Trade Deficit With China Is Misleading

“The world is not the way they tell you it is,” was a line used once to describe rambunctious financial markets in the 1960s. That thought is even more applicable today to almost anything you hear about China’s economy.

A crisis is brewing in U.S.-China relations, owing to an apparently yawning U.S. trade deficit with China. Last year, the U.S. imported $162 billion more from its trading partner than China imported from the U.S. And this year, as Chinese apparel and textile exports flood world markets, the trade imbalance is on track to top $200 billion.

In response, the Senate this month informally approved a measure that would slap 27.5% tariffs on all goods from China if that country doesn’t revalue its currency, the yuan, in the next six months. The Senate plans a formal vote on the proposal later this year. And President Bush said last week that he supported “pressing China for floating her currency.”

China meanwhile has publicly snubbed Washington’s overtures about the value of its currency. Pegging the yuan at 8.3 to $1 since 1995 has helped China maintain low prices for its growing exports of merchandise to Wal-Mart Stores Inc., Target Corp., Home Depot Inc. and Lowe’s Cos.

The argument popular in Washington says China must unpeg the yuan and let its value rise so U.S. companies can again compete to get their goods into Wal-Mart and Target.

But this is a fiction.

The trade deficit is a misleading statistic.

The merchandise trade figures do not take account of how products are made in today’s global economy. Companies in “our industry here in Southern California do the designs, the patterns and colors and sizing and specs for all the garments made elsewhere,” says Ilse Metchek, executive director of the California Fashion Assn., a Los Angeles-based apparel trade group.

The patterns and instructions are sent over the Internet to factories in China, where the garments are made. They are then shipped back through the ports of Los Angeles and Long Beach and on to stores. Although the patterns that go out over the Internet don’t count as “exports,” the garments that come back in through the ports count as “imports.”

Thus, the trade “deficit” is said to widen.

The pattern is the same in toys. Jordan Kort’s Northridge-based What Kids Want Inc. designs toys under license from Walt Disney Co. and the Nickelodeon division of Viacom Inc. Princess dolls and other toys are manufactured in China, but the lion’s share of the proceeds from making and selling the toys go to Kort’s firm, the retailers and Disney and Viacom. Indeed economists estimate that the Chinese manufacturers earn only 20% of the value of the goods they make for export.

Meanwhile, major U.S. companies are thriving in China.

Most world-class products in China are made by affiliates of U.S. and other foreign companies. Motorola Inc. makes a lot of the country’s cellphones, General Motors Corp. makes cars, Caterpillar Inc. makes bulldozers.

The numbers add up. Affiliates of U.S. companies enjoyed more than $75 billion in sales in China last year and recorded $3.5 billion in profits. None of those sales and earnings by affiliates figure in the export-import statistics.

Nor do official statistics really capture the growing inter-relationships of U.S. and Chinese institutions. USC’s Marshall School of Business, for example, runs an executive program in Shanghai in partnership with Jiao Tang University in that city. In its first year, the program has attracted 45 MBA candidates from many countries. At UCLA, John Long, head of the real estate investment firm Highridge Partners is backing a new center for the study of China-U.S. business.

So if relations are so good and the “trade” issue is overstated, what’s the problem?

The real trouble is not the growth of the Chinese economy but the slowing of that growth. The U.S. economy also is slowing, as the latest reports on retail sales and wage growth attest. But slow growth is far more serious in China.

Infrastructure is failing in China. Factories are operating three to four days a week because they lack electricity to stay open full time. Electrical power is insufficient because railroads can’t carry the coal to the power plants fast enough and there aren’t enough power plants to begin with.

That’s ominous. The Chinese government wants to keep annual growth at 8% of the $1.3-trillion gross domestic product so 20 million jobs a year can be created. The government fears unemployment because it can add to political unrest, already evident in frequent public demonstrations in the poorer, western regions of China.

The dilemma for the Beijing government is that raising the value of the yuan would curb exports and reduce employment further. Yet the foreign reserves that China is taking in from trade and investment by international companies and from speculators betting on Shanghai real estate are distorting the economy in other ways.

So China will take some action in the next year, most likely allowing the yuan to fluctuate moderately against the dollar, predicts Arthur Kroeber, editor of the Hong Kong-based China Economic Quarterly.

But another expert, Morris Goldstein of Washington’s Institute for International Economics, believes that moderation won’t work. China will have to revalue its currency strongly -- by at least 15% -- said Goldstein, formerly an official of the International Monetary Fund. “I don’t say it will be easy,” he said, “but it is necessary.”

What would be the result of such a revaluation? It would make only a slight difference in the prices of Chinese exports, but the stronger currency would be likely to spur Chinese investment in U.S. industry. Already Chinese companies are seeking joint ventures and investments in U.S. firms, says John Zhang, a Los Angeles partner of the international law firm Greenberg Traurig.

Chinese firms are investors in U.S. manufacturers of auto parts, golf clubs and other such products. The Chinese also are making strides in cellphone technology and some aspects of biotech and so will be eager to invest and learn from U.S. companies in those fields. And that is not a long-term forecast.

In June, Donald Tang, managing director of Bear Stearns and head of the Asia Society in Los Angeles, will bring a delegation of government officials and the heads of six to 10 Chinese companies here for a conference. In the fall, Gov. Schwarzenegger will lead a California delegation to China.

The bottom line: In calling for currency revaluation, Washington is wishing really for a stronger trading partner.

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James Flanigan can be reached at jim.flanigan@latimes.com.