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Economic Forecasts

A Trade War with China?

Neither country wants that, but there’s no mistaking an escalation in economic tensions.

A trade war between the U.S. and China is probably not in the cards. The world’s two largest economies have too much to lose from such a confrontation. China is the U.S.’ fastest growing market for exports, ranking third behind Canada and Mexico. Likewise, the U.S. is China’s top export market, taking in more than 20% of what China sells abroad. Neither country could find replacements very easily.

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But tit-for-tat reprisals are sure to grow, and there’s always a danger that they’ll get out of hand. By next fall, tariffs and other barriers may affect billions in trade. “We’re fairly close to a point where U.S. businesses are hurt more than helped,” says Gary Hufbauer, a trade policy expert with the Peterson Institute for International Economics.

A fight over currency poses the biggest risk. President Obama spent most of his Sept. 23 meeting with Premier Wen Jiabao at the United Nations discussing the pace of yuan appreciation against the dollar. According to Jeff Bader, senior director for Asian affairs on the National Security Council, the president was unusually blunt in connecting exchange-rate policy to trade. “The president made clear,” said Bader, “that he’s going to protect U.S. economic interests, and that we look for the Chinese to take actions. If the Chinese don’t take actions, we have other means of protecting U.S. interests.”

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As an example, Bader referred to two disputes the Office of the U.S. Trade Representative (USTR) filed against China with the World Trade Organization (WTO) on Sept. 15. One deals with Chinese duties on American specialty steel used in power generating equipment, the other with market access barriers to U.S. suppliers of electronic payment services.

While there’s wide disagreement among economists on what would constitute a fair exchange rate between the dollar and the yuan, the consensus is that China’s currency remains significantly undervalued. Beijing began to let the yuan rise in June after keeping it fixed for nearly two years. In the three months since, though, the yuan has only appreciated by about 2%.

Congress is determined to take matters into its own hands. House Speaker Nancy Pelosi (D-CA) wants a vote soon on a tough currency bill (HR 2378) so members can go home and campaign as champions of troubled workers and firms. The bill would brand currency manipulation an illegal subsidy, punishable by tariffs. Many U.S. industries -- notably tool and die makers, producers of molded plastics, metal fabricators and what’s left of U.S. light manufacturing -- have long argued that the exchange rate gives Chinese imports an unfair advantage in the U.S. market and are demanding relief. Organized labor echoes the point.

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The Senate will stall the House effort until the clock runs out on the 111th Congress. Too many senators fear the measure would prove counterproductive, provoking China to file a WTO case that it might well win. At the very least, Beijing could count on a significant diplomatic victory by denying the U.S. support from other nations, particularly those of Southeast Asia, who also worry about China’s currency policy. “It would change focus from China manipulating currency to the U.S. taking unilateral action that is inconsistent with WTO commitments,” says Calman Cohen, president of the Emergency Committee for American Trade.

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Beijing would also turn up the heat on U.S. companies doing business in China. Boeing, GE, Caterpillar and other multinationals stand to lose the most. State-owned businesses would cancel orders and steer future contracts to their European and Japanese competitors. Selective enforcement of legislation or regulations to the disadvantage of U.S. firms, already a problem, would worsen. Antidumping and countervailing duty cases against American-made goods would spike.

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But the issue won’t go away unless Obama can stay out in front of it. Next month, the Treasury releases its semiannual report on exchange rates. A finding that Beijing is deliberately manipulating exchange rates to promote Chinese exports would satisfy Congress without binding the administration to do more than it already is -- rounding up allied support to get China to let the yuan rise faster. But the longer the yuan stays weak, the more likely Congress will act on its own.

The Obama administration’s probable next move will be to file a WTO case alleging that Beijing provides illegal subsidies and other preferential treatment to China’s renewable energy sector. This last case follows a United Steelworkers' petition, to which the USTR must reply by Oct. 24. Also this fall, the Commerce Department plans to unveil new rules that will make it easier for U.S. firms to file and win antidumping and countervailing duty cases against rivals from nonmarket economies, of which the largest by far is China.

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