This morning, the New York Times reported that China is now actively lecturing the United States for its lack of “market regulation” in the mortgage crisis and for its failure to “halt the dollar’s unchecked depreciation” that has caused “soaring oil and food prices.”

This constructive criticism offers a rather fun way to start the fourth round of the Strategic Economic Dialogue (SED), which is taking place today and tomorrow in Annapolis. 

There’s rich irony in the Chinese lecturing the U.S.  As AAM Director Scott Paul pointed out on CNBC yesterday, the Chinese continue to brazenly flout world trade law, no matter how great the resulting distortions of the international market.

  With that said, ManufactureThis thought it might be fun to offer a brief preview of this week’s SED talks.  Specifically, Treasury Secretary Henry Paulson said the meetings would focus on five areas.  Below are those five sections, with a helpful reminder about why these issues actually matter to the world community:

“Managing financial and macroeconomic cycles.”
China utilizes numerous questionable subsidies to artificially boost production, including $27 billion in energy subsidies since 2000 for its steel producers.  If Secretary Paulson and his Chinese counterparts want to equitably manage “macroeconomic cycles,” they would start by ensuring that China does not continue to dump steel on the world market.  

“Developing human capital.”
China’s human rights abuses are notorious, as are the woefully inadequate labor conditions in many factories, including slave labor.  Rather than token efforts, Beijing must stop bashing heads in Tibet and begin to reform the institutionalized child labor (and other unacceptable practices) so rampant throughout its rural provinces.

“The benefits of trade and open markets.”
Despite a minor appreciation of the Yuan since 2005, Beijing continues to undervalue its currency by as much as 40%.  Such massive intervention in world currency markets is clearly one-sided—the exact opposite of a free, open trade.  With the EU and Japan joining U.S. calls for a significant rise in the Yuan, Beijing must commit to lifting its currency peg, or else face sanctions.

“Enhancing investment.”
China has been reluctant to open its market to foreign financial services, and has only approved one foreign securities joint venture—for Credit Suisse.  It’s hard to call this enhanced investment equitable.  Unless U.S. financial firms are given greater access to China’s market, sanctions must again be considered.

“Advancing joint opportunities for cooperation in energy and the environment.”
While the Environmental Protection Agency estimates that 25% of all California air pollution comes from China, the U.S. is considering sweeping measures to cut greenhouse emissions.  If Beijing honestly shares in such concerns it will demonstrate movement to share in such efforts.

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  Sen. Obama travels to Michigan this week to begin laying out his plans for reviving the U.S. economy.  Michigan has been among the states hardest hit in the recent downturn, with unemployment reaching 7.4% and one in eight Michigan residents now receiving food stamps.

As the general campaign gets underway, Obama’s Michigan trip may prove particularly well planned.  Earlier this year, John McCain made a spectacular campaign gaffe when he said of Michigan manufacturing “there are some jobs that aren’t coming back.”  It was widely suggested that Mitt Romney’s subsequent success in Michigan was attributed to his contrasting promise to “fight for every job.” 

Because Obama has been critical of U.S. trade policy with China, his new proposals may resonate clearly with struggling Michigan factory workers.  While McCain is focusing on greater tax cuts, Obama has vowed to crack down on Beijing’s currency manipulation and other subsidies.  It’s a message that may prove quite welcome in a state that has lost nearly 300,000 manufacturing jobs since 2000.

  Ironically, Treasury Secretary Henry Paulson heads to Annapolis tomorrow to lead the latest round of U.S-China Strategic Economic Dialogue (SED) talks.  Because the U.S. trade deficit with China hit an all-time record of $256 billion in 2007, negotiations with Beijing should take the highest priority.  Unfortunately, ManufactureThis predicts nothing little more than “chit-chat” diplomacy during the two day’s of meetings. AAM’s Scott Paul appeared on CNBC this afternoon to discuss the talks, which he sees as offering little real progress on China’s continued violation of U.S. and world trade rules.

The SED will be relevant, though, for the fall presidential election, though.  Both Obama and McCain have expressed divergent views on how to approach U.S.-China trade and it will be left to one of them to hold Beijing accountable for continued trade violations.  Which leads back to Michigan—until Congress and a new administration strongly enforce U.S. trade law, states like Michigan will continue to see good-paying manufacturing jobs evaporate.

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ManufactureThis notes the untimely passing of ‘Meet the Press’ moderator Tim Russert and sends profound condolences to his family.  Mr. Russert holds our fullest respect.  His blue-collar Buffalo, New York perspective on issues will be sorely missed.

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  Typically in recent years, companies have moved manufacturing operations overseas in an effort to reduce production costs.  Cheap labor, weak environmental standards, and a host of questionable subsidies have all combined to make production in countries like China seem attractive to the bottom line.

According to a piece by the Wall Street Journal’s Tim Aeppel, however, soaring oil prices are threatening to rebalance that equation.  Aeppel cites CIBC analyst Jeff Rubin, who notes that “the cost of shipping a standard, 40-foot container from Asia to the East Coast has already tripled since 2000 and will double again as oil prices head toward $200 a barrel.”  These rising transportation costs “are now the equivalent of a 9% tariff on goods coming into U.S. ports, compared with the equivalent of only 3% when oil was selling for $20 a barrel in 2000.”

Aeppel says that, for many U.S. manufacturers, “oil prices that have hurtled past $130 a barrel have been the tipping point.”  Such heavy shipping costs mean domestic manufacturers are scrambling to source production closer to home.  One example is Emerson, the St. Louis-based maker of electrical equipment, which recently shifted some production from Asia to Mexico and the U.S., all in an effort to “offset rising transportation costs by being closer to customers in North America.”

Though rising oil prices may help to somewhat recalibrate trade flows, it’s not certain that U.S. manufacturing workers will reap the rewards.  With Emerson as but one example, CIBC’s Rubin suggests that Mexico cold be “the biggest winner of all.”  While increased transportation costs may dissuade producers from large-scale Chinese imports, Mexico could take up the slack and become the preferred low-wage, environmentally lenient export platform.

But don’t cry for China just yet.  They’re still running a $20 billion monthly trade surplus with the U.S.
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The Wall Street Journal’s Asia edition featured an interesting editorial today from Peterson Institute fellow Daniel Rosen.  In nutshell, Rosen suggested that China may finally need to revalue its currency, the Yuan, simply because pegging it to the dollar has become too expensive.

Why might this be?

  An undervalued Yuan has made Chinese exports particularly cheap for U.S. consumers.  However, the dollar has been in freefall of late, taking the Yuan with it.  And so, a falling Yuan has made goods more and more expensive for Chinese importers.

Essentially, you get what you pay for.  Or, conversely, you can’t get what you don’t pay for.  As Rosen noted, “many [Chinese] importers are suffering from soaring commodity prices,” but more significantly, oil prices are hammering them, too.

Rosen points out that if China had not slightly budged its currency from a pre-July 2005 rate of 8.27 to the dollar, the cost of imported oil in the first four months of 2008 alone would have been an additional $7 billion dollars.  Looked at another way, the more the Yuan moves away from the dollar, the more money China could save on oil imports.

While Chinese exporters have benefited from a cheap Yuan, it’s possible that the rising toll on importers may soon override all other concerns.  At that point, Beijing could be forced to abandon its currency peg in order to afford the now frighteningly expensive barrels of oil.

It remains to be seen if such concerns will affect China’s thinking when it sits down for bilateral talks in Annapolis next week.  But it’s an interesting scenario.
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  As the latest Strategic Economic Dialogue (SED) approaches next week, China complained in Geneva on Monday that the United States has recently let the dollar depreciate, upsetting the global economy with higher oil prices.

Ironically, the United States functions as an open, free-market economy.  The dollar’s decline has come because nervous investors, eyeing ever grater U.S. trade deficits, have lost confidence in the sharpness of U.S. assets.  Thus, the “invisible hand” of the market is moving the dollar to a lower point.  Despite Beijing’s assertions, the U.S. government has not specifically maneuvered the dollar’s fall.

However, China’s currency, the Yuan has been specifically manipulated in recent years.  Since 1994, Beijing has deliberately undervalued their currency in order to promote exports.  Thus the irony of China lecturing the U.S. for higher oil prices due to a weakened dollar.

Funny that China is expressing concern over rising gas prices.  While U.S. manufacturers are undoubtedly feeling the pinch, Chinese manufacturers are enjoying a comparatively easier ride.  That’s because they receive huge government energy subsidies that lower the costs of production.

Take Chinese steel as but one example.  A recent study commissioned by AAM found that since 2000, the Chinese government has exponentially boosted the country’s steel output by providing more than $27.11 billion in subsidies for thermal and coking coal, electricity, and natural gas.  In that time, China has moved from a net steel importer to the world’s largest steel exporter.

It remains to be seen what the WTO thinks of these subsidies.  But with a Chinese delegation coming to the U.S. next week to hector the Administration about falling currency and rising oil, one can’t help but shake their head at Beijing’s gall.  Treasury Secretary Paulson should point a stern finger at China and simply ask them to explain their energy subsidies.  China’s concerns seem a bit hypocritical by comparison.

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As AAM Executive Director Scott Paul noted this morning, the monthly U.S. trade deficit reached $60.9 billion in April 2008, the highest level in 13 months.  In a brief statement he said:

  “As the trade deficit rises, manufacturing jobs continue to decline.  We hope this will serve as a wake up call for Congress and the Administration to stop unfair foreign trade practices like currency manipulation, dumping and subsidies, and reform our trade policies to ensure that we are shipping more products—and not jobs—overseas.  Senators Obama and McCain should make reducing the trade deficit and reforming our trade policies a priority in 2009.  This is an issue that matters to voters in battleground states throughout the industrial heartland of our nation.”

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  The latest monthly U.S. jobs report showed a loss of 49,000 jobs in May—with more than half of those (26,000) coming in the manufacturing sector alone.  After five straight months of job losses, and a seemingly endless freefall for manufacturing jobs, it seems palpable that something is amiss in the U.S. machine.

But what specifically is ailing us?  A rather obvious start would be the continuing loss of good-paying manufacturing jobs.  As one of the historical engines of growth for the U.S. economy, manufacturing is clearly linked to the success or failure of the U.S.  As was said many times in the 20th Century, “So goes General Motors, so goes America.”

The problem for manufacturing, though, is that U.S. trade policy has taken the wrong course.  This is the candid admission of Robert Cassidy, the former assistant U.S. Trade Representative for both Asia and China.  Cassidy was the lead negotiator for China’s 1999 Market Access Agreement, which paved the way for China’s accession to the World Trade Organization (WTO). 

Essentially, Cassidy was one of the chief architects of the plan that steered the U.S. into more global waters.  And now, he’s regretful, asking “whether the agreements we negotiated really lived up to our expectations.”  A “sober reflection” has led him to conclude that they “did not.”

So what went wrong?

According to Cassidy: “We failed to address the underlying fundamental market distortions that skew the benefits toward the few while leaving the rest of the economy less well off… The premise on which our trade agreements are negotiated is at best flawed, if not broken.” 

But what does that mean in practical terms?  Since China entered the WTO in 2001, the U.S. trade deficit with China has tripled, from $83 billion to $256 billion.  That massive increase in imports has also directly contributed to 1.8 million lost U.S. jobs, according to the Economic Policy Institute (EPI).

  As Cassidy explains it, upon joining the WTO, “China made unilateral concessions to reduce and, in some cases, eliminate barriers to entry for US goods and services.”  These concessions were projected to raise “US exports of goods to China… thus creating jobs in the higher-paying export sector.”  But in actual fact, U.S. exports to China have only grown “from a very low level.”

Cassidy notes that the real beneficiaries of increased U.S. trade are the multinational companies that have moved to China and the financial institutions that have financed them.  As he acknowledges, “Sourcing from China…has allowed companies to cut costs and increase profits, as reflected in increased corporate profits.”

Cassidy sees serious downsides as a result:
-“It is doubtful that the US economy or its workers are better off.”
-“US manufacturing jobs have declined by more than 2.5 million since China joined the WTO in 2001.”
-“Wages have been stagnant and real disposable income for three-quarters of US households has been stable or declining.”

Even more disconcerting according to Cassidy is that “the problem extends to nearly all trade agreements since they are based on the flawed premise that free trade benefits the economy. The premise is flawed and broken since free trade does not exist in a ‘free market’ petri dish where all other factors are neutral.”

The bottom line is that countries like China have “adopted an export-led development strategy, the centerpiece of which is a currency that is undervalued by 20-80%, with the consensus leaning toward 40%.”  China also has “internal barriers to trade” that “restrict US exports.”

The bigger question is why, if our trading partners have embraced export-led strategies, why doesn’t the U.S.?  With our mushrooming trade deficit ($709 billion in 2007), it’s clear that the U.S. has, in effect, settled on an outsourcing-focused strategy. 

Cassidy concludes by suggesting that “the next administration has to take a hard look at the trade agreements currently on the table…and ask: Who benefits? The answers should lead to a fundamental reassessment of what needs to be included in those trade agreements so that the benefits flow to broader and more equitable segments of the economy.”

  ManufactureThis couldn’t have said it better.  But we thought we’d let one of the people who set us on this path tell us where we’re going, and why we need to change course.

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ManufactureThis routinely talks about the importance of boosting U.S. exports in order to support domestic American manufacturing.  And so, we typically support increased exports to China, for example, as a way to reduce the $256 billion annual U.S. trade deficit with Beijing.

  But here’s one that we’re a little wary of: the Bush administration has approved the export of sensitive equipment and expertise to China’s military and police forces to bolster security at the Beijing Olympics, according to an article in yesterday’s Washington Times.  The support includes security and military equipment that is restricted for export under the Export Administration Act, prompting some critics of the policy to question its legality.

Currently, the FBI and other U.S. security agencies are helping China to develop counterterrorism operations ahead of the Beijing Olympics, and are patterning their efforts on the security plan used for the 2002 Salt Lake City Winter Olympics.

Two problems come to mind, though.

First, the same techniques that can be used for surveillance and military action against potential terrorists can also be used to crack down on internal dissent, or to augment repression of protesters in Tibet, for example.  And so, the democratically-minded United States may be inadvertently giving Beijing the tools to make more voices for Tibetan freedom simply disappear.

Second, the Chinese have become notoriously proficient in stealing intellectual property and computerized systems.  In addition to daily hacking of U.S. computer networks, the Chinese have been accused of spying on U.S. government officials.  The recent incident in which Chinese agents were accused of copying the computer files of a visiting U.S. Commerce Department official only exacerbates concerns that Beijing is stealing U.S. intelligence for its own gain.

Hi-tech security systems provided to Beijing for counter-terrorism efforts will surely mean that China copies and brings to market rival software applications.  Additionally, Beijing will undoubtedly scrutinize these American-made systems for ways to circumvent U.S. defense efforts.

Congress and the Administration have been Missing in Action when it comes to tackling China’s very aggressive, mercantilist trade policies, including dumping and piracy.  So the happy effort to supply Beijing with top U.S. military equipment and software defies common sense.  A good quid pro quo would suggest that if China wants U.S. help, they should start acting more like a cooperative friend.

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As ManufactureThis noted yesterday, John McCain has straight-talked himself into a bit of a corner.  During the recent primary season, he made it clear to voters that the manufacturing jobs that have sustained much of the American Middle Class “aren’t coming back.”  However, he also suggested to voters that his plan for lower taxes and reduced federal spending would prove helpful to the economy.

Interestingly, and now that McCain has entered the general election, he has shifted his “tone and emphasis,” according to Bloomberg News.  Acknowledging that “Americans are hurting,” McCain now suggests that he’ll fight for new jobs.

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