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The Alleged China Threat

December 15, 2005

It seems that many pundits believe that at any given time, at least one
half of the world's population should be in moderate fear of US bombing
campaigns. Besides North Korea and the entire Middle East, China has of
late been the object of growing hostility.

The tough talk passed a qualitative boundary over Thanksgiving
weekend when analysts on the Fox network shows said that China's
policies are a threat not merely to the US economy, but indeed to our
national security.

In an effort to cool this growing anger and fear towards a billion
foreigners, in this article I analyze some of the most commonly cited
Chinese "attacks" against the United States.

The Trade Deficit

The alleged connection between Chinese economic policies and US security is made explicitly in this typical article.
The author warns that "America's huge deficits are . . . undermining
national security by financing the expansion and modernization of
China's military," and that "the U.S.-China trade imbalance is boosting
the odds of a long, deep downturn in the entire world economy . . ."

The second claim is the easier to explode. There is nothing
intrinsically disturbing about a trade "deficit" or "imbalance" between
any two countries, in the same way that there is nothing shortsighted
in my own practice of consistently buying more goods from McDonald's
than I sell to the restaurant chain. (By the same token, the residents
of the city of Hillsdale are in a huge trade deficit with respect to
me, because Hillsdale College is my employer and that's how I earn most
of my income.)

Americans buy large quantities of the labor-intensive products
manufactured in China, while the Chinese (relatively speaking) buy
little of the capital-intensive products made in the United States. So
what? Right now the United States is running a trade surplus with countries such as Australia, the Netherlands, and Hong Kong.
Is this more evidence of the instability in the global economy? Or, as
I suspect, would the critics of the Chinese trade deficit applaud our
"farsighted" policies when it comes to these other trading partners?

"Ah yes," the critics could retort, "'we' have a trade surplus with
some countries, and deficits with others. But the total deficits
outnumber the surpluses, so that on net, we're buying more from
foreigners than they're buying from us."

Again I ask, so what? The officially reported "trade balance" only
includes the net balance of manufactured goods. It leaves out services
and (what is far more relevant) it neglects the sale of assets.

"What's the connection?" you ask. It is simply this: The overall
balance of payments has to balance. If the Chinese are selling more
products (measured in terms of market value) to Americans than
Americans are selling to them, that means American consumers are
offering more dollars (for yuan) than Chinese consumers want to buy.
For this to be possible, someone else must be willing to supply yuan in order to buy up those excess dollar bills.

Now who else might want US dollar bills, besides people intent on
importing goods made in the United States? Well, some individuals (as
well as foreign governments) might want to literally accumulate
stockpiles of dollar bills. But the far more common purpose is to use
those dollar bills to buy stocks, bonds, or other assets from the
United States. For example, in 2000 the United States had a (goods and
services) trade deficit of $375.7 billion, but it experienced a net inflow of capital of $407.3 billion.[i]

This highlights an inconsistency in the typical attitude towards
international trade: Most people think that trade surpluses (in goods
and services) are good, as well as net capital inflows (i.e., when
foreigners invest more in America than vice versa). Yet the two are
mutually exclusive; if foreigners want to buy more of our assets than
our investors want to buy of theirs, then they must ship us goods and
services to make up for it.

Finally, as far as the claim that our trade deficits are somehow
financing China's military, what can I say? It's not as if the Chinese
government says, "This year let's set military spending equal to
whatever our trade surplus with the US happens to be." If American
consumers bought fewer toys and TVs from China, would that really
thwart the ambitions of their political rulers, or would it simply make
their people poorer and increase international tensions?

Growing U.S. Indebtedness

The knowledgeable critic might respond to the above arguments along
the following lines: "Yes, a deficit on the current account (goods,
services, etc.) goes hand in hand with a surplus on the capital
account. But it's not that Asian investors are sending over venture
capital grants for high-tech American startups. Rather, they are buying
American debt, so that prodigal US consumers can live beyond their means. This situation cannot persist; the present prosperity is illusory."

This claim is true as far as it goes; when foreigners lend money to
American individuals or corporations (by buying bonds, for example),
that is a capital inflow whether or not the money is then used to
finance new investment or simple consumption.

Yet why are the Chinese the villains in this scenario? A few years
ago my wife and I (newly married) needed a car and so we got a loan
from a bank. We certainly consumed more that year than our joint
incomes would have allowed, and because of our monthly car payments we
now consume less every month than our joint income would allow. Is the
bank somehow malicious? Or did it rather allow us to enjoy a different
consumption path than our income stream alone would have permitted?

By the same token, if American consumers want to import foreign
goods in exchange for portions of their future income, why look
suspiciously at the foreigners who cater to these preferences? If the
critic is merely lecturing the profligate US consumer and urging more
responsible spending, that's one thing; I also think Americans should
be urged to swear less, give up smoking, spend more time with their
kids, etc. But if the critic thinks the US or Chinese governments should use their coercive powers to force Americans to change their ways, then I strongly object that it is none of his business.

"Fair Trade"

Many people deride free trade and instead champion what they call
"fair trade." To the extent that this is a voluntary plea for consumers
to refrain from purchasing the products of slave labor, I have no
problem with the movement. But often the proponents of "fair trade"
want to use the US government to penalize imports made by foreigners
earning low wages or by companies receiving subsidies from their
governments. Both accusations have been leveled against Chinese imports
that allegedly are "unfair" to their American counterparts.

It is true that the average Chinese worker earns a lower hourly wage
than the average American worker. Our workers (in general) enjoy better
training, as well as the use of more capital and superior legal
institutions. American laborers are hence more productive, and that's
why they get paid more. It is also true that in certain industries,
American firms can't stay competitive with Chinese imports if they have
to pay wages attractive to US workers. Yet that is exactly what should happen when two countries trade with each other; relative prices and wages channel the workers in each country into those industries in which they have a comparative advantage. If cheap Chinese imports didn't
put some US manufacturers out of business, then what would be the point
of trading with China in the first place? You trade with others so you
don't have to make everything yourself.

Regarding foreign governments' subsidies to their manufacturers, we must never forget that receiving gifts doesn't make one poorer.
Even in the "worst case" scenario, where the Chinese government (say)
completely subsidizes its TV exporters in order to ship US consumers
free plasma screens, this would be a boon to the American economy. Yes,
it would put US television producers out of business, but it would
allow US consumers to get TVs for free. After American workers had
reshuffled in response to the free goods, per capita US income would be
higher; instead of using scarce resources to produce television sets,
we would now be showered with them for free and could use the freed up
resources to produce additional goods and services. If, instead of free
imports, American consumers receive merely cheap imports, the
principle is the same: Foreign governments taking money from their own
people and giving it to American consumers doesn't make us poorer.

Undervalued Yuan

Another oft-cited Chinese crime is its intentional undervaluation of
its currency vis-à-vis the US dollar. Many have urged President Bush to
get tough with the Chinese on this point, and indeed two senators have proposed slapping a 27.5 percent tariff on Chinese goods until they allow the yuan to float against the dollar.

The principles here are the same as with subsidies to foreign
exporters; the Chinese government is once again making its own people
poorer in order to benefit privileged Chinese firms (and US consumers
of their products). However, in this case the Chinese government
doesn't use its yuan to allow the special firms to sell below cost.
Rather, the Chinese government enters the currency markets and buys
dollars (with yuan) in order to artificially prop up the dollar's
value. (In other words, if the Chinese government stopped buying so
many US dollars with yuan, then the demand for dollars would fall and
the yuan price of the dollar would fall — the dollar would depreciate
against the yuan.)

The point of these machinations is to stimulate Chinese exports. By
holding the dollar artificially high against the yuan, Chinese goods
(priced in yuan) are artificially cheap to US consumers, and hence they
are more likely to buy goods from Chinese firms rather than from
domestic competitors. As with subsidies, this policy of the Chinese
government represents a simple gift to US consumers. Yes, it hurts the
business of particular US producers, but not the economy as a whole; the benefits to consumers outweigh the losses to producers.

Some of those concerned about China understand the above, but they
worry about the reckoning when the Chinese government decides to stop
buying up so many US dollar bills. At that point, exchange rates would
reflect the underlying fundamentals, and American consumers could no
longer obtain Chinese imports as cheaply. Yet what's the problem? Isn't
this exactly what the critics want to happen? In other words,
isn't it strange that the supposed danger of these insidious Chinese
practices is that they may someday discontinue them?
(Incidentally, if it's merely the sudden shifts that worry people, we
can rely on currency and other speculators to forecast the changes in
policy as well as is humanly possible. After all, that's how
speculators make their money.)

Think like an Austrian: $350

Movie Piracy

Yet another complaint concerns "piracy" or "counterfeiting" of movies and other "intellectual property."
At this point we have hit the absurd. People can legitimately argue
about the merits of intellectual property rights, but the notion that
our national security is at stake because of bootlegged DVDs is
ridiculous.

Conclusion

In this article I have tried to demonstrate that the typical
complaints against China's economic policies are unfounded. No doubt
there are a dozen other plots hatched by the Chinese Communists to
infiltrate the American economy that I have not addressed. Let me end
simply by asking the concerned reader, do you think our free enterprise
system works or not? After all, if you really do believe that blind
faith in market forces will be trumped by crafty foreign politicians
who intervene in their own economies, then shouldn't you welcome our
domination by self-proclaimed communists?


Robert P. Murphy teaches economics at Hillsdale College. He prepared the Home Study Course in Austrian Economics, which is available for $350. Send him MAIL. Comments can be made on the blog.

[i] This data from Gwartney et al., Economics: private and public choice, p. 430. Their cited source is http://www.bea.doc.gov.
I should also point out that there is no reason for the trade deficit
and capital inflow to exactly cancel out for any given country; these
tendencies only hold in the aggregate. For example, it's possible for
the US to have both a current account deficit and a capital account
deficit with China, but it's not possible for the US to be running
trade deficits and net capital outflows with all other countries put
together.


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