much more needs to be done. It is even clearer that China will not be coerced into bowing to pressure to give up much of the gains that they have made in the past years.  Meanwhile, there is building momentum by all politicians and industry for more decisive action to be taken in order to address the situation.   A trade related showdown between China and the US looms.

Conley Turner
Wall Street Strategies