Why US speaks softly with China on trade

Many economists, however, caution that a trade war could harm both nations and the world economy. Their arguments include:

•The US and China, currently the twin engines of global growth, have become increasingly interdependent. Supporting gradual reforms, and a healthy Chinese economy, is more important than winning concessions.

•China's increasing clout makes it likely that its leaders will continue to make decisions based on perceptions of their own interests, not outside pressure.

•Even if the yuan were to rise sharply against the dollar, it is unclear how much impact that would have on the mammoth US trade deficit. America might simply import more from other nations, or pay more for imports from China.

Moreover, a large revaluation of the yuan might destabilize China.

"If they did it suddenly, their financial system might not be able to withstand the adversity," says Michael Cosgrove, an economist in Dallas who publishes the Econoclast newsletter.

A recent study, prepared for Congress's Joint Economic Committee, outlines a collection of challenges China confronts. It calls the banking system "dysfunctional," dominated by four state-owned banks and wrestling with a tide of nonperforming loans. One estimate, by the US accounting firm Ernst & Young, reckoned that the bad loans totaled $911 billion, or 41 percent of China's gross domestic product, at the end of last year.

China also has a jobless or underemployed "floating population" of some 140 million. By 2015, a decline in the working-age population promises to shore up the labor market.

But the flip side of that trend is an aging population without a social safety net. Already, this has distorted the economy by pushing China's domestic savings rate sky high. That's hindering the nation's hoped-for shift from an export-driven economy to one fueled more by domestic consumption.

"They themselves have come to the view that their current growth path is not sustainable," says Nicholas Lardy, an expert on China at the Institute for International Economics in Washington.

He says China is making headway with financial and other reforms.

Now it needs to find a way to boost domestic consumption while reducing runaway investment in industrial production – and to achieve this in lock step so that the economy doesn't slump. "The whole strategy is fraught with risk," Dr. Lardy says.

A more flexible exchange rate could help, he says. That would allow the central bank to focus more on domestic conditions and less on maintaining the yuan.

Paulson echoed that view in his recent speech on the global economy.

He spoke of "freeing up an inflexible currency regime" that hinders the development of a balanced economy. A more nimble monetary policy and financial system in China, he said, could "keep its economy from veering out of control."

Member nations of the International Monetary Fund are also nudging China and the US to do more to address imbalances in the world economy. To many, that means exchange-rate shifts in the dollar and yuan. It also means more saving (and less borrowing) in the US, and more consumption within China.

Lardy and others say China isn't fragile to the point of breaking. But it faces some tough transitions.

The reforms "will be when they feel it is in their interest to do so," Lardy says. "Paulson, at the margin, could help them see their way to the decision."

Page: 1 | 2