China's Economic Invasion: One Year Later

The Heritage Foundation ^ | 18. April 2006 | Tim Kane, Ph.D., Marc Miles, Ph.D., and Anthony Kim

[1rudeboy]

One year ago, the chorus of the consensus told America that the dollar’s exchange rate was due to fall in 2005. Under relentless assault from cheap Chinese imports and facing a record trade deficit, the dollar had nowhere to go but down. The influential Economist magazine went so far as to say, “[t]he deficit is unsustainable: sooner or later it will need to shrink, and that will involve a cheaper dollar.” Politicians and pundits predicted economic trauma at the hands of outsourcing. Time has proven them wrong. What the U.S. needed then and needs now is to stick to the reliable keys to growth: low tax rates, deregulation, limited government, and especially free trade.

 

A Dollar – Deficit Link?

The U.S. economy did set two records last year. First, 2005 saw a new record trade gap. Imports to the U.S. exceeded exports by $724 billion, or 5.8 percent of GDP. Second, more Americans were employed than ever before in history, arguing against those who preached doom and gloom.

 

The data continue to support our contention of last May that the trade deficit is not the signal to watch: “This is all wrong... Many economists and the weight of history suggest that the trade deficit, a symptom of investment capital inflows, is a sign of national economic strength.”[1]  Additionally, two papers published last spring pointed out the lack of a historical relationship between currency values and trade deficits.[2] Indeed, despite the widening trade gap, the dollar gained value against other currencies.

 

 

The January 5, 2006, Economist admits that the dollar pessimists “were all wrong.” Yet the conventional wisdom of “trade hawks” is again resurgent, arguing that trade deficits are unsustainable and the dollar cannot hold. Last week, the government reported the third deepest trade gap on record, with imports outweighing exports by $65.7 billion. Current exchange rates, however, appear normal compared with exchange rates over the last few decades.

 

Unless Congress moves from protectionist rhetoric to protectionist legislation, there is no reason to expect the dollar to slide significantly. Trade flows are the “tail of the dog,” as Fed Chairman Ben Bernanke once explained. From time to time the dollar does fall when the world’s investors lose confidence in the superiority of America’s institutions and markets. Sadly, congressional hostility to the U.A.E. port deal was a bipartisan embarrassment and isn’t likely to reassure the world that America is as free and fair as it proclaims. Equally troubling is the Schumer-Graham proposal in the U.S. Senate to place trade barriers on imports from China.

 

The Chinese Invasion

According to the last week’s data from the Department of Commerce, the U.S. trade deficit with China was $13.8 billion in February. In 2005, the U.S. trade deficit with China grew by 25 percent to $202 billion. That amounts to nearly twice the $103 billion bilateral deficit in 2002. The ratio of imports to exports with China is now 5 to 1, perfect for the “Chinese invasion” storyline. The U.S.-China deficit’s growth probably won’t continue, but not because it can’t. Consider these points:

• Mathematically, trade flows are balanced by investment flows. The bigger the trade deficit, the more capital flowing into the U.S. Chinese and other foreign investors prefer to trade their goods for America’s equity and debt. America is seen as the safest, surest investment bet in the world. That’s bad news?

• Realistically, trade represents voluntary exchange. Any “imbalance” is voluntary. As with trade between a consumer and a retailer at the local mall, the two consenting parties each benefit from the voluntary trade of goods for currency.

• Empirically, record trade deficits have coincided with positive economic news in the U.S.: record levels of employment, low unemployment rates, rising pay, and fast GDP growth. The argument that this is a debt-driven party is far less credible than the argument that imports are as economically valuable as exports.

• Pragmatically, much of the trade deficit with China represents re-importation by U.S. firms with factories overseas, such as General Motors, Motorola, and Boeing. Parts leave the U.S. and come back as more valuable assembled products. A 2005 National Bureau of Economic Research study[3]  reported that 90 percent of U.S. exports and imports flow through U.S. multi-national companies, with 50 percent flowing within a single firm. The lesson for Congress is that American companies, not just China, will be injured by protectionism.

We should cheer the triumph of capitalism and its alleviation of poverty within China, as well as its benefits for American consumers and shareholders. The only point of debate is whether American workers’ wages are suffering due to trade with China, but there is no clear evidence of wages “racing to the bottom.” Instead, China is experiencing a severe labor shortage that is driving wages up rapidly in a “race to the top”—the level of free-market workers.

 

The real dangers to America are not free trade or China’s currency. That’s not to say there aren’t smart policies that should be taken to curb abuses of fair trade, rather that protectionism and currency haggling aren’t part of the smart mix. The real danger is that Congress will try to fix what is not broken and adopt a mercantilist policy of import limitation. Congress would do well to stick to the reliable keys to growth spelled out in The Heritage Foundation’s Index of Economic Freedom: strong property rights, low tax rates, low regulation, limited government, and especially free trade.

 

Tim Kane, Ph.D., is Director of, Marc Miles, Ph.D., is Senior Fellow in, and Anthony Kim is Research Associate in, the Center for International Trade and Economics at The Heritage Foundation.

---

[1] Tim Kane, “The Brutal Price of a Dollar,” Heritage Foundation Backgrounder No. 1855, May 31, 2005, at http://www.heritage.org/Research/TradeandForeignAid/bg1855.cfm.

[2] See Ibid. and Tim Kane and Marc Miles, “Trade Deficits, Dollars, and China: Wrong Lessons Make Dangerous Policy,” Heritage Foundation WebMemo No. 743, May 12, 2005, at http://www.heritage.org/Research/Economy/wm743.cfm.

[3] A.B. Bernard, J.B. Jensen, and P.K. Schott, "Importers, Exporters and Multinationals: A Portrait of the Firms in the U.S. that Trade Goods," NBER Working Paper No. 11404, June 2005.

 

[1rudeboy]

Interesting material.

[rellimpank]

--yes--howfully there will be some comment from the folks who expect us to be bartering stuff for gold dust and Krugerrands within a few weeks--

[rellimpank]

--arrggh--"howfully" ="hopefully"--spelchek is my friend--

[Paul Ross]

Sadly, congressional hostility to the U.A.E. port deal was a bipartisan embarrassment and isn’t likely to reassure the world that America is as free and fair as it proclaims.

Leave it to the inane Tim Kane to never, ever see a national security issue if it bit him in the ass, and proceded to chew up his spine and swallowed him whole.

He would declare the whole process 'bracing, but therapeutic.'

Equally troubling is the Schumer-Graham proposal in the U.S. Senate to place trade barriers on imports from China.

Troubling to China...and its apologists, agents of influence, expatriates, lobbyists, profiteering middlemen and hired schills. Memo to Kane: The PRC classifies the U.S. as the "Main Enemy."

It is also amusing that he can come up with no explanation for the dollar "surprisingly" resisting the downward force of its uncompetitive trade posture. Guess that incongruity doesn't trouble him. But since he has no good explanation, he decides to brush past that in a real hurry, so, he merrily assumes it will continue forever and ever and ever....we just have to stick to good old free trade....

Meanwhile, it never occurs to him that the foreign nation's currency pegging actions... are predatory state interference in the terms of trade...radically skewing market forces... They are not engaged in...and never have been engaged in 'free trade.' Kane lives in a unilateral delusion.

[1rudeboy]

Most protectionists howl "national security" when stuck with a pin. They do it so often, in fact, that I fear the next time a real national security concern is raised, no one will listen.

[Paul Ross]

You've got it turned around. And as the failures of CFIUS have proved...its the enemies of national security who howl "protectionists" when someone properly notes a concern. They have never listened. And Treasury, Commerce, the Feds, State etc. wouldn't know a real national security concern...any more than Tim Kane would.

You should read up on the facts. But of course, you wouldn't believe the Defense Sciences Board.

Or its Reports Here, here and here.

[4rcane]

I'm in total agreement with this article. There are too many on our side (the right) and everyone on the left that think protectionist policies is the way to go; not realizing it will end up hurting the economy.

[1rudeboy]

Mr. Kane refers to the failed DPW deal as a "bipartisan embarassment." It was. Had the deal gone through, security at the terminals in question would have improved, as part of the security proposals that DPW itself submitted. Frankly, it's not a very effective argument to claim that the DPW deal should have failed because the U.S. is failing to provide national security elsewhere. And that was the gist of my comment. Howling "national security" when it is not implicated diminishes the concern when it actually is, as the reports you post point out.

[Paul Ross]

Had the deal gone through, security at the terminals in question would have improved.

Although I was willing to be persuaded on that issue, the slandering of the American people made that a tough sell. And the ones who reached so swiftly for that approach to argument made them unlikely salesmen. And it cast doubt on the strrength and legitimacy of any solid arguments in their position...which by then had been obfuscated by their defamatory shenanigans.

They had impeached themselves in effect.

Improved security according to who precisely? Treasury Secretary Snow? His former deputy at the Maritime Admin. and former DPW executive? The Commerce Secretary? I don't think these folks are going to win any prizes for popular credibility.

And keep in mind...there were very serious internal objections which someone in Treasury went way, way out of their way to conceal. It took Senate hearings and testimony to drag the existence of these objections out of the personnel. Meanwhile the proponents in the press had been trumpeting how it had been unanimously approved without dissent in CFIUS. Rather misleading, eh? It wasn't just the Coast Guard which objected (but was overruled) and could not vet the company. Homeland Security also objected, but also got overruled...based on the same paper 'assurances' apparently. Not a procedural fix with a U.S. subsidiary or some such approach. And Dubai was demanding waivers of our standard, routine requirements. A U.S. officer for legal purposes, etc. And someone in Treasury was-all-too-eager to give it to them. And Sec. Snow claims not to have known about the deal... No. It never passed the smell test.

And as we know, the DOD was conflicted and held hostage...not wanting to offend their host in Dubai.

Any security assurances or measures DPW 'agreed' to would have only given a false sense of security.

CFIUS was exposed to the public for what it was. Corrupt. CFIUS rejected only one of the roughly 1500 transactions submitted for its approval, per a 2005 government report. That’s not just a “bias to approve;” it’s a rubber stamp.

And the proponents decisively and definitively proved my point...they howled "protectionist" playing the 'free trade' card when all that was ever at issue was precisely that of national security. Your's is the side crying wolf. Or that the sky will fall.

The traders have destroyed the President's credibility, not just his popularity...and they have no one to blame but themselves. They had the entire President's staff reading Thomas Friedman's stupid book "The Earth is Flat"...which preaches nothing but magical thinking on national security.

Strange. Pot, meet kettle.

[1rudeboy]

I agree, the name-calling proved to be counterproductive. As for the security assurances, I can no longer find the proper article (also at Heritage) where I first saw them. In any case, it stands to reason that a double standard was applied to DPW in the sense that a good many Congress members couldn't care less about Chinese operation of our terminals, for example.

That's what I found disturbing . . . that political opportunism disguised as concern for national security (by the Dems in particular) ruled the day, and DPW was caught in the cross-fire.

[Mase]

We've heard for several years now that the twin deficits were going to destroy the dollar. When this didn't happen the same doomsayers claimed that rising oil and gold prices portended the imminent collapse of the dollar. Wrong again. In the past when gold was up the dollar was down. Now we have the dollar holding its own while oil and gold have increased dramatically in price. These are interesting times. My guess is that because the dollar is the world's reserve currency, global commodities trading is taking place mostly in dollars. Rising oil prices have created a demand for dollars. The dollar is the currency of global liquidity so if you want to conduct international financial transactions, the dollar is the currency to be used and is therefore in strong demand.

Whether this is true or not is secondary to the fact that the dollar pessimists and trade deficit alarmists have been wrong all along.

[LowCountryJoe]

The PRC classifies the U.S. as the "Main Enemy."

They have a funny way of showing it, Mr. Ross. They send us goods and their capital [ Mathematically, trade flows are balanced by investment flows. The bigger the trade deficit, the more capital flowing into the U.S. Chinese and other foreign investors prefer to trade their goods for America’s equity and debt. America is seen as the safest, surest investment bet in the world. That’s bad news? ]

Of course this pesky little capital flow issue is something that you either cannot grasp (and here's another example of your failure to grasp) or it's something you refuse to acknowledge ( here's you again, dodging the direct question).

[Toddsterpatriot]

I love that chart showing no relationship between rising trade deficits and a falling dollar. Paul used that chart for a while to show that there was a relationship. Paul can't read charts. Paul is funny.

[Paul Ross]

I love that chart showing no relationship between rising trade deficits and a falling dollar.

Note that if smoothed out it does show an interesting historical tracking of the two...despite foreign interventions attempting to blunt the effects.

And interesting how joe can't account for the fact of those interventions...which clearly are not 'free market' manifestations...and cost Red China $195 billion annually.

Joe is funny. He can't read between the lines of the charts.

[1rudeboy]

I've always enjoyed the following one:

Source: The Cato Institute

[Toddsterpatriot]

Note that if smoothed out it does show an interesting historical tracking of the two...

How would "smoothing" turn no correlation into correlation?

He can't read between the lines of the charts.

That's the thing about charts, there is no hidden "between the lines" info. Is that why you misread charts? You ignore what's there and add what's not?

[Toddsterpatriot]

That chart obviously shows that imports are destroying our manufacturing /Paul Ross economic ignorance off.

[1rudeboy]

Here's one from the lefties at E.P.I.

Source: The Economic Policy Institute

[Paul Ross]

They have a funny way of showing it, Mr. Ross.

They are exhibiting a classical communist mindset and patience. Which to a short-term U.S. analyst is mysterious and inexplicable. China apologists on this end don't comprehend economic warfare by communist states.

Nor truth be told do they comprehend how dangerous the outsourcing is. It is an alien subject for most traders to begin to grasp. Industry...of all types..."naturally" flows to them...due to the unnaturally low wage conditions they artificially maintain. That is the whole point.

They send us goods and their capital.

They only send us goods to capture still more industry...and shut down ours.

And for the most part they are not investing capital in the U.S. They are buying debt. Which merely props up the profoundly unproductive U.S. federal spending sector. I.e., they aren't spending to help build U.S. "muscle"...they are encouraging the glutton to get fatter...or the drunk to keep drinking.

I know this is really hard for you to understand, Joe, but this is really pretty important because you so BADLY MISAPPREHEND the nature of the capital flows. They are buying DEBT. Let me repeat that: They are buying debt. The money is not a "gift" or a product purchase. The Money they are lending us, the principal has to be paid BACK. With Interest. And the only reason they have been buying our debt is that it furthers their idea of trade war. And it works. It helps them keep the dollar up...temporarily... until they decide they have gotten enough of our industrial advantage relocated to their control. And then the 'wedge' of obligations hits the fan and the matured T-Bills have to be repaid.

They only need to keep the dollar up temporarily until they have successfully finished strip mining the U.S. of its core industrial capabilities. For them, decades are routine benchmarks. For you, Joe, they are an Eternity. You are doomed to short-term thinking. You would likely wise up...only when the dollar has actually collapsed. But you likely will still refuse to acknowledge that you were an enabler of the Communist plan...or that you helped set up the U.S. for the fall.

And, LOL!, I appreciate you reposting the threads where in you completely failed to acknowledge the truth that your own source Mankiw disputes your capital theory!

I see you have no other data. You are going off of theory. Fortunately for the conservative case...Mankiw's power point display is a set of axiomatic claims that does not support your positions...and apparent misinterpretations. Net 'capital inflows' doesn't mean what you think they mean. They are a liability. A debt. Which is why the continued U.S. import habit is representing a net reduction of U.S. savings and wealth.

Review Figure 2 in Images 19 and 20. Unfortunately the power point files were not accessible for posting here...but clearly they show that in fact the U.S. has been suffering a serious negative number in NX, net exports which drives all other issues. As Manciw's charts confirm the conservative case...that national savings "S" is diving as a result of the increasing trade deficit (S=I+NX), with corresponding declines in both Domestic Investment and capital savings.

Conclusion: You got it precisely backwards. Net Trade Imports don't increase our capital. Or our well-being. They are a capital liability. Hence They reduce it and our savings of it. GDP is also confirmed to be directly reduced by a trade deficit. Y=C+I+G+NX Translated: GDP = Consumption + Domestic Investment + Governmental Spending + Net Exports. In these equations, a negative number for NX, the net exports, lowers GDP 1 for 1.