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Matthews Asia Snapshot

The China Debate

Week of October 26, 2012

It seems to me that pretty much the only thing you can get Democrats and Republicans to agree on these days is that China is bad—a job-destroying exporter of cheap goods. And indeed, at the most recent two presidential debates, both candidates spoke of the trade deficit with China and described China as a rule-breaker, including the way it has managed its currency. They phrased their views as if trade were a competition between nations and that exports are obviously superior to imports. U.S. manufacturers might agree but consumers may demur. After all, the reason we trade is to import goods. Exports are the payment we have to make!

As for currency, at least President Barack Obama pointed out that China has actually made significant progress in allowing its currency to appreciate against the U.S. dollar of late. The renminbi, which is now about 6.3 to the U.S. dollar, has appreciated approximately 25% since the beginning of 2007, when the renminbi traded at 7.8 to the U.S. dollar. In addition, while the U.S. inflation rate has been fluctuating around the U.S. Federal Reserve’s target of 2%; the China inflation rate has only just dipped below 2% and averaged about 3% over the same period. Factoring in both the currency appreciation and China’s relatively faster rate of inflation gives us the real change in relative prices of goods. Thus, China’s real currency appreciation over the past five years has been closer to about 30%.

These developments have led to a dramatic fall in China’s current account surplus with the rest of the world, from a high of around 10% of GDP to less than 3%. To be sure, as Governor Mitt Romney pointed out, if we focus just on the U.S.–China trade deficit, the surplus has grown slightly in the past five years and is about 2% of U.S. GDP. Nevertheless, much of this trade is actually beneficial to U.S. consumers as it provides such products as inexpensive clothing and toys. Also, much trade with China is in low value-added activities, such as assembling electronic goods: the U.S. ships the parts to China, which puts them together at a very low margin before exporting them back to U.S. customers.

Meanwhile, due to rising wages and a stronger currency, the consumption power of China’s population on world markets has more than doubled over the last five years. And as the Chinese government continues to promote the development of a mass consumption society, both candidates might want to consider how the relationship between these two great nations might change in the future with China becoming an increasingly large market for U.S. capital goods, food, medical equipment and consumer products. Perhaps they do understand this—it’s just that their rhetoric tends to portray China as a thieving jobs destroyer. Ultimately, I found some comfort in Governor Romney’s comment that China wants “the economy to work and the world to be free and open,” and in President Obama’s statement that “China’s both an adversary but also a potential partner in the international community if it’s following the rules.” Perhaps the trading relationship will survive the election after all.

Robert Horrocks, PhD
Chief Investment Officer
Matthews International Capital Management, LLC

The views and information discussed in this report are as of the date of publication, are subject to change and may not reflect current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Investment involves risk. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Past performance is no guarantee of future results. The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews International Capital Management, LLC (“Matthews Asia”) and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information.