China's Trade Surpluses are Not a Source of Strength

By John Phelan.

"In his new book Dawn’s Early Light: Taking Back Washington to Save America, Kevin Roberts of the Heritage Foundation argues that, “China believes it has a mandate to rule the world,” and that it is using trade balances to accomplish this.

This is an old tactic. “As far back as the Roman Empire,” Roberts argues, “the demand for Chinese manufacturers around the world substantially exceeded the Chinese demand for the things other countries produced…That trade imbalance helped shape the world economy-coinage from all over Europe and Asia has been discovered in Chinese archaeological finds, but to my knowledge no ancient Chinese coins have ever been located outside East Asia.” 

“China’s economic dominance, supply chain monopoly for desirable goods, and carefully controlled trade policies created substantial wealth for China’s rulers, if not for its people,” Roberts’ notes. Indeed, Angus Maddison’s estimates show per capita GDP in China falling from 106% of that in Britain in 1000 to 71% in 1500 and 28% in 1880. 

But, ultimately, Chinese trade surpluses didn’t help China’s leaders either. When Britain resolved to open China to trade by force in 1839, the ruling Qing dynasty found that all the coins it had accumulated as the reward for its trade surpluses were no defense against Queen Victoria’s gunboats. Those coins would have been better spent on weapons than being buried for archaeologists to discover. It was the country with the trade deficit that won the war, not the country with the surplus. “Before 1839,” Roberts writes, “trade favored the Chinese.” Little good it did them: China experienced military humiliation, political and social disintegration, and an eventual descent into communism.

Roberts argues that China’s:

…traditional strategy of generating massive trade surpluses should not have worked in the modern monetary system, because money today is not backed by bullion (the tons of gold and silver that flowed to China under the Canton System). Instead, the trade surpluses incurred by exporting more than its imports should have caused China’s currency to appreciate and its trade partners’ to depreciate. In the long run, that would have made Chinese manufactures more expensive and less attractive for outsourcing…

“That never happened,” he continues, because “China illegally devalued its currency, harming its own people but ensuring that the CCP’s strategy for hollowing out western manufacturing and returning China to global economic centrality would work.”  

But, again, little good it did them. While GDP per capita in China has risen from a low of 7% of the British level in 1950 to 34% in 2018 – a level last seen around 1770 – Roberts is right that China’s currency manipulations have imposed costs on its citizens in terms of reduced real incomes. That isn’t all. The currency creation necessary to keep the yuan’s exchange rate with the dollar somewhat stable when new dollars are being produced at an impressive rate has helped fuel one of the biggest property bubbles in history. 

“But even a Chinese domestic spending and debt spree could not absorb all of the trade imbalance,” Roberts writes, discovering that a US deficit on the trade account must be offset with a surplus on the capital account:

What China did to maintain its export advantage was devious: it invested in the United States, buying US assets with US dollars, thus propping up the value of the dollar (to keep Chinese products cheap) while seeking ownership of US companies, real estate, and more out of the United States and buying trillions of dollars’ worth of US government debt. The CCP today sits atop a $3 trillion hoard of assets, many of them American.

And, again, little good it did them. Holding significant stocks of depreciating US government debt isn’t, in fact, a source of strength. China cannot dump them to drive Federal borrowing costs up without tanking their value, which the Federal government is doing itself. As for those US assets, like farmland, it isn’t going anywhere, just like the buildings bought to much distress by the Japanese in the 1980s.  

China’s government might well be running a trade surplus as a matter of policy. It may even be doing so with the aim of strengthening itself relative to geopolitical rivals like the United States. But if, as Roberts argues, it has tried this before, that same history indicates that the prospects for the government in Beijing are not good. Little good it did the Qing dynasty and little good will it do the Communist Party."