Suffering from "influenza" but let others take medicine

Rome was not built in a day.The rectification of the world economic imba-lance has become the core issue at present in the post-crisis era, resulting from various factors over a prolonged period. In the process of re-balancing the world economy, any structural adjustments will have serious impact on the corporate stakeholders in the country, and on the domestic allocation of interests. The vested interest group and corporate stakeholders within the country will naturally resist any adjustments to the existing structure, and this will become a big hindrance to any adjustments within the country.

Against the background of imbalance between China and the US, which is the key component in the current imbalance of the world economy, the US is shirking its responsibility in the re-balancing of the world economy, in order to protect its own interests, and blaming China for its trade imbalance with the US and even the world.

As reported in UK's The Daily Telegraph, US Federal Reserve Board Chairmen Bernanke has pointed his accusing finger at China for taking the risk of "slowing down the velocity of growth in all the countries". Bernanke insisted that allowing currencies such as the RMB to revalue will be tantamount to paying the down payment and deposit for the balancing of global trade and the global current account, and will become the desired result for the long-term stability of the economy and the financial system.

Arguments like these are actually excuses that the US uses for self-defense and for transferring the responsibility of re-balancing the world economy to China. This is like the US suffering from influenza, but insisting that China should take the medicine, and is bound to end in futility. To re-balance effectively, both China and the US need to cooperate in the adjustment. China taking the medicine alone will not cure the US of its "influenza".

Excuse 1: There is serious imbalance in China-US trade

The US has exaggerated the seriousness of the China-US trade imbalance.

First, the US has exaggerated the actual balance in the current account between China and the US.

In traditional statistics for import and export， the current account reflects only the import and export trade and investment return and expenditure of only one country, and does not consider the trade activities of multinational corporations. However, 60% of China's exports were completed by foreign funded enterprises.

It is well known that the actual scenario of China-US trade is this—US enterprises are gradually withdrawing from their domestic manufacturing industry, and moving their production and processing industries to China. Then they will ship their products to the markets in US, the rest of the world as well as China. Large scale US capital operating in China has to a large extent replaced the Chinese need from US export. Here, multinational corporations play an essential role.

Hence we can say that in assessing the imbalance in China-US trade, we tend to miss out this export item. It is inappropriate if we do not take into consideration the activities of multinational corporations that trade between China and the US. In actual fact, there is no consideration of the trade activities of multinational corporations in the calculation of US trade with China, and as a result, the actual imbalance in China-US trade has been exaggerated.

In addition, there are many discrepancies in the statistics of China and US trade in terms of statistical caliber, scope, country of origin, entrepot trade and value added. The US statistical methodology exaggerates the differences in the China-US Current Account. In reality, these statistical discrepancies in the trade balance between China and the US mainly originates from the entrepot trade between these two countries through some economies (such as Hong Kong).

Second, the US has reaped more benefits in the allocation of interests in China-US trade.

So we need to be clear that the trade structure between China and the US is mutually complementary, mutually beneficial and a win-win situation.On the one hand,China is a developing country. While the economy is large in scale, the standard of development is still low. When China exports to the US, it exercises its cost competitiveness, with most of the commodities being labor-intensive products.

On the other hand, the US as a super country enjoys absolute advantage in terms of intangible assets such as capital, technology and branding. As a result, the US enjoys a larger share in the allocation of interests in China-US trade. We can say that there is imbalance in the allocation of interests in China-US trade.

On the one hand,in the global production chain, China mainly engages in low-technology content and less lucrative areas such as processing and assembly. On the other hand, US mainly controls in areas such as research and development, marketing and service.

We can say that US capital firmly commands the rights of control and allocation in the global production chain. In the allocation of interests in China-US trade, US capital enjoys a larger share, and Chinese capital plays a weaker role in participation and interest allocation, and can only take a smaller share.

Hence, although China-US trade is a win-win relationship, yet the allocation of interests in the bilateral trade between the two countries is seriously imba-lanced. The US reaps more benefits in this trade relationship, yet it still claims that it was unfairly treated, exaggerating the seriousness of the imbalance.

Excuse 2:RMB should drastically revalue in order to re-balance the world economy

The logic of "RMB exchange rate has been undervalued→China's exports are low-priced→the China-US trade surplus expands→US production is in the doldrums→US unemployment rate remains high" is widely accepted by the Americans, and has become an excuse to force the RMB to revalue. In addition, the RMB exchange rate has become a political tool in the service of the US.

However, evidences related to China-US trade and trade with other newly emerging economies, as well as Japan-US and Germany-US trade history, have proven that adjusting the currency exchange rate is not a panacea for rectifying trade imbalance.

The huge trade surplus between China and the US is mainly caused by structural factors such as over-spending by the US and over-production by China. We can further assert that it is caused by the international currency system led by the US dollar, rather than by the RMB exchange rate. Indeed, as long as the US dollar remains the core currency in the international currency system, it will be impossible for the US to realize a long-term balance in external trade.

The US's own industrial structure has determined this fact—that a trade surplus will not necessarily boost the employment rate in the US, and a trade deficit will not necessarily reduce employment—the trade deficit of the US will boost employment in the areas of research and development, maritime transport, marketing, and financing. Of course, it is necessary to adjust the development modes in spending and corporate governance for both China and the US, in order to address the frail balance in the world economy resulting from China's over-production and the US's over-spending.

In the process of re-balancing the world economy, we need to be clear that on the one hand, exchange rate is only one of the factors that influence international trade, and not the only factor, and not even a basic factor. Other factors, such as division of labor, comparative advantage, the endowment of factors, difference products and demand overlap, market competitiveness, international transfer of capital, technological innovation and product innovation, as well as the supply and demand relationships among related countries and regions, all exert an influence in the trends in international trade.

When analyzing the imbalance in China-US trade, we must not completely neglect these other factors and exaggerate the factor of exchange rate. Otherwise we will be putting the cart before the horse.

On the other hand, we have mentioned earlier in this book that the imbalance of China-US trade is due to the global transfer of industry, the upgrading of the US industry structure, and the relocating of the production of medium to low grade products (ceased in the US) to China, together with the processing and assembly of products in the global production chain. This is a state of imbalance in international trade. This situation cannot be changed just by drastically appreciating the Renminbi(RMB).

From China's perspective, the imbalance of the world economy is a normal state in the process of globalization, with the US being the major beneficiary. The process of re-balance is a long-term task, and China should shoulder a certain degree of responsibility. We have very good reasons to believe that through adjusting China's economic structure, reforming the pattern of economic growth, and upgrading production, China's trade surplus will be reduced, and this will contribute to the re-balancing of the world economy.

In 2013, China's external trade surplus was US$259.7 billion, US$28.4 billion more than the trade surplus of 2012. Regarding the size of this trade surplus, we must first note that the increase in trade surplus of US$28.4 billion was recorded in the light of China's overall trade growth. In 2013, China's total import and export trade increased nearly US$300 billion compared with 2012. In other words, the surplus of US$28.4 billion was achieved on top of the increase of US$300 billion in total trade. If we compare this surplus of US$259.7 billion with the highest year (2008) of nearly US$300 billion, we can say that there is a decrease in reality. From another perspective, from 2009 to 2012, the ratio of China's trade surplus vs China's total import-export value that year was 8.9%, 6.2%, 4.3% and 5.9% respectively, and the ratio was 6.2% in 2013. Hence we can say that in recent years China's trade surplus has remained stable. China's trade surplus vs the GDP used to reach its highest point at about 6%, but in recent years the ratio has been controlled at about 3%, which is a reasonable level by international standards. From the perspective of the current account, the ba-lance vs the GDP can be regarded as balanced if the positive and negative deviation is within 2%. The range of 2% to 4% is generally considered to be acceptable, and China's figure has been maintained in this region in recent years.

However, this does not seem to be the outcome that the US wants. The US is not interested in long-term results, but hopes to re-balance the world economy through the revaluation of the RMB. The fact is that the domestic economy in the US remains weak, and the real unemployment rate and debts stay high. With the average income of employees unable to rise, US politicians need a scapegoat to free themselves from the political pressure.

The revaluation of the RMB is a double-edged sword to both the US economy and the world economy. The US Government and US politicians know better than anyone else that turning RMB revaluation into a political issue is like "catching fish in murky waters". We can say that if the RMB really appreciates quickly and on a large scale, the result will be a rise in the cost of US imports, and a drop in Chinese exports. This will deal an even heavier blow to the world economy that is already out of balance. The people will then be deprived of the benefits of economic re-balance, and become victims of an empty boost in the economy.

From an analysis of historical data on the experience of Japan and Germany, we can see that the revaluation or devaluation of a currency has limited effect on regulating the income and expenditure of trade. In the 1970s and 1980s, the US exerted pressure on Germany and Japan to drastically revalue their currency, in order to solve unbalanced trade issues. However, in 2008 the US still had a trade deficit against Germany to the tune of US$42.9 billion, and its trade deficit against Japan was even higher—US $72.6 billion. From 2005 to 2008, the RMB appreciated rapidly against the US dollar, and during the same period the trade deficit of the US against China rose at an average annual rate of 21.6%—the fastest increase in history.

In 2009, the exchange rate of the RMB against the US dollar remained stable, and the US trade deficit dropped 16.1%. So it is clear that the RMB exchange rate is not the key factor that caused the US-China trade deficit. The root cause is the imbalance of the US economy itself.

The fast appreciation of the RMB on a large scale will have a negative impact on China, leading to the escalation of the operations and industry structure of the country's macro economy. Let's look at the following simple arithmetic—suppose there is a sum of US$1 million entering China today, and is exchanged into RMB 6.13 million. Suppose RMB 1.13 million is spent on buying a property, while the remaining RMB 5 million is deposited in a bank to generate interest, waiting for the RMB to appreciate to the exchange rate of US$1 to RMB 5. Then the RMB 5 million is exchanged into US$1 million. Now the question is: where does the wealth of this property come from?

On the issue of RMB exchange rate, we cannot simply succumb to the pressure from the US. The reform in the mechanism that determines the RMB exchange rate must be based on the reality and demands of China's own economy. The process must be proactive, gradual, and controllable, and serve the reform of China's economic development and the pattern of economic development. In fact, China has been interfering less and less in its exchange rate, and the RMB exchange rate is very close to being determined by the market.

Excuse 3: China should increase its import of US products

To rectify the state of imbalance in the China-US trade, and to re-balance the world economy, the US proposed that on top of revaluating the RMB, China should step up its consumption and import of US products. But can this really alter the current imbalance in the China-US Current Account? The answer is still uncertain.

In analyzing this issue, we should first consider the trade pattern between China and the US. As a developing country, China said good bye to its era of shortage economy back in the 1990s. If China increases its import of US consumption goods, there will be greater pressure of competition in its consumer market, because this market is already in a state of saturation where supply exceeds demand. This will surely cause the closedown of enterprises that are less competitive, and an increase in unemployment. In turn, the domestic market will shrink, and people's income will drop and so will their spending power. This will further reduce people's demand for imported products from the US.

Meanwhile, the more competitive enterprises will export more of their surplus commodities. At the end of the day, this will not improve the trade imba-lance.

This is on the assumption that US products are competitive in pricing and performance. But in actual fact, in the consumer market, Chinese consumer pro-ducts in general are more competitive than US products. If the increased imports are investment goods, then on the one hand this will aggravate the surplus production capacity of some enterprises, and still lead to some enterprises closing down and unemployment escalating, and ultimately a drop in demand for imports. On the other hand, these increased investment goods will generate new capacity for production and export, thereby increasing the US's trade deficit. Hence forcing China to increase its import of US products and not to pay attention to the structure of trade may not be conducive to achieving trade balance.

On the one hand,one main factor leading to the China-US trade imbalance is the US policy to limit the export of advanced technology and products that are competitive. On the other hand, the low-tech products that can be exported lack competitiveness against similar Chinese products. China's domestic market is already saturated, and has no demand for US products.

The US has reaped huge real benefits from the imbalance of China-US trade. Through the import of high quality products from China, inflation in the US is effectively contained, and the general consumer in the US has enjoyed solid benefits in the form of huge consumer surplus. At the same time, the labor costs for US enterprises have been lowered. Meanwhile, China bought some US debt, as T-bill and corporation bond, using the US dollars gained through the trade surplus with the US, and the US thus gained financial benefits, while what China gained was nothing more than US bonds recorded in electronic codes, and even has to bear the loss in foreign reserves brought about by the depreciation of the US dollar. Under these circumstances, the US does not suffer any real loss. It must be admitted that the US is a beneficiary in the imbalance of the world economy.

Who should bear the cost of global imbalance?

The imbalance of the world economy is in reality an issue related to structure and system, and we cannot expect a fundamental adjustment on a global scale in the short term.

However, if we let it develop and deteriorate, then this will further exacerbate the imbalance and instability in the development of the global economy, and this will have a negative impact on the global economy that is recovering from crisis. Hence the parties in this imbalance, whether they are an advanced economy or a country with a newly emerging market, are all major players in the re-balancing of the world economy, and will bear their own responsibilities in the process of adjustment. If one country just hopes that other countries will adjust and it stays unchanged, there will not be a win-win outcome.

In the face of the imbalance of the world economy, and the economic crisis that is spreading throughout the world, advanced countries have come up with a strategy for the re-balance of the economy, in order to swiftly free themselves from the crisis and revitalize their domestic economies.

The re-balancing strategy for the Western economies is this—the adjustments in the re-balancing of the world economy incur costs, and advanced countries are able to transfer the main parts of these costs to the newly emerging economies through various economic policies and trade policies.

They hope that on the one hand they will reap the benefits in the re-balancing of the world economy, and on the other hand they will not need to suffer the pain in the adjustment and restructure. In this process, it is natural that China is considered to be the main country responsible for the imbalance of the world economy, because China is a large-scale economy, and an export-oriented economy that is developing fast. Also, it has a system and a set of values that differ from advanced countries.

A real strategy for economic re-balancing is not just concerned with the ba-lancing of the current account, or with putting the focus of balancing on the area of trade. Rather, the imbalanced parties should be firmly rooted in their own economic structure, and carry out optimization of the production structure and reform the existing international currency system. Thus, the global economy will regain its vitality under a low inflation rate, and the gap between the rich and the poor in various countries and regions will be narrowed, realizing an all-embracing growth in the world economy.

From a long-term perspective, economic growth can be sustained only when internal balance and external balance are achieved. On the other hand, emphasizing only the need driver of advanced countries, or emphasizing only the supply driver of newly emerging economies will not achieve ideal results. Meanwhile, a policy that tries to "quench thirst by drinking poison" will only exacerbate the imbalance of the world economy, and all related parties will become losers in the game.

In sum, the re-balancing of the world economy should be the direction and goal of all countries. In the process of adjustment, due to the reality that trade surplus occurs in the major countries, there will be a symmetry in the cost benefits. In other words, the countries with trade surpluses will bear more of the adjustment costs. China will bear, and will only bear, the portion of the cost related to its responsibilities, and the US should walk the talk and incorporate the international balance of income and expenditure into its system of objectives in its macro-economic strategy. For instance, while the US is appropriately increasing savings and re-modeling its manufacturing industry, it should also lower its financial deficit, and at the same time step up its export of high-tech products to China. Another example is that the US spending culture characterized by excessive advance consumption has seriously damaged the harmony between man and nature, society, and the future. Hence rational restraints and systematic regulation are necessary. Europe and Japan should implement reforms in their domestic economy and economic structure, increase domestic demands and economic growth rate, advocate technological innovation, and increase their potentials for economic development. On the other hand, newly emerging economies such as China should change their mode of economic growth, upgrade their production structure, and progressively increase the market orientation of the exchange rate.

To solve the problem of global economic imbalance requires cooperation and mutual support among different countries and regions, rather than transferring responsibilities to others. The re-balance of the world economy are the common responsibility of all countries in the world, and the realization of the objective of re-balancing depends on sincere and sustained international cooperation among the major imbalanced countries.

As the special positions of China and the US in the imbalance of the world economy are established, both countries must bear more responsibility and play a bigger role in the adjustment process in the re-balancing of the world economy. As the adjustments in the production structure, concepts of consumption and financial level between China and the US are very complex, coupled with the fact that there will not be any short-term change in the US dollar-driven international currency system, which is the systemic root of the imbalance, the re-balancing of the China-US trade imbalance will be a long, progressive and endless process, with huge adjustment costs to both parties