Trade War Between China and U.S. Intensifies

us-china trade warWashington may be indulging in a dangerous illusion; one in which it could be able to control China’s currency — the yuan. Since September, the yuan has gained about 1.8% against the U.S. dollar, to which it is pegged; so, although the gain seems small, it is not. Now, China may keep the illusion going for a bit longer, but that is only because it wants to delay Washington’s retaliation. What retaliation? Well, there are bills pending in both the House and Senate that would impose tariffs on China, unless the country allows the yuan to keep on rising. Now, these unilateral tariffs would surely feel good, but chances are that tariffs would only make things worse.

There are hard feelings in Washington with respect to the whole yuan situation. One of the Senators sponsoring the bill, Charles E. Schumer of the New York Democrats, said that, “China’s currency manipulation is like a boot to the throat of our recovery.” It is also understandable why there’s so much emphasis on China’s currency. The yuan is a tangible and trackable indicator of the relationship between the two countries. If the yuan’s value were to increase, then the U.S. trade balance would shrink and make U.S. goods and services more competitive on international markets. As an added bonus, a higher yuan would also mean subduing China’s inflation, which is definitely rearing its ugly head.

And, while China may disagree that its own economic growth should suffer under a higher yuan, ultimately it would be a mistake to muscle China into revaluing its currency. Firstly, if the U.S. oversteps its authority and goes for measures that the World Trade Organization (WTO) would never allow, at the other side of that decision would likely be a trade war, loss of support on the world stage, and potentially permanent damage to the already fragile free-trade systems.

In addition, the U.S. is picking on the wrong fight. Inflation in China is rising, which is also pushing the yuan’s inflation-adjusted value higher, in a way fixing itself, and that is all that matters right now on the international trade stage. To illustrate, China’s current account surplus is expected to decrease from 10.7% of GDP reported in 2007 to a mere 2.7% in 2011. This is why it seems that narrowing the focus on the yuan’s value alone is misguided. Whoever is looking at the broader picture would be able to see that this is a simpleton approach.

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As usual, China is playing a smart game. The country has dragged its feet when addressing the U.S. trade grievances. And it has not yet technically broken any WTO rules. So, if the U.S. retaliates against China by breaking the rules, it will be the U.S. labeled as the bad guy, not China.

What is the U.S. to do about this conundrum? One area of focus should be improving access for U.S. businesses in China. At the moment, China itself is running afoul of certain WTO rules, whereby it has implemented subsidies that discriminate against foreign companies, particularly if those engage in the high-tech industries. For example, on September 9 this year, the United Steelworkers Union instigated a trade complaint against China with the WTO regarding subsidies awarded to clean-energy technologies. That is the way to play the game.

Granted, dealing with China is not easy. Actually, it is quite the opposite of easy. But lashing out in anger or sheer frustration is a sure way to make things worse. So far, Beijing has played a smart and regimented game, and so should Washington.