China has done little to address the underlying causes of its trade surplus with the U.S., said Peking University’s Michael Pettis.
The US-China trade war will “inevitably return” given Beijing’s failure to address the nation’s high savings rate and low consumption that has constrained demand for US goods, with Washington expected to refocus on the trade deficit as the threat posed by Covid and inflation passes, Peking University economics professor Michael Pettis told MNI.
Pettis believes trade tensions will again dominate relations between the world’s two largest economies, as tariffs unveiled by U.S. President Donald Trump in 2018 have failed to close the yawning trade deficit that has seen the U.S record a deficit in excess of USD30 billion every month this year.
“People will be angry when they realise China is still running this huge surplus. I think the situation will get much worse than before”, he told MNI in an interview.
The cumulative deficit for 2022 stands at USD309 billion, up from USD301 billion at the same time in 2018, highlighting the limited impact the Trump-era tariffs have had in addressing the imbalance Washington finds unacceptable. U.S. President Joe Biden expressed his “concerns” over China’s non-market practices when he met China’s President Xi Jinping at the G20 summit in Indonesia.
However, Pettis believes the trade deficit is less the result of underhand competitive policies but rather a reflection of China’s high savings rate and relatively lower levels of domestic consumption. (MNI POLICY: China's New Leaders Face Challenges In Reform Push)
“Because China’s income inequality is so high, it means the value of what it produces is much more than what it consumes”, said Pettis. “This structural imbalance is driving the trade deficit.”
“Beijing needs to boost its consumption rate in order to effectively reduce the US trade imbalance. Tariffs and deals will not solve the underlying mechanism alone.”
President Xi Jinping's flagship policies of dual circulation and common prosperity both aim to increase household income and spending, helping reduce the deficit.
In a recent interview with MNI, Pettis noted that transitioning between growth models is difficult and could lead to years of stagnant growth in China, showing there is no quick fix to the US-China trade relationship. (See: MNI INTERVIEW: China’s Post-Covid Rebound Won’t Last – Pettis)
Pettis believes the People’s Bank of China will closely monitor the weakness in the yuan, as they will be uncomfortable with further significant drops against the dollar. (See MNI BRIEF: PBOC Says Market To Play 'Decisive' Role in FX - Yi)
“Exports in 2022 are doing well already, so further weakening brings no benefit, it just hurts domestic demand and leads to capital flight which hurts growth”, he said.
He said direct intervention from the central bank was unlikely as Beijing now relies on state banks to sell dollars in the market to support the yuan. “The PBOC will retain its non-interventionist policy whilst state banks do the work”, he said.
There have been reports that China’s state banks have sold large amounts of U.S. dollars, and used swaps and spot trades as a way of supporting the yuan.
This “off the books” method is what the government prefers as it avoids a repeat of jitters seen in 2015-16 when China’s foreign exchange reserves dropped by USD1 trillion, triggering concerns about a blanket ban on outflows, which exacerbated currency weakness.
Given its imbalanced economy, Pettis isn’t surprised to see China voicing its support for preserving the past decades’ international order amid talk of de-globalisation.
“China needs other countries to absorb its surplus through its exports, so it's in China’s interest to sign more trade deals and resist de-globalisation” he said.
Western companies will not decouple from China in a substantial way despite rising geopolitical tensions and concerns over its economy because government support is so large.
“Direct and indirect subsidies account for 2-3% of GDP in China. It makes producing here so competitive, de-coupling will therefore be limited” Pettis said.