The US-China Economic Relationship: Separating Facts from Myths

EDITOR'S NOTE: President Barack Obama should dispel myths concerning U.S.-China relationships and push for fast changes in the latter's economic policies, Steven Dunaway argues. Dunaway is adjunct senior fellow for international economics at the Council of Foreign Relations. For his full expert brief, please visit the council's Web site. A few excerpts:

Many myths surround the economic relationship between the United States and China. Four, in particular, stand out, and it is important to identify them as myths to avoid misunderstandings that could adversely influence policy decisions. The fact that China has become the largest foreign holder of U.S. government securities is taken as indicating that the United States is heavily dependent on China to finance its budget deficits. Similarly, since China is a major source for U.S. imports, U.S. consumers are seen as dependent on cheap Chinese goods. In addition, the Chinese authorities have emphasized that they strongly resist external pressures to try to influence policy decisions and that economic instability in China is bad, with adverse implications for the rest of the world.

Myth No. 1: Washington has limited leverage because China is the main "banker" for the United States.

China holds a large amount of U.S. government securities. Of China's $2.3 trillion in official reserves, it is estimated that 70 percent is held in U.S. dollar assets. China is a big customer for U.S. debt, but it is not America's banker. Nor is the United States dependent on China to finance its budget deficits. If China elects not to buy U.S. Treasuries, there are other willing public and private sector buyers, as indicated by the strong demand for these securities worldwide. Although the U.S. government might have to pay higher interest rates as an incentive to get other investors to buy Treasuries in the event that the Chinese reduce their demand, the increase in interest rates would likely be small.

Myth No. 2: The United States is heavily dependent on cheap Chinese goods.

This is not really true. Only roughly 15 percent of U.S. imports come from China. Moreover, all of the basic types of manufactured consumer goods that China exports to the United States (clothing, textiles, footwear, toys, small appliances, etc.) can be imported from other countries or could be produced domestically. The prices for goods that could substitute for products from China would be higher, but the difference in costs would be relatively small. Competition among producers has become fiercer, and as a result cost differentials between goods from China and other suppliers are narrowing.

Myth No. 3: External pressure on China for policy changes is counterproductive.

The Chinese authorities stress that in the face of external pressure, they tend to strongly resist economic policy changes. The Chinese have in particular used this argument to try to fend off pressures for appreciation of the exchange rate. While no country wants to appear to be weak and susceptible to external pressure, the truth is that, if there is no pressure, there is less incentive to change policy. This is especially true in China, where the authorities are wedded to the status quo because of past success and inclined to make only gradual changes to economic policies. Recent developments in China's exchange rate illustrate this point. In the absence of external pressure since August 2008, China has reverted to fixing its exchange rate relative to the U.S. dollar.

Myth No. 4: Instability is bad for China.

Chinese authorities also have suggested that instability in China is bad for the rest of the world because of adverse effects on China's growth rate. But instability (or the fear of instability) has played a big role in initiating economic policy changes in China.

Without a hard push from the United States on a bilateral and multilateral basis, changes in China's policies are likely to be delayed, and that is not in the best interest of the United States and the rest of the world. It also is not in the best interest of China, because without a shift away from heavy dependence on investment and exports to drive growth toward greater reliance on consumption, China will not be able to sustain rapid economic growth and development. Getting China to fully realize this and to act more quickly than the authorities are inclined to do is a considerable task for the United States and other major economies.

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