- The Washington Times - Wednesday, April 12, 2006

The United States and China, the world’s twin engines of economic growth, have a relationship that has worked well to keep the economy expanding — but some analysts fear it could end badly.

The U.S. role has been to buy increasing quantities of Chinese-made consumer goods, amassing the largest trade deficit ever seen between two countries: $202 billion last year.

Most analysts say that deficit will grow even larger this year, despite a slowing in February to $13.8 billion from $17 billion in January, largely because of the cessation of work in China during the Lunar New Year.

China has kept up its share of the economic compact by accumulating a gigantic treasure chest of U.S. dollars from its export sales and reinvesting most of those dollars in U.S. Treasuries and corporate bonds.

The recycling of dollars, though less visible and less publicized than the trade deficit, is just as essential in the economic relationship because it provides U.S. consumers and businesses with the credit they need to keep on buying Chinese and other goods.

Though China is bad-mouthed regularly in Washington by politicians chafing over the mounting trade deficits, the mutually dependent trade relations are credited with helping to keep the world economy afloat and enabling it to recover from the 2001 recession. Lately, it has inspired an economic boom in Asia.

“U.S. imports have contributed to the growth of output and employment in many countries around the world,” said Harvard economist Martin Feldstein, detailing in a Foreign Affairs article how rapid rates of consumption growth in the United States have been fed by a steep decline in U.S. savings and an increasing reliance on inflows of credit from China and other foreign governments to finance purchases.

China recently surpassed Japan to become the largest holder of dollar reserves, with a war chest of $833 billion. Most of that is thought to be invested in U.S. instruments. Altogether, Japan, Russia, China and other Asian countries hold two-thirds of the world’s dollar reserves, which they have amassed through years of large trade surpluses with the United States.

While former Federal Reserve Chairman Alan Greenspan predicted that the cycle of U.S. trade deficits and debt to the world would end when foreign creditors lose interest in purchasing U.S. debt and other assets, Mr. Feldstein thinks it will end when U.S. consumers start saving again. And that could be any time.

“In the long term, a substantial rise in household saving will have a positive effect on the U.S. economy,” he wrote in the Foreign Affairs article. “But the initial effects will pose problems for the United States and its trading partners. If these effects are not managed well, the result could be declines in output and employment and a corresponding rise in U.S. protectionism.”

Mr. Feldstein is particularly concerned about the reliability of money flows from outside the United States, as it is not clear whether and when China and other Asian governments will decide to stop financing U.S. deficits. It is particularly dangerous, he said, for U.S. businesses to be dependent on potentially fickle foreign financiers for investments to create growth and jobs in the United States.

John Chambers, chairman of Standard & Poor’s sovereign rating committee, also is predicting a “painful” global economic adjustment when Asian countries stop building up U.S. currency reserves.

“Countries that rely heavily upon net exports will be particularly hurt,” he said.

The massive build-up of dollar reserves appears to have been largely motivated by the desire of Asian governments to avoid a repeat of the Asian financial collapse in 1997 and 1998, which was precipitated by the fall of currencies from South Korea to Thailand and spread into a general recession, he said.

Had the Asian governments possessed the treasure trove of reserves they have today to defend their currencies, they might have avoided the 1990s financial collapse. Another reason for the build-up of reserves has been to keep the value of Asian currencies cheap compared with the dollar, making Chinese and other Asian products enticing to U.S. consumers.

China’s manipulation of its currency has been a principle source of trade tension with the United States. Members of Congress have proposed drastic steps, such as imposing 27.5 percent across-the-board tariffs on Chinese goods if the practice continues. Many China-watchers think it may take further steps to disconnect the yuan from the dollar before Chinese President Hu Jintao visits with President Bush next week.

Jim Trippon, editor of the China Stock Digest, said members of Congress should not blame China for America’s economic problems. China is widely vilified for forcing up oil and gasoline prices, for example, even though the United States remains the world’s largest consumer of oil and has taken few steps to curb its own consumption.

But he predicted little would come of efforts in Washington to penalize China. “China is a superpower that can’t be messed with,” he said. “They aren’t going to be intimidated by a few politicians trying to scare them.”

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