China's Economy and Its Effect on the U.S. Economy

The Surprising Ways China Affects the U.S. Economy

Text reads: "How china affects the U.S. economy: China is the largest foreign holder of the U.S. treasurys, china buys U.S. Debt to support the value of the dollar, China's role as america's largest banker gives it leverage"

Image by Michela Buttignol © The Balance 2019

China's economy produced $25.3 trillion in 2018, according to the International Monetary Fund. That's based on purchasing power parity which takes into account the effect of exchange rates, making it the best method for comparing gross domestic product by country.

It also makes China the world's largest economy. The European Union is second, at $22 trillion. The United States is third, producing $20.5 trillion.

China has 1.38 billion people, more than any other country in the world. China remains a relatively poor country in terms of its standard of living. Its economy produces only $10,870 per person. In comparison, the U.S. gross domestic product per capita is $67,430.

China's low standard of living allows companies there to pay their workers less than what American workers earn. That makes products cheaper, which lures overseas manufacturers to outsource jobs to China. They then ship the finished goods to the United States, China’s largest trading partner.

Components of China's Economy

China built its economic growth on low-cost exports of machinery and equipment. Massive government spending went into state-owned companies to fuel those exports. These state-owned companies are less profitable than private firms and return only 4.9% on assets compared to 13.2% for private companies.

These companies dominate their industries and include the big three energy companies: PetroChina, Sinopec, and China National Offshore Oil Corporation. China developed cities around these factories to attract workers. As a result, one-fourth of China's economy is in real estate. The government also funded construction of railways and other infrastructure to support growth and imported massive amounts of commodities, like aluminum and copper. 

By 2013, the 10% annual growth threatened to become a bubble. That's when China looked toward economic reform.

China spends 9% of GDP on infrastructure. In 2013, it launched its Belt and Road Initiative, one of the largest global infrastructure projects in history. China will spend $150 billion a year to link 68 countries along the old Silk Road with Europe. It will build ports, railways, and pipelines.

China's plan is to make a China-dominated Eurasia an economic rival to the American-dominated transatlantic trading area.

China's president, Xi Jinping, hopes the project will accomplish four objectives:

  1. Provide investments for China's foreign exchange reserves. Most of them are tied up in low-return U.S. Treasurys.
  2. Provide new markets for China's high-speed rail firms, and for cement, steel, and metal exports.
  3. Stabilize countries on China's western border.
  4. Increase China's claims in the South China Sea.

China's Exports

China regained its position as the world's largest exporter in 2017 when it exported $2.15 trillion of its production. The EU briefly took the No. 1 spot in 2016. It now is second, exporting $1.93 trillion. The U.S. is third, exporting $1.57 trillion. 

In 2018, China shipped $479.7 billion worth of goods to the U.S., contributing to a $419 billion trade deficit for the U.S. That accounted for 19.2% of China's exports that year, greater than any other country. Hong Kong was next at $302.9 billion (12.1%), followed by Japan at $147.2 billion (5.9%).

China's Imports

China is the world's second largest importer. In 2017, it imported $1.7 trillion. The United States, the world's largest, imported $2.3 trillion. China imports raw commodities from Latin America and Africa. These include oil and other fuels, metal ores, plastics, and organic chemicals.  It's the world's largest importer of aluminum and copper.

China also is one of the world's largest consumers of commodities: 

China's Share of World Commodity Consumption

Commodity Share of World Consumption
Nickel 56%
Copper 50%
Steel 50%
Aluminum 47%
Cotton 33%
Rice 31%
Gold 27%
Corn 23%
Wheat 17%
Oil 14%

How China Affects the U.S. Economy

China is the second-largest foreign holder of U.S. Treasurys. As of May 2020, it owned $1.08 trillion in Treasurys, around 15% of the public debt held by foreign countries. The U.S. debt to China is lower than the record high of $1.7 trillion held in 2011.

China buys U.S. debt to support the value of the dollar. This is because China pegs its currency, the yuan, to the U.S. dollar. It devalues the currency when needed to keep its export prices competitive.

China's role as America's largest banker gives it leverage. For example, China threatens to sell part of its holdings whenever the United States pressures it to raise the yuan's value.

Phase One Trade Agreement

As two of the world's largest economies, the U.S. and China have been involved in many trade disputes in recent years and historically. In January 2020, the two powers agreed to the Phase One Trade Agreement after several years of an escalating trade war.

In the deal, China agreed to increase imports of U.S. goods by $200 billion annually, and the U.S. agreed to cut tariffs on some goods by half.  The two parties still were negotiating Phase Two of the trade agreement.

Economic Growth Slowing for China

In 2018, China's economic growth rate slowed to 6.5%, continuing several years of declining growth. Its GDP had regularly seen double-digit increases prior to 2011.

Part of the decline was part of a deliberate strategy to head off an economic bubble before it burst. China's economy had been growing at a rate its institutions could not sustain, necessitating a revamped strategy. The government mandated that its banks provide low interest rates in return for protection of the strategic industry. It created business investments in capital goods. It also led to inflation, a real estate asset bubble, growth in public debt, and severe pollution.

Shanghai Cooperation Organization

The Shanghai Cooperation Organization is a central Asian military alliance that combats terrorism and drug trafficking while supporting free trade agreements. Its members share intelligence and combine military operations to counter both terrorism and cyber-terrorism. It is China's version of the North Atlantic Treaty Organization.

Its members are China, Russia, and the countries along their borders, including Kazakhstan, Kyrgyzstan, Tajikistan, Pakistan, India, and Uzbekistan. The group represents almost half of the world's population. Four of its members have nuclear weapons: Russia, China, India, and Pakistan.

Many nations in the SCO possess large reserves of oil and natural gas, giving the organization potential to be a major economic influence in the world, but some analysts see friction among the member states as an obstacle to reaching full potential.

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