Why the Chinese Trade Boom Could Cause the Country to Go Bust

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By Jason Simpkins
Associate Editor

China's trade surplus for the first 10 months of the year expanded by 59% to $212.4 billion, easily eclipsing the full-year record of $177.5 billion set in 2006.

According to figures released by the General Administration of Customs, October's trade surplus rose 13.6% from the same month last year, to a new monthly record of $27 billion. The previous monthly high was $26.9 billion set back in June.

The massive influx of foreign currency into China has resulted in excess liquidity, soaring foreign reserves and rapid inflation - all three of which are irritating trade partners. Still, the Beijing government has refused to let its currency appreciate.

Trade partners, specifically the United States and European Union, insist that the undervalued yuan provides China's domestic exporters a significant price advantage over competitors.

For the month of October, China's trade surplus with the EU rose nearly 50%, reaching $13.9 billion. According to the European Commission, the EU trade deficit with China rose by one-fifth last year, and is rising at a rate of 15 million euros an hour [the equivalent of $21.91 million an hour] - which is actually a higher rate than the one faced by the United States.

China is by far Europe's largest source of imported goods, but the 27 member nations of the EU export less to China than they do to Switzerland.

In October, China's surplus with the United States rose 12% to $15.7 billion. The United States reported a $232.5 billion trade deficit with China last year.

The United States has historically led the charge in lobbying China to abolish unfair trade practices, but the European Union isn't far behind. Admitting that the dialogue - and cooperation - with Beijing had broken down, European Trade Commissioner Peter Mandelson has been a leading critic of how European diplomacy has repeatedly failed to bring about changes in China's economic policy. Mandelson has even suggested that the EU should follow the United States' lead in levying trade sanctions against China.

In a four-page letter to the president of the European Commission last month, Mandelson referenced the "Chinese juggernaut," and challenged the EU to take a tougher stance, one more closely aligned with Washington, the International Herald Tribune reported. He said that, China has "failed to respond to a policy of cooperation and dialogue," adding that current policies are "no longer delivering sufficiently credible results."

In the letter, Mandelson wrote that European countries should be more willing to use the World Trade Organization's avenues of dispute resolution to enforce the rules, and noted that Europe's nations "shall also need to maintain rigorous use of anti-dumping and other means of trade defense."

Since 2001, Mandelson says, the EU has brought only one case against China to the WTO; the United States has brought six cases during the same period.

In economics, "Dumping" is another word for "predatory pricing," and is the term employed in international trade circles when one country sells goods in another market for a lower price than it sells those same goods back at home. It's a twofold strategy. It helps the exporter grab overseas market share. And, over the long haul, it can drive the targeted foreign rivals out of business, or at least weaken them so much that they're vulnerable to a takeover.

Japan was once the global bad boy when it came to dumping. In a famous WTO case in the 1990s, photo giant Eastman Kodak Co. (EK) alleged that Japan-based rival FUJIFILM Holdings Corp. [formerly Fuji Photo Film Co. Ltd.] (FUJI) was using its home market of Japan as a "profit sanctuary," by largely blocking out foreign competitors. Then it "dumped" film in the U.S. market, eroding Kodak's market share and its profit margins. Kodak lost the WTO case, Fuji built a modern film plant in South Carolina, and then digital photography leapfrogged conventional film much faster than anyone expected. Kodak has been an embattled corporation ever since.

Now China appears to have supplanted Japan as the dumping heavyweight; China is now the country that's the most frequent subject of anti-dumping investigations, with 36 complaints brought against its exports in the second half of 2006 alone. The second-place country, Indonesia, had seven cases brought against it.

Indonesia was the second biggest target with seven cases brought against it.

However, anti-dumping measures aren't all China has to worry about. Cash pouring into the country has also resulted in a higher rate of inflation. Food prices rose 17.9% in October from a year earlier, with pork soaring 55% and fresh vegetables spiraling 30%.

As a result inflation has been driven to an 11-year high of 6.5%. And most experts believe that figure is drastically understated.

"Food inflation has expanded into other categories - energy, labor and asset prices," Chris Leung, s senior economist at DBS Bank Ltd., told Bloomberg News. "Everyone in China is feeling inflation, especially the poor."

And the massive currency reserves aren't really helping the country, either. That's because the "money supply is growing very fast and that is [worrisome] because it may push inflation higher," Paul Cavey, an economist at Macquarie Securities Ltd., told Bloomberg.

China's central bank - The People's Bank of China - already has increased the proportion of deposits banks must hold in reserve nine times, a move aimed at reducing lending in the country. Three days ago, the central bank ordered lenders to set aside 13.5% of their deposits from Nov. 26, the highest proportion since 1987. The bank has also raised the benchmark one-year lending rate six times this year, and it now stands at a nine-year high of 7.29%.

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