Trade tensions between US and China threaten investors

China\'s rampant economic growth has the rest of the world rattled. Nowhere is this more apparent than in intensifying Sino-American trade tensions. There is a growing fear that such tensions could develop into a trade war, with America resorting to protectionism to shield domestic industries and jobs from low-cost Chinese competition, triggering counter-measures from China.

Protectionism and a tit-for-tat trade war are generally acknowledged to be a threat to equity investors: economics consultancy GaveKal points out that they lead to lower returns from invested capital and push down asset prices. If a trade war were to dent the American stockmarket, other countries’ bourses would be caught in the crossfire. Hence the fate of the Sino-American relationship has global repercussions. But how likely is a full-blown trade war?

At the heart of the Sino-American dispute is China’s currency policy, which keeps the renminbi pegged in a narrow band of about 8.28 to the dollar. America claims the renminbi is undervalued, giving Chinese manufacturers an unfair advantage – American firms cannot compete on price, because China is not “playing by the rules”.

Some American lawmakers, meanwhile, allege the undervalued renminbi leads to an ever-widening American trade deficit with China. That deficit hit $162bn (90bn) in 2004, up 30% on the previous year. The lawmakers argue that a rising deficit costs America jobs, is bad for economic growth and increases foreigners’ claims on American assets, since America has to borrow from abroad to cover the gap.

The whole issue was brought into sharp focus at the start of 2005 after 30-year-old global textile quotas lapsed. America was deluged by cheap Chinese clothes. “Local US manufacturers simply could not compete,” wrote Glenn Levine in an research note released in June. “Many were forced to close, leaving thousands of textiles workers unemployed, who together with lobby groups appealed to Washington for help.”

America is thus exerting a great deal of pressure on China to revalue the renminbi. It has effectively set a deadline for China to do so. First, from September the US Senate will be poised to vote on a bill imposing a blanket 27.5% tariff on Chinese imports. This is the amount by which the renminbi is undervalued, according to the bill’s sponsors. The bill has already won support on Capitol Hill.

Secondly, in October the US Treasury Department releases the second of its biannual currency reports. Unless the Chinese have revalued the renminbi by then, the report may brand China a currency manipulator. This would pave the way for America to take retaliatory, protectionist measures.

The level of the renminbi is not the only point of contention between the two countries. The others concern intellectual property rights (IPRs) and China’s desire to flex its new-found financial muscle by purchasing foreign firms, including American ones.

The US Chamber of Commerce reckons the global trade in fake and pirated goods costs the American economy $250bn per year. Neil C Hughes, a former China specialist at the World Bank, argues in the current issue of Foreign Affairs that the bill to American businesses from Chinese piracy is $2.5-$4bn annually. “The right laws are in place,” he says. “But China has shown little inclination to crack down on patent, trademark and copyright infringements, or even the outright theft of brands and technology by Chinese companies.”

Meanwhile, American lawmakers are aghast at state-controlled Chinese oil firm CNOOC’s recent bid for American oil company Unocal. The Chinese firm’s $18.5bn bid exceeds an earlier $16.3bn offer from Chevron. Last week the US House of Representatives expressed its desire to block the bid on national security grounds.

China, of course, is unimpressed by American posturing. It has repeatedly said it would not be forced into revaluing the renminbi and would do so only when it judged the time was right. A revaluation could hamper Chinese exports, put financial pressure on Chinese firms and increase “hot money” flows betting on future renminbi revaluations, whereas China prizes economic stability.

Meanwhile, a Chinese official last week said America had unfairly singled China out for the infringement of IPRs. Vice-minister of commerce Zhang Zhigang claimed the losses incurred from piracy in America and Europe exceeded those in China.

If both the protagonists in the Sino-American dispute dig in, the risk of American protectionism and Chinese retaliation would grow. China could retaliate by dismissing any prospect of a renminbi revaluation, prevaricating on the enforcement of IPRs or even by selling some of its $173bn hoard of treasury bonds, the world’s second-largest American government bond stockpile.

A Chinese disposal of US treasuries would probably lead other bond investors to sell also, causing a sharp rise in American interest rates. This would slow the US economy significantly. China would be hurt too: America is one of its key export markets and China’s remaining stockpile of its competitor’s government bonds would fall in value.

Since a trade war could be costly for both America and China, analysts expect the two countries to avoid one. Andy Xie, an economist at Morgan Stanley, expects the two sides to “muddle through” and avoid “open-ended strategic competition” since they are both “profit-driven” countries.

He argues that the “economic integration of the US and China” has been “overwhelmingly beneficial to the US economy”. This is partly because American firms, shareholders and consumers have all benefited from low-cost Chinese products – American firms can manufacture goods cheaply in China, boosting their profits and share prices, while American consumers can enjoy better living standards than if consumer goods were more expensive. From this perspective, America would hurt its own economy by imposing tariffs, even before a Chinese retaliation.

Several analysts predict a modest renminbi revaluation in the months ahead, averting a trade war. However, China would still enjoy a big competitive advantage because of its low wages, and Americans’ appetite for the array of goods China exports is famously resilient. So a revaluation might do little to staunch the flow of Chinese exports to America, or rein in America’s trade deficit. Hence the Sino-American economic relationship is likely to remain fractious, which will keep investors on their toes.