Why America's Trade Deficit With China Is So High

The Real Reason American Jobs Are Going to China

U.S. China Trade
The U.S. trade deficit with China is the largest in the world. Illustration: Lee Woodgate/Getty Images

The U.S. trade deficit with China was $347 billion in 2016. The trade deficit exists because U.S. exports to China were only $116 billion while imports from China were $463 billion. 

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:

  1. A lower standard of living, which allows companies in China to pay lower wages to workers.
  2. 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.

How China's Standard of Living Is Measured

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 2016, China’s GDP per capita was $15,400.

 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.

How China Manages Its Currency

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 August 2017, the U.S. debt to China was $1.2 trillion. That's 30 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.

(Source: "Employees by Industry," Bureau of Labor Statistics.)

What's Being Done

President Donald Trump promised to lower the trade deficit with China. He threatens to impose duties on Chinese imports. He wants China to do more to raise its currency. He claims that China artificially undervalues it 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 dollar has strengthened by 25 percent since 2014. It's taken the Chinese yuan with it. China must 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 indicates that the yuan is overvalued. If the yuan were undervalued, as Trump claims, it would have risen instead. 

How the U.S. Trade Deficit With China Is Part of the Balance of Payments

The Balance of Payments

  1. Current Account
  2. Capital Account
  3. Financial Account