Why the Pelosi Democrats Scare China

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"She scares the hell out of them." That's the way an American businessman, one with strong ties to the Chinese elite and a frequent traveler to Beijing, described to me how that nation's leadership views Speaker of the House Nancy Pelosi. But Madam Speaker shouldn't take it too personally. She probably serves as symbolic shorthand for the Democratic-controlled Congress that took power partly based on a promise to get tough on China. And it sure looks as if it intends to. Earlier this week, Pelosi and other Democratic House leaders called upon President Bush "to present to Congress within 90 days a comprehensive plan to eliminate the surging trade deficits with these 'Big Three' economies [China, Japan, and the European Union] by tearing down market access barriers and eliminating unfair trading practices that have existed for years–in some cases, decades." Also this week, Democratic Sens. Byron Dorgan of North Dakota and Sherrod Brown of Ohio, along with Republican Lindsey Graham of South Carolina, said they were introducing legislation that would strip China of its permanent normal trade status with the United States, subjecting the trade relationship to an annual review by Congress. Brown said in a statement:

U.S. trade policy has failed workers and small businesses across our country. As far as I am concerned, there is nothing normal about allowing our trading partners to use slave labor to compete with our workers. There is nothing normal about manipulating currency to make exports cheaper. There is nothing normal about mouthing concern for intellectual property in the midst of rampant piracy. And if this is indeed normal, then I certainly don't want it to be permanent.

Now there's some evidence that all these threats by Democrats are having an effect. China has been criticized for keeping its currency artificially low to boost exports. So far in 2007,though, the Chinese yuan is one of the fastest-appreciating Asian currencies, up about 0.6 percent. That may not sound like much, but it is pretty notable given that the yuan has risen by less than 5 percent since China ended a direct peg with the U.S. dollar in July 2005. Also back in 2005, Graham and Sen. Charles Schumer of New York cosponsored a bill that would have imposed a 27.5 percent tariff on Chinese imports.

Will there be a United States-China trade war? Protectionism is a major concern on Wall Street right now. In a recent analysis, Morgan Stanley chief economist Stephen Roach compared U.S. trade friction with China today vs. that with Japan in the 1980s–and found today's circumstances far more worrying. Two major take-aways here:

1) Roach notes that as of last year's third quarter, the U.S. current account deficit stood at 6.8 percent of gross domestic product–double the 3.5 percent shortfall hit in the fourth quarter of 1986 when the imbalance was at its worst back then. Japan accounted for 37 percent of the peak U.S. merchandise trade deficit in 1987, whereas the Chinese share is about 29 percent today. But because the trade deficit is much larger today, China's bilateral imbalance is currently about 1.9 percent of GDP–more than 50 percent larger than Japan's 1.2 percent share in 1986. "Consequently, on the basis of this simple calculation, the China factor appears to be considerably bigger than the Japan factor–stoking concerns of the protectionists who claim there is much more to fear from one trading partner today than was the case nearly 20 years ago."

2) In 1986, the pressures of globalization were hitting both business and labor. The profits share of national income of about 7 percent was well below the 10 percent level of a decade earlier, and the labor compensation share of about 58 percent was below the 60 percent level of earlier in the decade. Today, you have a far different situation, with profits at record highs and the share of income going to labor at 40-year lows. Roach concludes:

In essence, capital and labor are working very much at cross-purposes in the current climate, whereas back in the late 1980s they were both in the same boat. ... In the late 1980s, many of the once proud icons of corporate America were fighting for competitive survival at the same time that U.S. workers were feeling the heat of global competition. The pain was, in effect, balanced. Today, U.S. companies, as seen through the lens of corporate profitability, are thriving as never before while the American workforce is increasingly isolated in its competitive squeeze.

In the 1980s, just as with China today, many in the United States were pushing Japan to strengthen its currency. How did that work out for Japan? As Will Hutton, China expert and author of the book The Writing on the Wall: Why We Must Embrace China as a Partner or Face It as an Enemy, told me in an interview late last year:

The more than 50 percent rise in the yen in the late 1980s was the single most important cause of Japan's near 15 years of economic stagnation that followed; if the yuan went up by 40 percent suddenly against the dollar, it would have a similarly devastating impact on China. . . . Such a rapid appreciation of the yuan over a short period could be a tipping point for a wave of unrest, which could threaten the regime's stability. The party leadership sees the demand for fast yuan appreciation as an act of economic warfare. In these terms, you can see why.

And would troubles in China affect America? Here is the scenario that Hutton sees:

China's stagnation would trigger a global slowdown, maybe even recession. ... The World Bank estimates that if China's growth rate fell by just 2 percent, up to 60 percent of China's bank loans would become nonperforming–so threatening both China's and, via Hong Kong, Asia's financial system. The flow of saving to finance the U.S.'s deficit would dry up, probably forcing U.S. interest rates up–so worsening the economic slowdown.

A scary scenario, no doubt–and one both Democrats and Republicans should do their best to avoid.

Around the blogosphere. Here is what I am reading:

1) A worrisome take on housing and the economy from Barry Ritholtz at the Big Picture

2) An insightful analysis of the latest trade numbers from Prof. James Hamilton at Econbrowser.

Comments and/or questions can be sent to me at jpethokoukis@usnews.com

TAGS:
Pelosi, Nancy
China
international trade

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