Current trading relationship Between the United States and China Essay

Introductions International trade refers to the exchange of raw materials and manufactured goods (and services) across national borders. This situation happen since every country has specific products or services that are better in terms of quality, price, or any other measurable factors than one form other countries. This idea refers to competitive advantage. This situation drives countries to exchange their products and services to benefit from the countries that can produce goods more effective and efficient. Within the past few decades, the increase of international trade has driven the integration of the world economy. Furthermore, there are interesting facts that between 1980 and 2002, the volume of world trade has increased significantly relative to world output. This is because, for instances, traded goods have become cheaper over time relative to those goods that are not traded. In addition, we witness there are three factors characterize the increase in trade: The decrease in costs of trade. In transportation, communication and search, currency exchange and tariffs are all factors that influence when trading goods internationally. Within the past 20 years, these costs are falling; suggesting that there would be an increase in the volume of trade. Second factor is the fact that tradable goods sector experience improved productivity growth. According to studies, it is found that productivity growth tends to be higher in the tradable goods sector than in the non-tradable goods sector. This situation will in turn increase the ratio of trade to output. The third factor is the increase of income per head. The increasing income will likely drive consumers to shift their spending away from basic food and clothing products and into manufacturing goods, which offer more differentiation, diversification and international Due to the needs to trade with other countries, a country is driven to find and develop their competitive advantages, which in turn sustain their trade relationship with other countries in the world.   Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚   Concerning the international trade, this paper will discuss about current trade relationship between U.S. and China including the current status of this trading relationship, impact of devaluing of the U.S. Dollar affect this trading relationship, sources of Chinese domestic inflation, American recession affects the Chinese economy, and the future of trading relationship between U.S. and China. Current Status of U.S – China Trading Relationship The trade relationship between U.S. and China represents a significant issue for both countries. This is because, each country regards the trade between the other party is important. For the U.S., for example, the trade with China is ranked number 3 with US$29.9 billions of dollars. The first trading partner for the U.S. is Canada (US$48.9 billions of dollars) and Mexico (US$29.9 billions of dollars). This condition highlights that the trading between the two countries will be managed suitably although the two countries often involved in political tension regarding military force, Tibet issue, and trade secret.   Table 1 shows the U.S. trade relationship with China in the first two months in 2008. Table 1  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚   Trade Relationship between U.S. and China NOTE: All figures are in millions of U.S. dollars. Month Exports Imports Balance January 2008 5,854.9 26,167.7 -20,312.8 February 2008 5,773.9   24,128.6 -18,354.7 TOTAL 11,628.8 50,296.3 -38,667.4 Source: U.S. Census Bureau, 2008   Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚   Above figure represents the stable trends in which a year later in 2007, the trade value is undulating as shown in the following table (Table 2). The top value of trade between U.S. and China occurred in October 2007 where it reached US$31.6 billions of dollars (U.S. Census Bureau, 2008). Table 2  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚   Trade Relationship between U.S. and China in 2007 NOTE: All figures are in millions of U.S. dollars. Month Exports Imports Balance January 2007 4,364.2 25,635.0 -21,270.9 February 2007 4,630.7 23,064.5 -18,433.8 March 2007 5,479.4 22,725.4 -17,246.1 April 2007 4,849.4 24,222.9 -19,373.5 May 2007 5,322.7 25,338.4 -20,015.7 June 2007 5,900.1 27,061.1 -21,161.0 July 2007 4,779.2 28,583.4 -23,804.2 August 2007 5,904.6 28,431.4 -22,526.8 September 2007 5,610.5 29,375.3 -23,764.8 October 2007 5,683.1 31,611.2 -25,928.1 November 2007 5,816.3 29,768.8 -23,952.6 December 2007 6,898.2 25,690.2 -18,792.0 TOTAL 65,238.3 321,507.8 -256,269.5 Source: U.S. Census Bureau, 2008   Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚   There are many reasons why U.S. has strong trade relationship with China. The country is home for more than 1.3 billion people, becomes one of the world’s fastest growing economies. Within the past decade, the country recorded an average of 8.2% of GDP growth. The figure put China to be the world’s 7th largest economy and 4th largest trader to date (Jintao 2003). The main reason of the country’s successful rapid growth comes from its decision to conduct comprehensive economic reforms, including its 2001 WTO accession (â€Å"People’s Republic†, 2005).   The impact of such reformation is China becomes famous for its dramatic shift from a relatively closed economy prior to 1970 to the world’s largest recipient of Foreign Direct Investment to date. The year 1978 was the time when the country conducted a massive makeover of its foreign trade policy (Coughlin, 1999). As the first policy of allowing limited amount of foreign investment has seemed to work superbly, the Chinese government figured out that it was a good idea to let ‘a little more’ money coming in. Once the decision to get â€Å"a little more money’ set up, immediately afterwards, the foreign investment into China grows significantly, putting the country to be one of the main pillars of Chinese economic reformation while playing a key role in Chinese economic integration initiatives. Concerning the situation, analysts believe that FDI into China continues playing a major part in the development of China (Coughlin, 1999). Thus, we can say that to some degree, China’s economic development can be observed through the activity of FDI inside the country. Recent development shows that FDI inflow patterns into China form an obvious trend. The technology-intensive industry has attracted more investors to put their plants in China while increasing the number of FDI in-flows into the country. Along with condition, FDI inflows to traditional industries like footwear, travel goods, toys, bicycles and electrical appliances have been declining. Experts believe that the trend will reasonably continue in the future (‘China’, 2002). Devaluing of the U.S. Dollar affect this trading relationship Multinational companies having subsidiaries all around the world or a country that conducts trade with other countries generally has at least one issue to constantly think about, which is foreign currency exposure. Companies or countries cannot operate using the same currency within different countries and markets. However, their national reporting standards generally require these companies to report all their incomes and expenses within a single currency. Hence, the problem of managing foreign currency exchange risk becomes significant. Multinationals who failed to manage their currency risk accordingly could end up losing millions of dollars annually due to currency exposure (Abo & Simkins, 2004). Investorwords.com defines exchange rate risk as the risk that a business’ operations or an investment’s value will be affected by changes in exchange rates (Investorswords, 2008). Under such circumstances, for example, â€Å"if money must be converted into a different currency to make a certain investment, changes in the value of the currency relative to the American dollar will affect the total loss or gain on the investment when the money is converted back (Investorswords, 2008). Since companies that deal with foreign currency will encounter the risk of undulating exchange rate, they had better to have risk management and tools to reduce and alleviate the negative impact of such undulating rate to maintain their companies’ profit. In trade relationship point of view, the devaluation of U.S. dollar would put the trade deficit much deeper. In Table 1 and Table 2, we find that U.S. trade with China always experiences a deficit. This condition could get worse if U.S. dollars experience devaluation since it means China companies will pay less to the U.S. counterparts when they conduct trade in U.S. dollar currency. Figure 1 shows the U.S. trade deficit. Figure 1  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚   U.S. Trade Deficit with China (Mankiw, 2003) Sources of Chinese domestic inflation In general, inflation is influenced by a number of factors, including the degree to which the productive capacity in the economy is being utilized; one-time shifts in product prices resulting from shocks to important supply and demand curves; changes in productivity growth; and inflation expectations. Kohn in his speech further reveals that there are four determinants of inflation: Economics slack. history reveals that economic slack indicates that when capital and labor are not fully employed, competition for market share and for jobs tends to bring down the inflation rate and vice versa Price shocks. Supply and demand influence the increase in a few prices for the specific products. This situation in turn contributes to the broad pickup in inflation although Kohn believes that price shocks are not going to be a source of continuing upward pressure on prices. Productivity. The combination of rapid productivity growth and weak aggregate demand has resulted in the slack in resource utilization, which contributed to the decrease in inflation. In addition, productivity growth also influences inflation through its effects on labor compensation and profit margins. Inflation expectations. This determinant plays a key role in price determination. In addition to other effects, a rise in inflation expectations tends to become self-fulfilling as people seek to protect themselves in the process of setting wages and prices. (Federal Reserve, 2004) Concerning China domestic inflation, we find that the country’s government policy becomes one major issue that influences the inflation. In 1989, for example, the government enacted policies which were intended to prevent the overheating economy. The policy was taken because in 1988, there was an aborted effort at the wholesale price reform. The incident resulted panic buying and wildly increased inflation. This explains the sudden raise of GDP growth. However, the government managed to create price stability by canceling large investment projects and decreasing domestic demands of products and services. The following economic turmoil was caused by the Beijing Massacre 1989. AS displayed within the table, the incident causes slowdown of national businesses, especially those involved with foreign investments. In 1991, the economy started to rise again, however, still with limping steps due to the worsened national image. In 1992, Deng Xiaoping decided to perform a tour through the Southern region of the country and attempt to revive international trust to the national economy. The tour achieved a significant portion of its intentions. Immediately, international interest in the rapidly growing economy was revived and FDI inflow to the coastal regions of the country was significantly boosted. Particularly in Shanghai, the new economic tendency brought significant governmental investment into the region, to build further infrastructure for international investment. The governmental initiatives brought increasing trade activities within the region, which encourage growth and also inflation (People’ Daily Online, 2006) Bilateral trading relationship heading in the near future The first analysis in conducting a trade with other country is about analyzing the country risk. This is important factor that U.S companies should be taken into account since trading with other countries involve any factors such as law enforcement for traded goods etc. in software industry, for example, many times, U.S. software developer complain about high rate of software piracy in China.   In short, country risk analysis is performance assessment regarding the uncertainty of a particular country in order to know about business environment in that country. In addition to using several macro and micro factors of country risk rating such as checklist approach, Delphi technique, and inspection Visits (Madura 485), U.S. – China trading trends is because China still holds the highest FDI Index that encourage U.S. companies to continue conducting trade with China in the future as shown in following figure. Figure 1  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚  Ã‚   Top 25 Countries in term of FDI Confidence Index Source: A.T. Kearney References    Aabo, Tom. Simkins, Betty J. (2004). Interaction between real Options and Financial Hedging: Fact or Fiction in Managerial Decision Making. Adler, M. B Dumas. (1984). Exposure to Currency Risk: Definition and Measurement. Financial Management 13, pp 41-50. China. (2005). Retrieved May 7, 2008 from http://www.dfat.gov.au/geo/fs/chin.pdf#search=’China%20Fact%20Sheet%20pdf’ Coughlin, Cletus C. Segev, Eran. (1999). Foreign Direct Investment in China: A Spatial Econometric Study. Federal Reserve Bank of St Louis. Retrieved May 7, 2008 from http://research.stlouisfed.org/wp/1999/1999-001.pdf Federal Reserve. (2004). Remarks by Governor Donald L. Kohn. Retrieved May 7, 2008 from http://www.federalreserve.gov/boarddocs/speeches/2004/20040604/default.htm Foreign Direct Investment. (2003). Retrieved May 7, 2008 from http://ucatlas.ucsc.edu/fdi/fdi.html Jintao, Hu. Australia-China free Trade Agreement Joint Feasibility Studies. Retrieved May 5, 2008 from http://www.dfat.gov.au/search International Trade Theory. Retrieved May 5, 2008 from http://www.radford.edu/~aorlov/econ340/Ch04.pdf Investorswords. (2008). Exchange Rate Risk. (2004). Retrieved May 5, 2008 from http://www.investorwords.com/1808/exchange_rate_risk.html Krugman, Paul R., and Maurice Obstfeld. (1997). International Economics: Theory and Policy. Addison-Wesley Mankiw, N. Gregory. (2003). China’s Trade and U. S. Manufacturing Jobs. Retrieved May 7, 2008 from http://www.whitehouse.gov/cea/mankiw_testimony_house_ways_and_means_oct_30.html Mclain, Charles. (1995). China’s Foreign Trade and Foreign Investment Law. Retrieved May 5, 2008 from http://www.1990institute.org/publications/pubs/ISUPAP11.html People’ Daily Online. (2006). Poverty Reduction Remains Tough Job for Asia-Pacific Countries. Retrieved May 6, 2008 from http://english.people.com.cn/200609/19/eng20060919_303966.html U.S. Census Bureau. (2008). Trade in Goods (Imports, Exports and Trade Balance) with China. Retrieved May 7, 2008 from http://www.census.gov/foreign-trade/balance/c5700.html