Back from the Brink of a China-US Trade War April 6, 2010, Bill Witherell, Chief Global Economist
Last weekend, Treasury Secretary Geithner announced a delay in publication of a report to Congress on the economic and exchange-rate policies of the major trading partners of the United States that was scheduled for April 15. Geithner’s statement can be found at http://www.ustreas.gov/press/releases/tg627.htm . Speculation had been mounting that in this report the Treasury would designate China as a currency manipulator, a step for which loud voices in Congress were calling. Protectionist pressures have been rising and the risk of a ruinous trade war breaking out has become uncomfortably high.
Secretary Geithner pointed out that important high-level meetings involving both China and the US will be held in the coming three months and announced that the US intends to use these meetings to press for “material progress.” The statement highlights the issue of China’s inflexible exchange rate but also refers to the large external surpluses of Germany and Japan and their need to encourage “more robust growth of internal demand.”
This move by the Obama administration is welcome for several reasons. Policymakers in China are giving indications that they are close to deciding to permit some appreciation in their currency. Were the US to take this opportunity to brand China as a “currency manipulator,” the move almost certainly would be counterproductive. China would loathe appearing to be responding to bilateral pressure. They would be much more likely to participate in a multilateral move to reduce global imbalances.
In fact, the US trade deficit is correctly seen as a multilateral issue. As Morgan Stanley’s Stephen Roach pointed out in a March 29 commentary in the Financial Times, “In 2008-09, the US had trade deficits with over 90 countries.” While the deficit with China was the largest, it is only part of the problem. We should not expect a stronger Chinese currency to be a silver bullet for the US economy and employment. Indeed, a big part of our problem has been the far-too-low US savings rate, which has meant we have had to import savings from other countries (including China) to finance our growth. Since the financial crisis, deleveraging in the private and consumer sector fortunately has increased domestic saving, but our government has moved in the opposite direction with its heavy deficit spending.
Another important consideration, not mentioned by Secretary Geithner, is that the US does not want to harm the apparently improved chances for closer cooperation with China on some important issues, in particular with respect to the nuclear threat from Iran. It now seems possible that agreement can be reached on the sanctions issue. This is not a time to attempt to stigmatize China by an action that would have no meaningful effect (it would simply require the administration to enter into a dialog with China, which it already is doing.)
While we applaud the administration for taking the correct action this time, we remain concerned about the strong calls in Congress for protectionist moves. We support effectively defending our negotiated rights under the World Trade Organization, which likely will require taking steps against China on some issues and taking those disputes to the WTO. Such skirmishes are a normal part of the give and take between major trading partners. But unilateral protectionist actions, as some have proposed, risk a descent into a catastrophic trade war in which all would suffer greatly. President Obama’s economic advisors are well aware of this serious risk. We sincerely hope their views prevail.
On the assumption that China and the US mutually recognize the folly of a ruinous split, we continue to hold significant China positions in our International, Emerging Market, and Global Multi-Asset Class ETF portfolios. The Chinese market underperformed in the first quarter of 2010, as many investors apparently feared that monetary tightening steps taken by the authorities would choke off China’s dynamic economic growth. We, in contrast, regarded the tightening as well-taken moderate taps on the brakes of an economy that had begun to advance at an unsustainable pace.
The latest data indicate continued strong, but not excessive, growth in output and very welcome strong growth in domestic demand. In the January-February period, retail sales are up 17% on a year-to-year basis. In March the Chinese equity market recovered and joined in the global equity advance.
When using ETFs to take a position in Chinese equities, it makes a difference which one you choose. The most heavily used is the iShares FTSE/Xinhua China 25 fund, FXI, which also is the least diversified as it invests in the 25 largest Chinese firms listed in Hong Kong. When monetary tightening began we moved out of that ETF because of its heavy concentration in the financial sector (46% of the total). In the first quarter, FXI ended down 0.4%. We held on to and in some cases added to our positions in the SPDR S&P China fund, GXC, which is considerably more diversified (over a hundred firms in its holdings). It did slightly better in the first quarter, up 0.3%.
Our preferred Chinese ETF is the Claymore/AlphaShares China Small Cap fund, HAO, which advanced 5.07% in the first quarter. The one-year total return for HAO is +95.03%, significantly higher than the 51.89% total return for FXI. Another recently listed ETF that has done well so far is the Global X China Consumer fund, CHIQ, which targets an increasingly important part of the Chinese economy. The Chinese market is volatile and requires close monitoring.
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