Embrace China, but for just a moment

Australians should be mindful that China’s current importance is probably transient and there are subtle reasons to regard the US as Australia’s key partner.

East Asia Forum

Shiro Armstrong recently claimed in these pages that China is Australia’s most important economic partner, indicting Australian government endorsement of the US for the position. The defence of the US offered by Australia’s foreign minister Julie Bishop and others is unsatisfying, and the case for China is reasonable. However, Australians and others should be mindful that China’s current importance is probably transient and there are subtle reasons to regard the US as Australia’s key partner.

One way to argue for the US over the PRC, as Australia’s foreign ministry has, is to cite the larger stock of American investment in Australia as trumping Sino-Australian annual trade volume (which is much larger than US-Australian volumes). Armstrong is quite right to dismiss this. A trade dollar is not comparable to an investment dollar and merging them in one overarching ‘relationship’ figure does not make sense.

The stock of investment accumulates over time while trade is reset annually. If only annual transactions are compared, trade is much larger and swamps investment. More important, individual trade transactions are one-time while investment transactions constitute a continuing relationship. Hence trade and investment are separated into the current account and capital account, respectively, in the balance of payments.

There is also a practical reason not to stress American investment as crucial in determining the most important partner: American investment in Australia may not always outstrip Chinese.

American outward investment around the globe ebbs and flows, soaring in 2011 but slipping in 2012 and 2013. To this point, Chinese global investment, while it remains far smaller than American investment, has steadily increased. Further, Australia is more important to the PRC as an investment partner than Australia is to the US. So investment in Oz may not always be a bastion of American pre-eminence.

Meanwhile, Australian goods and services trade with China was more than twice as large as with the US in 2012–13. Perhaps more important, Chinese demand for Australian goods surged as the global recession hit in 2008 and accelerated through 2010. While other countries struggled with government borrowing and loose money as policy responses, Australia enjoyed very effective stimulus, courtesy of the PRC.

Oddly, though, it is trade that illustrates flaws in deeming China as number one. Growth in Australian exports to China has slowed considerably since 2010. While understandable, this is also set to continue. It may even be that exports will contract.

Iron ore, of course, dominates the trade relationship, accounting for about half of total exports and 30 per cent of all trade, including services. And iron ore exports have much more downside risk than upside.

There are two scenarios for Chinese steel production: no growth and outright decline. China has refused to rein in steel for some time. Regardless of whether or not Xi Jinping’s government is different from Hu Jintao’s, though, the industry cannot get bigger. Overcapacity is too extensive, exceeding demand by perhaps one-third.

If the current government in Beijing is actually serious about overcapacity, as it claims, steel is first on the chopping block. The process may have already started in the top provincial producer Hebei. In that case, total iron ore imports are likely to decline, threatening Australian producers.

Chinese urbanisation will not be riding to the rescue, as many commodities producers still hope. The wildly expensive forced urbanisation program bandied about a year ago all but disappeared at last month’s meetings of the National People’s Congress (thankfully). While it will still be discussed, it is highly unlikely to materialise. One reason: the size of China’s debt is prohibitive.

The same story holds for less-important metals such as copper and nickel. Other commodities could emerge as replacements, but Australian competitiveness in supplying China with coal, gas and wheat is unclear. If metals exports are capped indefinitely or shrink, Sino-Australian trade will be sizable but no longer exceptional.

As Armstrong notes, a painful contraction in metals exports would indeed prove China’s current importance to Australia. But that importance will also prove temporary, whether metals contract or just stagnate. Those espousing China as number one may be buying at the peak.

It is true that China being overvalued does not automatically make America undervalued. Australian trade with the US will remain considerably smaller even if China decisively curbs its steel industry. Dollar figures will still cast doubt on the US as top partner.

But dollars don’t reveal the full value of the US economically — something Singapore has not forgotten and Australia should not, either.

China has demonstrated ability to inhibit progress at the WTO, but not to lead it. The US is currently disengaged from the WTO but has certainly led in the past. Despite American missteps, the Trans-Pacific Partnership is an attempt at a deeply liberalising, even transformative agreement. The Regional Comprehensive Economic Partnership is far less ambitious.

If the global economy is going to be changed for the better, it will be done based on principles established by the US and with indispensable American participation. China is nowhere near this kind of global partner and does not look to be one anytime soon. This is also part of valuing an economic relationship.

The embrace of China as number one that Armstrong and others want should be a short one.

Derek Scissors is a resident scholar at the American Enterprise Institute.

InvestSMART FORUM: Come and meet the team

We're loading up the van and going on tour from April to June, with events on the NSW central & north coast, the QLD mid-north coast and in Perth, Adelaide, Melbourne, Sydney and Canberra. Come and meet the team and take home simple strategies that you can use to build an investment portfolio to weather any storm. Book your spot here.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles