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With Chinese Visits Planned, Trade Deficit Is Front and Center

How much Americans pay for their next cell phones, weather-proof ski jackets, sport utility vehicles — or just about anything else they might buy — could be sharply affected by how well high-level talks go this week between the United States and China.

In his first visit as president of China, Hu Jintao will arrive at the White House Thursday for meetings with President Bush, and trade is expected to be among the top priorities. Chinese policy-makers came to Washington, D.C., last week to meet with Cabinet officials ahead of talks between the nation's two top leaders.

For American negotiators and policy-makers, the aim of those talks will be to knock back one of the most widely-quoted economic indicators: the $723 billion annual and growing trade deficit.

"China in the past year has become our third-largest trading partner, and we welcome the rise of a China that is a responsible stakeholder in the international system; that is, a China that cooperates with us to address common challenges and mutual interests," James R. Keith, senior adviser for East Asia and Pacific affairs at the State Department, told reporters on Monday.

"One of China's largest challenges is to continue to move from a half-reformed economy to a fully marketized system by opening China's markets to U.S. goods and services, respecting intellectual property rights and by moving toward a flexible market-based currency," Keith said.

Because trade with China represents more than one-quarter — or $202 billion in 2005 — of the overall U.S. trade deficit, that country's rapidly growing economy appears more and more tied to the success — or failure — of the U.S. economy.

Academics and industry observers say China's policy toward trade with the United States can ease America's trade deficit and help its economy stay strong, or it can help tilt the balance further against the United States and threaten America's economic health.

Hungry Student, Unhealthy Diet

Richard Marston, a finance professor at the University of Pennsylvania's Wharton School, said the U.S. trade deficit can be viewed like an out-of-control college student tapping into his parents' trust fund to buy pizza for his buddies. The student has the ability to buy more than he earns, but when the student loan bills come due, the money might not be there.

"The fundamental problem is that we are not producing enough relative to what we are spending," Marston said. "Eventually, the financing of that deficit won't be possible."

That means, Marston said, that the United States won't be able to pay off international loans and bills, and generally will no longer be able spend at historic levels. While it's not an immediate concern, if left unchecked a growing trade deficit could also deplete confidence in the historically healthy American economy, which would put jobs at risk, jar investment markets and cause domestic prices to soar.

The trade deficit has doubled since 2001 primarily because of two basic factors: federal spending has pushed past revenues in the current administration, forcing the U.S. government to borrow from abroad, and personal savings by Americans has also turned negative, with individuals on average spending more than they earn. As a result, the country is banking against its future, much like the out-of-control student, Marston said.

Americans' thirst for petroleum products is a major long-term factor weighing down the deficit, economists say. Low labor costs have shifted goods production to Asia and Latin America, which Americans aren't shy to buy. The U.S. tech sector and expensive products like airplane shipments are among the U.S. goods that have helped keep exports stable.

Other factors include international investment, job markets, industry trends, the cost of materials and exchange rates.

China's Controlled Currency

While most major world currencies are bought and sold on a world market — much like stocks and bonds, which means fluctuation occurs daily — China is tightly controlling its currency, the yuan.

Without the unlimited rise or fall of the yuan, the exchange rate to the U.S. dollar — at 8.35 yuan per one dollar — has remained stable, and many economists say, undervalued. If its value were allowed to rise, it would take an increasing number of dollars to buy yuan. At the same time, a dollar would be worth fewer yuan.

Facing pressure from the international community including the United States, China last summer began to let the yuan's value rise slightly. As of Monday, prices were 8.02 yuan per dollar. But lawmakers, academics, economists and labor representatives say the yuan, if left to drift on the open market, could gain another 30 to 40 percent in value against the dollar.

If the yuan spiked 40 percent, for example, that would mean a $100 American-made DVD player that cost the Chinese 800 yuan last week would cost only 571 yuan this week, and that would mean American products would be cheaper for the Chinese to buy, spurring U.S. exports.

The slow-paced rise of the yuan isn't fast enough for some politicians. Sens. Charles Grassley, R-Iowa, and Max Baucus, D-Mont., have introduced a bill that would change the rules on currency manipulation, increase the penalties the Chinese and others could face if they don't act more appropriately in the eyes of the critics, and create an assistant secretary position just to monitor currency.

Sens. Charles Schumer, D-N.Y., and Lindsey Graham, R-S.C., have threatened to bring a bill to a vote that would impose tariffs of 27.5 percent on Chinese goods if the Chinese don't take a more liberal approach to their currency. After a recent trip to China, however, the two said they would wait until September to see if China was serious about making changes it has pledged to make.

More Than Just the Funny Money

Add to the proper valuation of the yuan a 1.3 billion-strong populace and a workforce of more than half that, and China's ability to buy and produce goods has barely been tapped, said Frank Vargo, vice president of international economic affairs for the National Association of Manufacturers. He pointed out that last year the manufactured goods portion of the trade deficit was $55 billion — $40 billion of that deficit was with China while $15 billion was with all other countries combined.

By itself, Marston said he doesn't think focusing on exchange rates alone will work to solve the trade deficit, and suggested an overall federal budget cut is the best place to start.

"They know what to cut," Marston said of Congress without offering his suggestions of where to strike the budget.

Menzie Chinn, an economics professor at the University of Wisconsin-Madison, agreed that focusing on currency alone won't fix the problem. He said a yuan hike will affect only the portions of production that actually occur inside China. It will not impact the price of any materials sent to China to produce more complex items.

Chinn said he thinks energy will be key to either the deficit increasing or an improved trade balance. He suggested an energy tax of some sort to dampen the thirst for oil.

Sharp protectionism, though, which would be seen broadly in kicking out foreign companies or stopping their products at our shores, would also be a mistake, Chinn warned.

He pointed to the case of the Dubai Ports World deal earlier this year. The Bush administration had approved the sale of terminal operations at six U.S. ports by a British company to the United Arab Emirates-owned DP World. But a popular backlash forced reconsideration of the deal and a plan to sell DP World's American assets to U.S. companies.

Chinn said the scuttled deal by itself isn't a threat, but if similar moves are made on other firms, it could reduce foreign investment.

"If it's something that signals a big change in outlooks in investment in the U.S., then I guess you could have turmoil," Chinn said.

U.S. officials have other means to try to improve the trade balance. Through bilateral trade agreements, international trade bodies like the World Trade Organization and the International Monetary Fund, U.S. representatives can win greater trade freedoms with other countries while protecting U.S. industry from unfair trade practices.

The Treasury Department can also act as the currency police of sorts, by labeling countries currency manipulators. Treasury officials have declined to label China a manipulator so far, but Secretary John Snow is expected to issue a report by April 30, and if he declares China to be manipulating the yuan, which now seems less likely, he could refer the matter to the WTO or IMF.

China is accused of inadequate controls on intellectual property and giving unfair preference to its own exporters through tax breaks, loan cancellations and other perks, while being cool to import business.

"Governments should not be interfering with the markets," Vargo said. His group represents all major U.S. industries and lobbies on their behalf, including ones that have been hit by the Chinese problem like steel, furniture, plastics and machinery.

Last week, Commerce Secretary Carlos Gutierrez announced that the U.S.-China Joint Commission on China and Trade had reached agreement on opening China's markets to U.S. beef and medical devices, and more talks were being scheduled on telecommunications, steel, pharmaceuticals and access to government procurement contracts. Chinese officials also agreed to close factories producing pirated software and issue rules to require manufacturers to use legal software on computers sold in China, Gutierrez said.

For manufacturers, the trade deficit boils down to a simple problem, Vargo said. The more money that flows overseas, the more manufacturers at home close their doors, and jobs dry up.

The nation's unions will be keeping an eye on what happens this week, said AFL-CIO policy director and chief economist Thea Lee.

"We have a huge concern that our trade deficit is unsustainably large and potentially destabilizing, not just for the U.S. economy, but for the global economy," Lee said.