Snow opens fire against China's cheap exports Political pressures are mounting at home as US treasury secretary flies into Beijing to talk tough on undervalued currency
Jonathan Watts in Beijing Tuesday September 2, 2003 The Guardian Fresh from a tour of the depressed rust belt of the midwest, United States treasury secretary John Snow today flies into China - the land of rising skyscrapers and fast-growing manufacturers - with a message that the Bush administration can no longer afford the political price of cheap imports from the Far East. In what could prove the opening salvo in a full-blown trade dispute between the world's richest and most populous nations, Mr Snow has promised to raise the sensitive issue of the Chinese currency's peg to the dollar - a topic with the potential to influence next year's US presidential election and derail the phenomenal economic expansion that Beijing insists is essential for social stability. Since 1995, the Chinese government has shackled its currency within the tight band of 8.276-8.28 renminbi to the dollar, even as its economy has soared upwards with average annual growth of more than 7%. Exporters have reaped the benefits. At first, it was just cheap, labour-intensive goods such as toys and shoes which could benefit from the vast, low-paid Chinese workforce. In recent years, multinational companies such as Volkswagen and Matsushita have expanded their tie-ups with local partners to produce high quality cars and electronic goods. China is now the workshop of the world, filling shop shelves in London, Tokyo and New York with goods produced far more cheaply than elsewhere. For most of the past decade, this has been tolerated as a consequence of the conversion to market economics and a boon to consumers. With economies slowing and jobless levels rising elsewhere in the world, the success of China-based firms has started to become a cause for concern. Since 1997, China's exports to the US have more than doubled to hit $125bn (£80bn), while trade in the opposite direction has inched up from $13bn to $19bn. Alarm bells started ringing last year, when the US-China trade deficit surged 20% to $120bn, equivalent to a quarter of America's international total. US officials point out that the gap with China is now wider than it was with Japan at the height of Washington's trade dispute with Tokyo in the 1980s. The solution then was the 1985 Plaza Accord, which lowered the value of the dollar and brought Japan's economic juggernaut to a halt. Pressure is now growing in Washington for a similar arrangement to check the rise of China. Last month, 16 senators and congressmen petitioned the administration to deal with what they called Beijing's unfair currency manipulation. Senator Joseph Lieberman, a Democrat presidential candidate hopeful, struck what is likely to be a campaign theme in accusing President Bush of pursuing an economic policy that has created more jobs in China than the US. The American steelworkers' union has declared it will back whichever party pursues the most protectionist policy. Mr Snow, ahead of his trip to Beijing, travelled to the midwest to hear first hand why local workers blame China for the loss of 2.6 million American manufacturing jobs over the past five years. Yesterday, a focus of the US Labor day demonstrations was a criticism of Beijing's trade policy. The Washington Post, New York Times and Wall Street Journal have been filled with commentary articles on the subject, many suggesting the renminbi is undervalued by as much as 40% and should be allowed to float freely. Diplomatic fallout Mr Snow has been cautious, saying only that the issue of the renminbi will be "on the table" during his visit to Beijing. Other international policymakers have been less diplomatic. Wim Duisenberg, the head of the European Central Bank, said recently that some Asian currency policies were creating a "major macroeconomic imbalance" and were a threat to world growth. In Japan, where the central bank has intervened in the currency markets on an enormous scale this year, several cabinet ministers have accused China of "exporting deflation". Even South Korea, which enjoys strong trade ties with its western neighbour, has expressed concern about the surge of cheap Chinese exports. Beijing has made a defiant response to growing international pressure. Last month Wen Jiabao, the prime minister, said China had no intention of floating the renminbi. Domestic newspaper editorials have been filled with rebuttals arguing China is merely operating according to market economics in exploiting cheap labour. Commerce minister Lu Fuyuan told a recent meeting of Asian and European ministers that China's exchange policy will be "determined first and foremost based on China's own domestic economic needs". An appreciation of the renminbi - and the economic slowdown that it would cause - represents a political nightmare for the Chinese communist party. Beijing estimates that it needs annual growth of at least 7% to smooth the country's transition from a state-controlled economy to a free market. According to the state information centre, even with a growth rate of 8.5% a year, the country will be able to create new jobs for only 80% of the additional 50 million people who are expected to join the workforce in the next five years. Anything below this would risk social turmoil, already hinted at in the huge demonstrations which occasionally take place in China's own north-eastern rust belt. Beijing's policymakers also argue that they are owed a favour. During the 1997/98 Asian financial crisis, China proved a source of stability by resisting a wave of competitive currency devaluations. Foreign affiliations Contrary to Japan's case in the 1980s, China's supporters also point out that more than half the country's exports come from foreign affiliated companies - including US conglomerates such as General Motors and Motorola - that have set up manufacturing operations, such as those concentrated along the Pearl river delta. American retail outlets are also benefiting from cheap Chinese goods and passing on the gains to consumers. Wal-Mart accounts for $10bn of imports a year, equivalent to 10% of the bilateral trade deficit. Yet there are growing signs that China's economy is overheating - producing far more goods than the still developing domestic economy can consume or international markets absorb. From new cars and mobile phones to steel and cement, production capacities and inventories are growing at a rate that is worrying domestic policymakers. There are already signs of a Japanese-style bubble, bad loan problem and deflation. The Chinese central bank is awash with cash, having amassed $345bn in foreign exchange reserves. With loans easy to secure, fixed capital investment shot up by 32% in the first seven months of the year. There are so many more sellers than buyers that cars, homes and mobile phones have fallen in price and created a peculiar situation in which a fast-growing economy is simultaneously suffering deflation. The central bank acknowledged its concern last week, with its first monetary tightening measure in almost a decade. But speculators are betting that domestic concerns about overheating and international pressure will force the government into the more drastic step of allowing the renminbi to appreciate. Since the start of the year, more than $20bn of "grey money" has flowed into China as a result of widespread expectations of a currency exchange adjustment. China's leaders, however, are not likely to be as compliant as those of Japan in 1985. Despite the country's recent spectacular growth, the average Chinese worker still earns far less than most unemployed Americans, Japanese or Europeans. Election or no election next year, Mr Snow will do well to come away with even a promise that Beijing will reconsider the value of the renminbi.