Watch your flanks! That's a sound piece of advice US politicians have ignored as they remain mesmerized by the train wreck called Iraq. Meanwhile, a ruthlessly mercantilist China is running a flanking maneuver so effective that it now threatens America's economic, financial, and political independence.
America is addicted to a daily "fix" of Chinese capital that floods in to purchase US government bonds – and thereby fund the US budget and trade deficits.
China finances the US deficits as part of a broader mercantilist strategy to keep its currency undervalued. The way it does so is to set a "fixed peg" between the US dollar and the Chinese yuan. To maintain that peg in the face of a record trade imbalance between the US and China, China simply recycles its surplus US dollars back into the US bond market.
Today, as a result of its currency manipulation, China has become the largest monthly net buyer of US securities. More than two-thirds of its massive and highly undiversified $1 trillion in foreign currency reserves are estimated to be invested in US bonds. China will very shortly eclipse Japan as America's largest creditor. And its foreign currency reserves are projected to double within a few short years.
Here's the clear and present danger: What may have started out as a simple mercantilist currency gambit for China to sell its exports cheap and keep imports dear has morphed into a powerful weapon to hold off any effective US response to China's unfair trade practices. And make no mistake: Such practices run the gamut from a complex web of illegal export subsidies and currency manipulation to rampant piracy and woefully lax environmental, health, and safety standards.
From time to time, US politicians have railed against these practices – and the collateral hollowing out of America that China's "weapons of mass production" have brought about. However, any time that the Bush administration or Congress threatens any kind of significant and tangible action – as opposed to simply beating its chest – China can now credibly threaten to stop financing US deficits and start dumping greenbacks.
This is a very credible threat. If executed, inflation, the costs of imports, and interest and mortgage rates would skyrocket. With higher housing costs leading the way, consumers would soon be overburdened. The result: a nasty stagflation shock.
Some say that the Chinese would never take such an action because it would hurt them as much as Americans. But it's Beijing's view that the Chinese people are far tougher and better able to withstand any economic shock than Americans who've grown soft living the good life – and they are probably right. Chinese officials also take a far longer view of strategic action. So if a "dump the greenbacks" strategy needs to be implemented to break the back of a rising American protectionism, to secure Taiwan, or to achieve any other strategic goals, sobeit.
That's the snapshot right now – and it goes a long way in explaining why the Bush administration, and particularly Treasury Secretary Henry Paulson, have taken such timid actions in dealing with this threat.
But the long-run picture is even scarier. In the next five years, as China's foreign reserves hurtle toward the $2 trillion mark (and perhaps as China begins to allow its currency to appreciate somewhat), the Chinese government and its many state-run enterprises will be in a very strong position to go on an acquisition binge for US companies.
So what, you say? Corporations bearing the flags of countries such as Germany, Japan, and France regularly shop for US assets, and no harm has come of it.
This is very different. China's "buying of America" will be largely financed and orchestrated by the Chinese government – not corporations. This means China's acquisition binge will be far more strategic from a policymaking, rather than from a profitmaking, perspective. The likely result: a rapid acceleration in the transfer of sensitive technology, as well as the outsourcing and offshoring of US jobs. Ironically, as more US companies offshore their production – and as more fall into Chinese hands – there will be fewer voices to lobby against China's mercantilism.
To protect against these dangers, Congress must pass a comprehensive bill. The US trade representative and commerce secretary must have freer rein to seek relief from Chinese mercantilism in forums such as the World Trade Organization. More broadly, the Bush administration must work with the many other victims of Chinese practices around the world – from Brazil and Mexico to Europe – to take a much harder line in trade negotiations.
Absent prompt action from Washington, the US will lose this undeclared trade war without firing a shot.
• Peter Navarro is a business professor at the University of California, Irvine and author of "The Coming China Wars."