For some time now, the US-China trade relationship has been capturing the attention not just of the United States financial media and political classes, but also of mainstream media. The degree to which even ordinary Americans, famously uninterested in events beyond their shores, appear transfixed and threatened by China's transformation is reminiscent of the popular obsession with Japan in the late 1980s and early 1990s. As then, it is probably symptomatic of some deeper malaise. And once again, many opinion shapers and policy makers seem to be simultaneously overestimating, underestimating, and needlessly antagonizing a key trading partner. Overestimation first.
First, there is the overestimation of the size and purchasing power of China's middle class. This is a long-standing misperception. The fact is that China's fast-growing middle class is still very small, and as yet not strictly comparable to what we consider middle class in the West in terms of purchasing power. There is no denying that this middle class represents an opportunity for Western businesses, but it is an opportunity that requires much patience. China's regionally imbalanced development has not really reached much of the interior, and until it does, the risks of over-investment and overcapacity may outweigh any immediate market opportunity for many Western companies.
Then there is the overestimation of the perceived threat of Chinese companies as acquirers of US assets. Here one finds parallels with the exaggerated concerns of the era of "Japan bashing" when the US seemed to be in terminal decline and Japanese companies were snapping up trophy properties at inflated prices. The analogy, however, is useful only to the degree that it reveals a certain xenophobia residing in the American popular imagination.
With the Chinese suitors (Lenovo, Haier, CNOOC), as before, the threat to US competitiveness has been greatly overblown. In fact, far from being a victim, IBM was only too happy to unload its money-losing commodity PC unit on Lenovo. Maytag, at one point the object of Haier's affections, has been in decline for years, and no one could argue that America's long-term manufacturing competitiveness was fundamentally at stake in either of these cases.
CNOOC's abortive bid for Unocal was vastly more complicated. The Chinese oil giant's bid, greeted with skepticism on Wall Street and more than a little alarm in Congress, seemed from the very beginning unlikely to come to fruition. A post-mortem would have to start with the CNOOC board's initial rejection of the proposal in the Spring. This left an opening for Chevron, and by the time CNOOC's board had bought into the proposed acquisition, the US Congress was anything but receptive. The final obstacle was an amendment attached to the recently passed energy bill calling for additional regulatory scrutiny of both the economic and putative security implications of the proposed acquisition. This was a transparently political move designed to block the deal by increasing regulatory uncertainty. In fact, even apart from that obstacle, any such deal would likely have been referred to the Committee on Foreign Investments in the United States, a multi-agency panel charged with examining the national security implications of certain foreign acquisitions. The CFIUS typically scrutinizes deals involving sensitive military or dual-use technologies, though interestingly, Lenovo's acquisition of IBM's laptop business had to pass muster with this panel. That Congress saw fit to insert itself into this process by adding yet another layer of regulatory oversight is an indication of how politicized trade relations have become.
The fundamental question is: was it really necessary to politicize the bid to such a degree? I think not. Didn't Unocal's share-holders deserve the benefit of an open and competitive bidding process, one that was not subject to political meddling? Furthermore, is it not the case that oil is the perfect example of a fungible commodity? Any incremental supply that China gains from acquisitions will be oil it doesn't have to buy on the open market. The net effect on oil prices will be negligible. Moreover, Unocal is a minor, not a major oil company, and in the event the deal had been consummated, CNOOC had vowed to keep US product in the US. It may have been ready to divest US operations. With respect to the key Southeast Asian gas assets, any acquirer will be saddled with a host of long-term supply agreements between Unocal and customers like Japan, South Korea, and Thailand. Finally and most damagingly, one consequence of this fiasco may well be that in some quarters the US is perceived as practicing free trade very selectively, if not honoring it in the breach.
Perhaps the most egregiously hyped overestimation, however, is the notion that the yuan revaluation will be a solution to the US-China bilateral trade imbalance. Trade hawks and protectionists in the Administration and Congress have presented yuan appreciation as a solution to much that ails the US, from loss of manufacturing jobs to the trade imbalance itself. But as Alan Greenspan pointed out in his June testimony before Congress, a yuan revaluation will have virtually no impact on the trade deficit, nor will it contribute to job creation or the health of domestic manufacturing; at most – and this would have to involve a much larger appreciation than seen thus far – it will merely shift imports sourced from China to other low-cost locales and harm US consumers to the extent that import prices rose.
In the run-up to the recent 2.1% revaluation, Greenspan and Treasury Secretary Snow both warned Congress against slapping punitive tariffs on China. Neither official lent any credence to the notion that yuan revaluation is a panacea for the US trade imbalance, for sluggish job creation, or for the long-term structural decline of US manufacturing. Nevertheless, Snow did agree that the yuan-dollar peg had a distorting effect on global trading patterns, and Greenspan further argued that a more flexible yuan would be in China's own best interests in that it would likely ease inflationary pressures building in the Chinese economy. This line of reasoning, and private diplomacy, rather than the hectoring of Congressional China critics, appears to have facilitated the transition to a more flexible currency. Still, while a currency regime that is more responsive to the market and less a matter of administrative intervention is part of the solution to global imbalances, it is far from the whole solution. But that view doesn't provide much mileage for politicians intent on demagoguing the issue.
China having taken the first "baby steps" towards adjustment (in the words of trade hawk Senator Charles Schumer of NY), some of the congressional ire has been at least temporarily deflected; much now depends on further incremental appreciation, regarding which the Chinese monetary authorities are sending decidedly mixed signals. In the meantime, advocates of a more drastic revaluation should recall how grateful the world was when China did not devalue its currency at the height of the Asian financial crisis, helping to stabilize regional economies. That decision sent the clear signal that China was intent on being perceived as acting as a responsible participant in the global trading system. Now, as China is increasingly integrated into that system, is not the time for xenophobic alarmism and protectionism.
Michael Smolker is with the University of Washington. He has been observing and studying China since the Nixon Administration.
