Early in President Obama's first administration, he dispatched Secretary of State Hillary Clinton to China, not to insist on trade balance, but to beg the Chinese government for loans. The Taipei Times reported on February 23, 2009: "In Beijing, [Clinton] called on Chinese authorities to continue buying U.S. Treasuries, saying it would help jump-start the U.S. economy and stimulate imports of Chinese goods."
President Obama is starting his second term on a different note. The Associated Press reports:
WASHINGTON - The U.S. is seeking a more balanced trade relationship with China at talks Wednesday that could set the tone for cooperation after political transitions in the world's two largest economies.
The annual joint commission on commerce and trade meeting comes weeks after President Barack Obama's re-election and the elevation of new leaders of China's ruling Communist Party.
Few concrete outcomes are expected, but Washington will be looking for signs of the economic policy direction under new Chinese leader Xi Jinping. The U.S. wants China to stimulate domestic demand and become less reliant on export growth and allow more market access for American companies.
Meanwhile, the U.S. merchandise trade deficit with China (negative net exports) continues to worsen, hitting $311.6 billion over the 12 months ending in October as shown by the graph below:
The merchandise trade deficit of the graph only includes the goods trade. The United States has a compensating service trade surplus with China of $15.3 billion in 2011. Assuming the same level in 2012, our total trade deficit with China for the last 12 months was about $295 billion, about 58% of our total trade deficit.
How China Does It
China keeps out American exports through a wide variety of barriers. For example, in December 2011, they raised their already high tariffs of about 25% on American automobile exports, forcing Cadillac and Jeep to build their new factories in China in order to have continuing access to the Chinese automobile market.
But China's main technique for growing its trade surplus with the United States is currency manipulation. The Chinese government buys hundreds of billions of dollars worth of foreign currencies each year in foreign exchange markets. According to the Asian Development Bank, the People's Bank of China added $669.8 billion to its foreign currency reserves (and related items) in 2011.
Meanwhile, the increased demand for the dollar and the increased supply of yuan in foreign exchange markets, caused by China's foreign currency purchases, keeps the dollar at a high exchange rate, and keeps the yuan at a low exchange rate. As a result, American producers continue to experience artificially reduced market share in U.S. and foreign markets while Chinese producers continue to experience artificially increased market share in U.S. and foreign markets.
The foreign savings flowing into the United States, largely from China, shifts the supply of savings in the U.S. to the right, but at the same time it takes away investment opportunities for American producers, which shifts demand for investment to the left. The shift to the right in savings and the shift to the left in investment are illustrated in the supply-demand graph of the loanable funds market below:
The Scaled Tariff Could Be The Solution
My father, son and I have a WTO-legal solution. We have invented the scaled tariff, a tariff designed to balance trade. It is adjusted so as to take in half our trade deficit with each trading partner as U.S. government revenue. It goes up when the trade deficit goes up, down when it goes down, and disappears when trade approaches balance with each country. Also, the whole tariff disappears when overall U.S. trade approaches balance.
It helps comparative advantage because the implicit assumption behind comparative advantage is that trade is balanced. And the scaled tariff balances trade.
If trade is balanced, we trade a basket of products that we produce with comparative advantage for a basket of products that others produce with comparative advantage and everybody benefits.
Currently, China is producing what it produces with comparative advantage and what we produce with comparative advantage, and only trading with us for products that they can't produce at all, such as grains, coal and natural gas.
The immediate effect of the scaled tariff would be to cause America to buy more from Canada and Brazil, countries that buy more from us when we buy more from them.
The slightly delayed effect is that the Chinese government changes its policies, decides to let in imports from the U.S. after all. It decides to do so in order to keep market share for its exports in American markets.
The growth in investment opportunities in America's export-producing sectors would be enormous. The only danger is that interest rates would go up too much. But that wouldn't be the case if we instituted the scaled tariff at the same time that we brought budgets toward balance.
The Obama administration is finally asking China to bring trade toward balance. If China refuses, President Obama may have to take stronger action. He could insure balance by imposing the scaled tariff.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.