Just two days ago, 15 Asia-Pacific nations agreed to what is arguably the most important trade deal in history. Known as the Regional Comprehensive Economic Partnership (RCEP), it will unite the 10 countries from the Association of Southeast Asian Nations (ASEAN) – Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, and Viet Nam – with Australia, China, Japan, New Zealand, and South Korea to create the largest trade bloc in the world. With its members accounting for about one-third of the world’s population and about 30 percent of its GDP, the RCEP will be even larger than the EU and USMCA (formerly NAFTA). While several countries have not yet ratified the agreement, it is only a matter of time.
For the uninitiated, countries in a trade bloc give each other preferential commercial treatment, which basically means removal of or at least sharp reductions in tariffs and quotas. Countries outside the bloc become “second class,” and trade with them is more restricted. China especially, because of its size, stands to gain from the agreement. With improved access to so many markets, it likely means a boost to its exports. And possibly more important, the RCEP will only help China further increase its “sphere of influence.” With sizable investment inroads into Africa and South America over the past two decades, China is moving ever closer to gaining economic superpower status.
The United States, left out of this agreement as well as the Trans-Pacific Partnership (TPP) negotiated by Obama prior to Trump’s quitting it in 2017, has reason to be concerned. With its manufacturing in decline starting in the 1970s, the U.S. spent the period spanning roughly 1975 and 1995 importing its high standard of living from (and in so doing supporting the continued development and industrialization of) Japan and, to a lesser extent, Germany. Since the mid-nineties it has been China playing a much larger part in this game (see Chart).
Since around 1990, the importance of China’s economy to the U.S. has been considerable, and especially so over the past decade, more or less. Our trade deficit with China in 2015 was an almost unfathomable 97% of what it was with the rest of the world. But notice the sharp decline in this figure after 2018. It may be indicative of China’s recent “diversifying” away from the U.S. economy. The RCEP, then, would only promise more of the same.
Wait a minute, you say, why is this bad news? Don’t we want our trade deficit with China to decline? Well, it is not so simple. You might have heard that China (along with Japan) is one of the largest purchasers of U.S. government debt. It is, in fact, just the other side of the trade coin. When we run trade deficits with China (and other countries), we are importing more stuff from them than we export but we are exporting dollars to them. What should China care about dollars? It can recycle them back into our economy buying Treasury bonds, which are what our government produces to finance its debt. So, in essence, China has been lending us money to artificially maintain a robust living standard. But just as the importance of trade with China has dropped off in recent years, so has China’s appetite for our debt (see Chart).
China’s holding of our Treasury bonds dropped approximately 20 percent just in the year 2016. After recovering a fair amount in the following year, it has been on the decline again (the same is true of Japan, but that is for other reasons, and for another day).
But again, how is China’s unloading of our debt not a good thing? Did I mention that economics is complicated? The debt that the Treasury issues, the same that China and other countries buys, is a direct consequence of our not being able to keep our own domestic finances in order. It is no secret that the U.S. government runs a substantial budget deficit every year, none larger than in the fiscal year concluded in September of this year. It matters because China’s no longer being as interested in holding our bonds does not make our debt problem disappear. It only means that we will need to find other parties interested in lending to us.
Even that in itself is not that big a deal. The greater problem is that for the past half century our own manufacturing has fallen far short of providing for our expected living standard. We have had to rely on other countries to export products to us, and to an ever-greater extent. If China’s interest in our bonds continued to diminish, it would be far less eager to export its merchandise to us, since it would no longer need so many dollars. In order to keep up our customary level of consumption (well, pre-pandemic anyway), we would need to find another country from which we could import hundreds of billions of dollars’ worth of goods each year.
I have without doubt greatly simplified a problem that is considerably more complex than I make it appear. But on this topic, general comprehension is far more important than the details. I did not even get into the potential near-term weakening of the dollar, and what it might mean for our trade, borrowing, and standard of living. I will need to address it in a future post.
Comments 1
Great!