Well here’s a tricky one—China’s economy is showing real signs of slowing down.  According to a Bloomberg News article, China’s GDP dropped 0.5% in the second quarter of 2008, while consumer prices have simultaneously been rising at more than 7% for the last two months.  The emerging slowdown across the People’s Republic is the most significant since 2005.

China’s currency, the Yuan, also fell this morning, a surprising drop that suggests Beijing is concerned about maintaining its export-led economic orientation.  Because the Yuan is tightly managed by Beijing, it’s quite possible that government officials are trying to provide “breathing room for the export sector,” according to Jing Ulrich, JPMorgan’s chairwoman of China equities.  Bloomberg News quotes her as saying that “the performance of the export sector could influence the government’s approach to pacing the appreciation of the yuan.”

The tightrope that Beijing is now walking stems from their having pegged the Yuan to the dollar.  With the dollar now plummeting in world markets (breaking $1.60 per Euro, for example), China is on the receiving end of the same inflationary pressures as the U.S.  As Ulrich explains it, Beijing now faces “the cost of containing imported inflation from higher commodity prices.”

While an artificially low Yuan has helped China become the world’s fastest growing economy in recent years—and a manufacturing juggernaut—such a meteoric rise has also sewn the proverbial whirlwind.  Economic problems like rising energy costs, constraints on agricultural production, lagging rural incomes, and troubled global financial markets mean that, more than ever, China wants to keep its export engines running full tilt.  But maintaining a low Yuan is starting to bite hard, especially with higher oil prices.

It seems that Beijing is hitting a wall—damned if they do, damned if they don’t.  And so, while Congress frets and fractures over whether to take action on China’s undervalued currency, it’s quite possible that inside Beijing’s ruling regime, the same currency debate is taking place.

In the meantime, U.S. manufacturers continue to take a double beating, both from climbing energy prices and competition from China’s undervalued goods. 

It’s gonna get interesting…

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  As the U.S. economy teeters along a recessionary line, it’s interesting to study this month’s latest U.S. trade figures.  Historically, recessions and economic slowdowns have led to a narrowing of the U.S. trade deficit.  In the 1991 recession, for example, the annual U.S. trade deficit fell a whopping $34 billion.

As the latest Commerce Department figures show, the monthly U.S. trade deficit dropped slightly in May, dipping from $60.5 billion to $59.8 billion.  Curiously, though, despite a worried economy and a weakening dollar, the U.S. trade deficit with China rose from $20.2 billion to $21 billion. 

Just what is it about China that makes the U.S. keep racking up huge monthly deficits?

As ManufactureThis is wont to note, China is the world’s most flagrant manipulator of its currency.  While currency rigging is illegal under world trade law, China has continued to artificially depreciate its currency, the Yuan, in order to boost exports.  The result is a growing export surplus with the U.S., even during months when the U.S. trade deficit otherwise takes a dip.

U.S. manufacturers are rightly concerned about China’s cheating.  And they’re not alone.  First the EU and Japan started to speak up.  And then, more recently, the World Trade Organization (WTO) joined calls for a rise in the Yuan.

The bigger hurdle, however, will be to see if Congress and the Administration can jump on the bandwagon and get serious about dealing with China’s cheating.  Until then, ManufactureThis will continue to note, “The monthly U.S. trade deficit with China climbed again…”

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  ManufactureThis’ friend, Sen. John McCain, is traveling to Bogota today to help promote a free-trade agreement with Colombia.  The senator has been vocal in his support for a deal with Colombia, which he believes will be a boon to the U.S. economy.

While the good Senator is flying south, ManufactureThis wants to suggest that bigger problems lay to the east.  Secretary of State Condoleeza Rice is currently in Beijing, where Premier Wen Jiabao has expressed significant concerns about the weak state of the U.S. dollar.  Premier Wen was quoted this morning by the Wall Street Journal as saying that the Chinese “hope the U.S. will quickly pass through the subprime crisis and stabilize the exchange rate of the U.S. dollar; this is of great importance to the world economy.”

Notwithstanding Sen. McCain’s passing interest in economics, it would seem that he’s currently talking to the wrong country.  Two-way trade with Colombia in 2007 added up to $18 billion, with the U.S. charging up a mere $876 million in trade debt.  By contrast, U.S.-China trade hit $386 BILLION, and most of that ($256 billion) racked up as increased U.S. debt. 

It’s because of the huge overall U.S. trade deficit that investors are losing confidence in the dollar.  Ironically, China has continued to manipulate its currency, in violation of the free market, to continue its huge trade advantage.

If Sen. McCain wants to steady the U.S. economy, he should consider a longer plane flight—one that will take him straight to Beijing, where he can firmly remind Premier Wen that Beijing’s currency finagling has been unraveling world markets for a number of years.

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  This morning, the Wall Street Journal’s Michael Phillips discussed an interesting aspect of world trade flows, namely that $361 billion worth of foreign investment in the U.S. in 2007 came from “emerging-market nations.”  That’s nearly 40% of the $920 billion that foreign investors spent last year on U.S. stocks, bonds, and government securities.

What’s striking about this “emerging market” investment is that it runs counter to long-accepted notions of international trade flows.  As Phillips pointed out, “In economic textbooks, capital is supposed to flow from slow-growing, rich countries that have a lot of it to fast-growing, poor countries that don’t. Certainly that was the case before World War I, when Europeans exploited the natural wealth of their colonies. Now the textbooks are being turned upside down.”

While some of the $920 billion in total foreign investment comes through Britain from oil-rich Persian Gulf states, many billions of dollars also flow from China, Mexico, Brazil, Russia, Singapore, Malaysia, South Korea, and other developing nations.
Essentially, the United States is now attracting investment from Third World countries.  Phillips cites Bank of America strategist Joseph Quinlan, who says of the Unites States, “Not only are we addicted to other people’s money, but the money we’re addicted to is from the poor countries.”

There’s a reason for this, however.  China alone accounts for 21% of foreign investment in the U.S., according to Phillips.  China also accounts for more than one-third of the $700 billion U.S. trade deficit in 2007.  And so, Beijing has used much of its $256 billion trade surplus to buy U.S. assets.

This is one result of current U.S. trade policy—namely that we are importing far more than we are exporting.  As a result, and with no unified vision regarding the importance of domestic manufacturing, dollars are accumulating overseas.  Foreign investors find themselves in the envious position of needing to spend that money.

Phillips worries that the U.S. will find itself “not only dependent on money from the developing world, but in large part dependent on money from governments in the developing world — and undemocratic ones.”  What’s troubling is that “there’s no guarantee that the benevolence will last and, at some point, governments in places like Beijing may decide to exercise the leverage that their riches imply.”

As ManufactureThis is wont to say, a prudent course of action would be to seek more balanced trade.  Because China is brazenly flouting world trade law, step one would be for Congress and the Administration to begin strongly enforcing existing U.S. trade law to see that illegal currency manipulation, dumping, and subsidies don’t result in a continuing, vast outflow of U.S. dollars.

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  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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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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  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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  Earlier this week, the American Enterprise Institute (AEI) held a conference that asked “Is China Taking Unfair Advantage of Its Trade Partners?”  AAM Executive Director Scott Paul was among the panelists and, as Inside U.S. Trade noted, he had some ready answers to the question of how the U.S. should handle China.

With both the EU and Japan joining U.S. calls for Beijing to revalue its artificially depreciated currency, it’s clear that something has to give regarding China’s unprecedented current account surplus.  The issue, though, is whether dialogue will push the Chinese to revalue, or whether concerted unilateral action must be taken.  It’s suggested that China would benefit from a more flexible exchange rate in order to lower potential inflation at home, but so far the Chinese regime has made only token adjustments.

It’s important to note that China foreswore currency manipulation when entering the WTO in 2001.  But not until 2005 did it even begin to budge its currency, the Yuan, by any token increments.  Most economists consider the currency still undervalued by as much as 40%, a helpful, continuing boost for its exports.

The June 2 panel discussion at AEI offered some diverse approaches to the currency issue, with several panelists favoring ongoing discussions, such as the upcoming semi-annual ‘Strategic Economic Dialogue’ (SED), to push for a resolution of the currency issue.  AAM’s Scott Paul suggested that enforcement of U.S. laws to press China on its commitments could also be a sensible and fair step. There was a definite consensus among the panelists, though, that the currency is pegged and should be revalued, which would be of benefit to both China and the U.S. in the long run.

China has been pegging its currency to the dollar since 1994.  In those intervening 14 years, Chinese exports to the U.S. have jumped from $39 billion annually to $321 billion, a stunning increase, something the panelists were quick to note.

The issue needs resolution, and soon.  Dropping trade barriers such as currency manipulation would be a useful gesture to enhance the free market.  Scott Paul suggests that a currency revaluation agreement similar to the 1985 Plaza Accords could be a good start—something interesting to aim for, rather than just another round of dialogue at the SED.
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Bloomberg News’ Mark Drajem reported yesterday that the World Trade Organization (WTO) is urging China to revalue its currency, the Yuan.  The WTO’s comments join steady calls from the EU, Japan, and concerned U.S. legislators to end the manipulation of its currency that has seen China devalue the Yuan by as much as 40%.

  Specifically, the WTO report noted that “A more flexible exchange rate regime could enable China to operate a more independent monetary policy, which would be better suited to ensuring a low and stable rate of inflation.”

What’s interesting to note is that essentially the entire world is concerned with China’s currency practices.  Everyone that is except some U.S. lawmakers and the Bush administration.  Even though China has been rigging its currency exchange rates since 1994, and has continued to do so despite promises to the contrary when joining the WTO in 2001, the Bush administration has steadfastly refused to take concerted action.

As ManufactureThis noted last week, the Treasury Department once again refused to characterize China’s currency practices as outright “manipulation,” thus avoiding any effective action to rectify the problem.  Treasury Secretary Henry Paulson has frequently suggested that China should raise the value of its currency, and has praised any incremental steps in this regard.  But he has refrained from taking any serious action.

The end result is simply “chit-chat diplomacy”—a nod, a wink, a smile…and no effective change in the status quo.

Next month, a delegation from Beijing will meet in Annapolis with U.S. officials for negotiations in the latest semi-annual Strategic Economic Dialogue (SED).  As with previous SED’s, little of substance will be accomplished.  In the interim, the U.S. continues to shed good-paying jobs due to China’s mercantilism.

  The China issue will be of significant note come the fall presidential election.  Hopefully all of the candidates will be talking about this, and will express their desire to stand up to Beijing.

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All right, it’s time to take John McCain to task again.  He’s gone and done it once more—said some things that just don’t add up.

  In a Town Hall meeting yesterday morning in St. Louis, the good Senator made a very revealing remark: “The moral of the story is…we’re not going back to the old manufacturing base of the economy.”

But what exactly does that mean?

In the past 150 years, the United States amassed the greatest concentration of manufacturing capability in the history of the world.  In 1860, our economy was half that of Great Britain’s.  By 1913, it was more than double. 

In World War II, the United States became the “Arsenal of Democracy,” building more than 300,000 airplanes in five years.  In the years since 1945, the United States has generated much of the world’s wealth and served as protector and benefactor for many struggling countries.

Does anyone believe this would have been possible without a massive industrial base?

Consider some statistics:
-Manufacturing creates wealth: it generates $1.6 trillion for the U.S. economy—12% of GDP. 
-Manufacturing supports millions of good-paying jobs: it employs 14 million directly, with another 6-8 million related jobs throughout the rest of the economy.
-Manufacturing accounts for nearly three quarters of the nation’s industrial research and development. 
-Manufacturing provides the military hardware necessary to maintain our national defense. 

  But if we’ve lost 40,000 factories in the past 10 years, shed 3.5 million middle class manufacturing jobs since 2000, and are “not going back to the old manufacturing base,” just exactly where are we headed?  Is there some greater, even more prosperous route to be found in a nation of burger flippers and cash register attendants?

But it doesn’t end there.  In the same St. Louis speech, McCain also said, “I do not believe in isolationism and protectionism.” 

Fine, if true.  But it contradicts everything Senator McCain has wrought in his elected career.  Inexplicably, he has blocked every U.S. effort to tackle China’s protectionist trade practices, including illegal currency manipulation.

  And so, his comments about “old manufacturing,” like his inconsistency on China, reveal troubling hypocrisy in a would-be president.  They also demonstrate a simplistic disregard for history at a time when the United States is financially and militarily overextended throughout the world. 

To suggest that manufacturing is an antiquated part of the economy defies both common sense and the irresistible laws of commerce.  Like gravity, job losses tend to weigh us down, not build us up.  It’s doubtful, though, that Senator McCain gets the point.
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