Why the U.S.-China Trade Spat Won't Escalate
Both sides have been down this road before and this latest dispute may well resemble a choreographed pas de deux. "The U.S. is not accusing China of doing anything wrong, and China has a track record of responding rationally according to the [World Trade Organization] process," said Andy Rothman, CLSA China economist, on the sidelines of its annual investor forum that kicked off in Shanghai on Sept. 14. "I don't think this is going to set off a trade war."
That's good news, especially as the world economy remains in a parlous state. China appears to be on track to achieve its 8% growth target for gross domestic product this year thanks to huge government spending on investment. But the holy grail for the Chinese government—to rebalance China's growth away from exports toward stronger consumer spending—appears as elusive as ever.
The Consumption Difference The ability of Chinese consumers to take up the slack created by the fall in U.S. consumer spending is limited indeed. Americans spent about $10 trillion last year, compared with $1.4 trillion by Chinese, and consumption in the U.S. accounts for about 70% of GDP compared with about one-third in China, according to Morgan Stanley (MS). And although spending on automobiles and new housing has recovered faster this year than expected, it will have limited impact on imports as much of what China buys from its neighbors are components assembled and re-exported.
Before the news of the latest tariff move by the U.S. broke, an overriding theme at the so-called Summer Davos, the World Economic Forum held in the northeastern Chinese city of Dalian on Sept. 9-12, was the importance of getting Chinese consumers to open their wallets, but Chinese and foreign delegates alike acknowledged that will be no simple task. "This [financial crisis] is China's wake-up call to recognize that the model that's worked so brilliantly for the past 30 years, especially the past 15 years— the export driven model—needs to give way to one that gives way to internal private consumption," says Stephen Roach, chairman of Morgan Stanley Asia.
According to Roach, the accumulation of huge trade surpluses driven by excessive dependence on the U.S. consumer is an unsustainable growth model. Getting China's notoriously heavy savers to change their ways won't happen until Beijing increases spending on health, unemployment, and retirement benefits. "The lack of a social security net is the missing link in China's macro equation," he says.
Currency Concerns Beefed-up consumer spending in China could also slow its accumulation of reserves, which now top $2 trillion. As the largest single holder of U.S. Treasuries, with a $700 billion hoard, China stands to lose billions if the U.S. dollar continues to weaken against the Chinese yuan. In March, Chinese Premier Wen Jiabao expressed concern over the U.S. ability to guarantee the safety of China's holding of treasuries.
Despite the slowdown in exports this year, China continues to accumulate hundreds of billions through its trade surplus. "If China buys more now, it will have less of a headache in investing its reserves," says David Dollar, the U.S. Treasury Dept.'s economic and financial emissary to China who advocated China diversifying its holdings into gold and other financial assets.
Still, the greatest challenge is how to change Chinese savings habits. "This involves changes in tradition and culture. The Chinese will still be thrifty and not like Americans who buy 20 T-shirts a year," Zhao Qizheng, a member of China's powerful Communist Party Central Committee, told the audience. "It will take at least 10 years to increase consumption."