May 5 (Reuters) - Senior U.S. and Chinese officials will grapple with the vast and sometimes contentious relationship between the world’s two biggest economies in two days of talks in Washington on Monday and Tuesday.
Here is an explanation of the issues that may be discussed at the latest annual Strategic and Economic Dialogue.
U.S. TRADE DEFICIT, CHINA‘S SURPLUS
A key cause of trade friction between Beijing and Washington is the U.S. trade deficit with China. Despite a pledge by both countries to work together on overcoming global imbalances, the U.S. trade deficit with China in 2010 rose to $273.1 billion, a 20.4 percent increase from the shortfall in 2009. That surpassed the record of $268 billion set in 2008, illustrating how heavily China still relies on exports to the United States to fuel economic growth. China’s own figures showed its overall trade surplus narrowed in 2010 for the second straight year. The 2010 surplus was $183.1 billion, down from $196.1 billion in 2009 and nearly $300 billion in 2008.
China’s currency policies have been a major irritant in ties for several years and a focus of U.S. congressional anger at China since at least 2005. Contention over the yuan exchange rate has cooled a bit this year, but remains strong. Many U.S. lawmakers believe the yuan is undervalued by 15 percent to 40 percent, giving Chinese companies an unfair price advantage in international trade.
China loosened its currency from a nearly two-year peg to the dollar in June, and this year the People’s Bank of China has guided the yuan to record highs. It has now appreciated about 5 percent since June 2010.
Policymakers in Beijing have made it clear they will deploy the currency as a weapon to fight inflation, which hit a 32-month high of 5.4 percent in March. With prices moving up much more rapidly in China than the United States, the yuan’s real exchange rate has risen about 10 percent since last June. U.S. Treasury Secretary Timothy Geithner said on May 3 that China would be better off allowing for a faster nominal appreciation that would help temper inflation.
The U.S. Treasury was scheduled to issue a semi-annual report on April 15 on the currency practices of U.S. trade partners that, in theory, could have labeled China a foreign exchange manipulator. That report has been delayed indefinitely and it is likely the Obama administration will opt for continued behind-the-scenes persuasion rather than roiling the diplomatic waters by calling Beijing a manipulator looking for a trade edge.
The Obama administration faces continued calls from Congress to do more to pressure China. The U.S. House of Representatives approved a bill last September pushing the Commerce Department to treat currency undervaluation as a subsidy under U.S. trade law. That would allow U.S companies, on a case-by-case basis, to ask for steeper countervailing duties against Chinese imports than they currently can. The bill died when the Senate did not hold a vote before its term expired at year end.
After a trip to China in late April, however, Senator Charles Schumer, a prominent Democrat from New York, said he was “more convinced than ever” of the need to pass legislation to force China to raise the value of the yuan. However, Republican leaders in the control of the House have said they have other priorities.
China has the world’s biggest foreign exchange reserves. They rose by nearly $200 billion in the first quarter to $3.05 trillion, with about two-thirds estimated to be invested in dollars.
Beijing has a big interest in protecting the value of those dollar-denominated assets and has repeatedly nudged Washington to give public assurances about government debt levels and the strength of the dollar.
After ratings agency Standard & Poor’s slapped a negative outlook on the United States’ top-notch AAA credit rating in April, China urged Washington to protect investors in its debt. But China has little choice but to keep its dollar-denominated debt for now, and that deters the government from voicing any worries about U.S. fiscal policy more loudly.
China has repeatedly warned that loose U.S. monetary policy risks undercutting the dollar, but it has continued to accumulate dollar assets. It bought about $260 billion of U.S. Treasury securities last year, according to U.S. data. With the Chinese government determined to limit yuan strength, it must buy a large amount of the dollars streaming into the country from its trade surplus, and it recycles those into U.S. investments.
The state of talks in Washington over cutting the U.S. budget deficit, on course to hit $1.4 trillion this year, will no doubt be a subject of discussion, as will the Obama administration’s related effort to convince lawmakers to raise the $14.294 trillion limit on the U.S. government’s debt.
Geithner has said China has confidence Congress would ultimately vote to raise the debt ceiling. If it fails to, it would ultimately lead to a first-ever U.S. debt default.
China has long faced American companies’ ire about widespread unauthorized copying of software, music, films and other products -- from luxury goods to industrial machinery. The International Intellectual Property Alliance, which represents U.S. copyright industry groups, has estimated U.S. trade losses in China due to piracy at $3.5 billion in 2009. Meanwhile, U.S. customs officials say 80 percent of the fake tennis shoes, clothing, luxury bags and other goods they seize each year at the border come from China.
China says it is making progress against intellectual property piracy and launched many enforcement campaigns to stamp out bootlegged books, music, DVDs and software. Still, all are still openly available in Chinese shops and street stalls. China remains on the U.S. “priority watch list” of countries deemed to have serious copyright and trademark theft.
Microsoft (MSFT.O) and other members of the Business Software Alliance in the United States complain nearly 80 percent of the software installed on personal computers in China is pirated. They have called for a “results-based” deal to boost U.S. software sales and exports to China by 50 percent in two years. China has said it is making progress in its campaign to ensure government offices do not use pirated software. Two-fifths of central government offices were using legal software and another two fifths were buying it, an official from China’s National Copyright Administration said.
Big U.S. companies like General Electric (GE.N) are worried that China’s industry-supporting “indigenous innovation” policies could make it more difficult for them to compete in China. The “indigenous innovation” regulations are intended to promote innovation within China and reduce its dependence on foreign technology and companies.
U.S. industry fears China is using discriminatory policies in areas from government procurement to technical standards and tax policy to promote its state-owned enterprises at the expense of foreign firms.
U.S. companies are also worried that under indigenous innovation, they may be forced to transfer development and ownership of intellectual property to China to participate in the country’s huge government procurement market.
President Hu Jintao and other Chinese leaders have indicated goods produced by Chinese affiliates of U.S. and other foreign firms would be considered indigenous innovation products. But the Obama administration and U.S. businesses have said they want stronger follow-up from Beijing to ensure that commitment is kept.
U.S. companies also complain that state-owned enterprises receive many other unfair advantages from the Chinese government. U.S. officials have said they would push in various forums for rules to establish a “competitively neutral environment” for state-owned enterprises.
China, which controls 97 percent of available global rare earth supplies, has alarmed its trading partners by restricting exports of the minerals which are used in a variety of clean energy and high-industry technologies. The U.S. Chamber of Commerce has pressed the United States to secure a commitment from China to remove rare earth export taxes and quotas, and the United Steelworkers union also raised concern about the issue in a petition to the U.S. Trade Representative.
China has defended its restrictions as measures to manage supplies and control pollution associated with rare earth production. USTR officials have said they are looking at what action they can take, and note they have challenged other Chinese export restrictions at the World Trade Organization.
Beijing complains that Washington, while pushing for greater access for U.S. firms in the Chinese market, imposes unwarranted restrictions on Chinese investment in the United States, often citing national security concerns. China says it wants a level playing field for its investment into the United States, saying that its intentions are benign and will benefit the U.S. economy and create jobs.
A new report this week estimates that China’s outward investment in new greenfield projects or mergers and acquisitions could increase sharply by 2020 to an estimated $1 trillion to $2 trillion. The United States says it is open to Chinese investment in all but a few cases, but accuses China of blocking investment completely in some industries or imposing onerous conditions on foreign companies.
China says it would also buy more from the United States if not for overly restrictive U.S. controls on high-technology goods. The United States says China’s argument is overstated, but it is in the process of reforming its export control system, which could lead to increased sales of some less-sensitive items.
Experts say better Chinese protection of U.S. intellectual property is a prerequisite for any major easing of export controls. Without that, say analysts, U.S. tech exports will taper off as Chinese firms copy the products. (Reporting by Chris Buckley and Doug Palmer; Editing by Chizu Nomiyama)