In 2017, U.S. exports to China were $130B while imports from China were $506B: a trade deficit of $375B. This is a continuation of a trend since 2015. The US-China trade deficit was $367B in 2015 and $347B in 2016. Such high levels of trade deficit posts a national security threat for the U.S. and it needs to be dealt with in a very tactful way. This article looks into the cause of such high levels of trade deficits, the relevant parties and how it is played out within each country.
Whenever we go to Walmart, Target, Macys, Value City Furniture, or any other major retail store in the US, we find lots of products marked with the label “Made in China”; when we look around at the furnishings and appliances in our homes, we will also find the same label “Made in China”; when we log onto online retailers such as Amazon, there is a high chance we are buying products marked with “Made in China”. Furthermore, American-owned companies are selling these “Made in China” products.
The key word is OEM (Original Equipment Manufacturer). We seldom see Chinese-owned brands in the U.S. Chinese companies are not bringing their products to the US consumer market. Instead, US companies are bringing their manufacturing to China because the manpower cost over GDP in the US is much higher than that in China. In fact, manufacturing costs of the same products in China is much lower than that in the US or any other developed countries.
American companies have every incentive to find ways to reduce the cost of manufacturing. However, one consequence of that is an offshoring of low-skilled/blue collar jobs to China, leading to higher levels of unemployment rates in the U.S.
To stimulate the economy, the U.S. government issues bonds and puts more money into the market. The problem is that having more investment from the government does not changing the fact that the CEOs of American companies want to minimize the cost of doing business. As more OEM orders flow into China, the Chinese government steps in to the US bond market and becomes the biggest creditor of the US government. This downward spiral has created a serious national security threat for the US.
Lower income families got fed up with the poor economic situation. They used their rights to vote for change, and that is in part how we end up with Donald Trump as the President.
China is not the only developing country in this OEM model, but China is by far the number one among all other countries in term of the trade deficit with the US. The combined US trade deficit with 5 other trade partners (Canada, Mexico, Japan and Germany) is $223 while the total trade is $1.51T.
What makes China so unique in US international trading? To answer that, one needs to study the Chinese way of doing business, its foreign currency policy and the socialist system.
In China, most large enterprises are state owned business. They conduct their business directly or indirectly under Chinese Communist Party (CCP) direction. Their importing activities are closely managed by the central government, CCP in another word. In spite of all kinds of promises it made when China joined the WTO, all these promises can be overridden with an internal “Red title Central document”. Its decisions about whether to import certain products from other countries are made silently. There are no WTO rules violation, no trade tariffs, no law limiting importing; but Chinese companies are not buying products from the U.S. anymore.
After looking at China’s state owned enterprises, let’s look at its private businesses. Let’s say you and I, as Chinese citizens, form a company called "Best OEM LLC”. Best OEM gets a contract to manufacture Gucci watches. The client provides parts and best OEM does the assembly. For each Gucci watch best OEM made, the client pays us $50, while its MSRP is close to $6000.
Lots of Chinese think such business practices are a form exploitation. In their minds, the western company buys the watch at $50 from China and sells it elsewhere at $6000 to get huge profit. This is because they forget that manufacturing is only one element in a multi-step process in the business cycle.
With minimum exceptions, most “Made in China” products are designed, sourced, marketed and distributed elsewhere. Take an example, iPhone is manufactured in China, but all its product design, software design, packaging design are done at its HQ at the heart of Silicon Valley. Its marketing, distribution, post-sales support are also done locally.
A more realistic version would be by moving the manufacturing from US or other developed countries, Apple may reduce its manufacturing cost by half. Should Apple decide to move the manufacturing of iPhone from China back to the US, its cost of manufacturing would double, but the total cost of the product would not be doubled. The total cost of an iPhone would be increased, say by 10% or 15%.
Coming back to the story of Best OEM LLC, let’s say Best OEM manufactured 1000 Gucci watches, and the client in the US pays Best OEM $50 a piece, 50K in total. When the client wires $50K to Best OEM, the money goes through the state owned and run bank, People’s Bank of China. The bank converts the money into Chinese RMB, say 300K RMB, and deposits that amount to Best OEM’s account with the bank.
But, if Best OEM wants to import some products from overseas, that would be another story all together. The usage of foreign currency goes by a kind of quota system.
The company needs to submit an application, state its purpose, what it needs to import, from which country, the detail specification, and its price. The government agency can approve or deny it based on the central government guideline / policy at the time. Best OEM company would also need to provide the transaction record to prove it received foreign currency funding in the past. This process is done in a “black box” fashion -- there is no legal basis for either approval or denial. WTO regulation is useless in front of this type of import control process, and there is no way for either the exporting company or country to challenge the decision. With this exporting / importing process, the Chinese government accumulated a large amount of foreign currency reserves.
For a long time, Chinese government have been promoting exporting while limiting importing, so that it can build up its foreign currency reserves, from 2T in 2009 to close to 4T in 2014/ 2015. As it is now, it has 3.15T in its hands.
Look at the entire cycle across the Pacific Ocean, there are some winners and losers.
For the Chinese government, the more trade surplus, the more foreign currency the central bank will get, the stronger its economic power. Without a doubt, the Chinese government is a big winner.
For American companies, they cut their operational cost, and shareholders are satisfied. They are also winners in a certain sense.
For American workers, they are the losers, because the job their fathers worked, the job they used to work, no longer exists in the country.
For the American government, they know they need votes to get elected, so they need to appease American workers. But they are depending on Wall street, big MNCs to provide donations to run their campaign, so no politician wants to take drastic measures to stop job loss. In other words, no politicians want to touch “trade deficit”. if the economy is not good, it issues more bounds and inject more dollars to the economic system. In the long run, the American government is a loser as well.
How about those worker in China, are they winners? No, they are losers as well!
Again, for the Chinese government, the more trade surplus, the more foreign currency the central bank will get, the stronger its economic power is. But when it receives foreign currency, it needs to pay out RMB. When there is no enough RMB to use, what will it do? Print more RMB! What is the result of that? Inflation!
In other word, the harder Chinese workers work, the less value of their money worth! In past 10 years, according to china official report, Chinese RMB inflation rate range from 5.6% in 2011 to 2% in 2017. but most experts estimated the actual inflation rate is much higher than what the official reports.
Coming back to those American companies sending the job oversea. Are they really the winners? the fact is No.
For a company to succeed, it needs consumers to consume its product or service. As we can see, once the money goes to China, it does not come back buying American products / services. They are back to BUY us! As the money flow out of the country, the American consumer does not have the money to consume American products or services. The profit generated in cost cutting will be offset by reduction in sales!
Finally, let’s take a closer look at the two governments,
With much financial power, China is poised to step in US, financial, technology space. They want to use the US money they have to acquire big companies like Intel, AT&T, they want to acquire oil pipeline, they want to invest in US stock market. In other words, they want to invade the US without military war!
if we do not stop this trend, the only winner would be the Chinese Communist Party government!
To-dos for US government:
Under WTO framework, implement laws, procedures, push for a real plan to reduce trade deficit and eventually reach to trade deficit neutral. Together with trade agreement, push for higher wages for Chinese workers. By reducing the import tax / tariff, improve the affordability of Chinese population to consume western products and services. push for China currency exchange policy reform, to achieve currency free exchange market in China.
In summary, pushing for trade deficit neutrality is good for Chinese people, is good for US business, is good for US people, is good for US security. The only party who is not happy to see it happening is the Chinese CCP government, because it will not able to bully its own people, it will not be able to threaten the stability of the world, it will not be able to invade the west with its financial muscle.
