U.S. Trade Deficit With China and Why It's So High
The Real Reason American Jobs Are Going to China
The United States imports consumer electronics, clothing and machinery from China. A lot of the imports are from U.S. manufacturers that send raw materials to China for low-cost assembly. Once shipped back to the United States, they are considered imports.
Causes of the Trade Deficit
China can produce many consumer goods for lower costs than other countries can. Americans of course want these goods for the lowest prices. How does China keep prices so low? Most economists agree that China's competitive pricing is a result of two factors:
- A lower standard of living, which allows companies in China to pay lower wages to workers.
- An exchange rate that is partially fixed to the dollar.
That means many American companies can't compete with China's low costs. As a result, U.S. manufacturing jobs are lost. From time to time, legislators try to impose tariffs or other forms of trade protectionism against China to bring jobs back.
If the United States implemented trade protectionism, U.S. consumers would have to pay high prices for their "Made in America" goods. That's why it's unlikely that the trade deficit will change. Most people would rather pay as little as possible for computers, electronics and clothing, even if it means other Americans lose their jobs.
China is the world's largest economy. It also has the world's biggest population. That means it must divide its production between almost 1.4 billion residents. A common way to measure standard of living is gross domestic product per capita. In 2017, China’s GDP per capita was $16,600. China's leaders are desperately trying to get the economy to grow faster to raise the country’s living standards.
They remember Mao's Cultural Revolution all too well. They know that the Chinese people won't accept a lower standard of living forever.
China sets the value of its currency, the yuan, to equal the value of a basket of currencies that includes the dollar. In other words, China pegs its currency to the dollar using a modified fixed exchange rate. When the dollar loses value, China buys dollars through U.S. Treasurys to support it. In 2016, China began relaxing its peg. It wants market forces to have a greater impact on the yuan's value. As a result, the dollar to yuan conversion has been more volatile since then. China's influence on the dollar remains substantial.
How It Affects the U.S. Economy
China must buy so many U.S. Treasury notes that it is the largest lender to the U.S. government. Japan is the second largest. As of February 2018, the U.S. debt to China was $1.18 trillion. That's 19 percent of the total public debt owned by foreign countries. Many are concerned that this gives China political leverage over U.S. fiscal policy. They worry about what would happen if it threatened to call in its loan.
By buying Treasurys, China helped keep U.S. interest rates low. That helped fuel the U.S.
housing boom, which lead to the subprime mortgage crisis. If China were to stop buying Treasurys, interest rates would rise. That could throw the United States and the world into recession. But this wouldn’t be in China's best interests, as U.S. shoppers would buy fewer Chinese exports. In fact, China is buying almost as many Treasurys as ever.
U.S. companies that can't compete with cheap Chinese goods must either lower their costs or go out of business. Many businesses reduce their costs by outsourcing jobs to China or India, which adds to U.S. unemployment. Other industries have just dried up. U.S. manufacturing, as measured by the number of jobs, declined 34 percent between 1998 and 2010. As these industries declined, so has U.S. competitiveness in the global marketplace.
What's Being Done
President Donald Trump promised to lower the trade deficit with China.
On March 1, 2018, he announced he would impose a 25 percent tariff on steel imports and a 10 percent tariff on aluminum. The tariff will raise the costs of imported steel, which are primarily from China. Its economy depends heavily on steel exports. Trump's move comes a month after he imposed tariffs and quotas on imported solar panels and washing machines. China has become a global leader in solar panel production. The stock market fell, as analysts worried Trump's actions might start a trade war.
The Trump administration is developing further anti-China protectionist measures. It may impose tariffs on $30 billion of Chinese imports. It wants China to remove requirements that U.S. companies transfer technology to Chinese firms. China requires companies to do this to gain access to China's market.
Trump also asked China to do more to raise its currency. He claims that China artificially undervalues the yuan by 15 percent to 40 percent. That was true in 2000. But former Treasury Secretary Hank Paulson initiated the U.S.-China Strategic Economic Dialogue in 2006. He convinced the People's Bank of China to strengthen the yuan's value against the dollar. It increased 2-3 percent annually between 2000 and 2013. U.S. Treasury Secretary Jack Lew continued the dialogue during the Obama administration. The Trump administration continued the talks until they stalled in July 2017.
The dollar strengthened 25 percent in 2014 and 2015. It took the Chinese yuan with it. China had to lower costs even more to compete with Southeast Asian companies. That's why the PBOC tried unpegging the yuan from the dollar in 2015. The yuan immediately plummeted. That indicated that the yuan was overvalued. If the yuan were undervalued, as Trump claims, it would have risen instead.
How the U.S. Trade Deficit With China Fits Into the Balance of Payments
- Current Account
- Capital Account
- Financial Account