Hu Jintao, Bush's Banker?

Writing of Hu Jintao's April 2006 visit to the United States, The Observer quipped, "Last week George Bush, leader of the most powerful country on earth, met Hu Jintao, his banker."

While issues like human rights and freedom of speech capture much of the public's attention, one of the most pressing (although admittedly less glamorous) issues in U.S.-China relations is the continued trade imbalance.

The United States and China share the most imbalanced bilateral trade relationship in the world. The United States imports more goods from China than it exports to a tune of $202 billion dollars each year. All told, China alone accounts for nearly 26% of the United States' $725.8 billion trade deficit.

Increasingly, this imbalance has been the subject of a major political backlash within the U.S. congress, where some have charged that the US is "destroying its industrial base to support a communist country's industrialisation."

What Causes the Trade Imbalance?

The current trade imbalance is caused in large part by intrinsic features of China's labor market and consumer base. The vast majority of China's 1.3 billion people still live in rural areas. China has, by some estimates, a surplus rural labor force of 120 million people, many of whom migrate to industrial centers to look for factory work, and drive down wages.

As long as wages are low, the United States will continue to gobble up products made in China, while Chinese consumers will prefer to buy cheaper, homespun alternatives to American products.

How the Currency Peg Helps Sustain the Trade Imbalance

The currency peg exaggerates the natural imbalances created by low wages. An artificially strong dollars gives foreign businesses and consumers more purchasing power than they should "naturally" have (i.e., if the exchange rate were determined by the market) and makes Chinese goods even cheaper. An artificially weak Yuan makes foreign goods more expensive for Chinese consumers.

The single most important step the Chinese government could take to address this trade imbalance would be to unpeg its currency - currently 8 Chinese Yuan to the dollar - and allow it to float freely on the market.