Obama and the dragon

While diplomacy will be the order of the day during US president Barack Obama's first trip to China, trade tensions are simmering between the two nations. Obama has a good reason for taking aim at China.

The United States, the European Union and Mexico asked the World Trade Organization (WTO) last Wednesday to establish a dispute settlement panel and investigate China's restrictions on exports of nine key raw materials. The parties had sought formal consultations during the summer, but with the US Trade Representative spokesperson saying that consultations have been unsatisfactory, they now are moving on to the next level in their protests. The request for a settlement panel is the latest evidence of rising trade tensions as governments strive to recover from the global recession. And more importantly, it draws attention to growing trade frictions between the United States and China.

China claims the export restrictions are part of its pro-environmental resource preservation policies. But the practice in question reveals something more integral to China's economic system.

With a population of 1.3 billion people, China’s greatest fear is social instability; therefore, the government goes to great lengths to keep employment levels up. This requires maintaining production levels even in periods of low global demand, rather than cutting back on excess capacity and creating hordes of unemployed workers who might turn to protests. Hence, in the case of the raw materials in the WTO situation, the central government directs industries to stockpile massive amounts of raw materials for inputs and implements export restrictions to ensure that the domestic supplies are high and domestic prices are low. This cuts down on costs for producers, while subsidies are applied where needed to make up for the lack of profits.

With a deluge of Chinese products pouring across the globe, competing manufacturers are wiped out and China wins greater market share.

A problem with this practice arises if one happens not to be China. Prices for the same raw materials are high because China is hoarding them, so manufacturers elsewhere see costs rise and markets evaporate. This explains the unity in US, EU and Mexican demands that China cease this practice. Export restrictions (not to mention a variety of other charges against China) clearly violate WTO protocols – and though Beijing did secure a list of exceptions when it joined the WTO, the materials in this dispute are not included. According to WTO procedures, the four countries will have 60 days to try to resolve the disputes through the consultation process. It might be years before the trade body adjudicates a case like this. But at present, it's the threat that counts.

Nevertheless, the timing of Washington's move seems counterintuitive. Next week, US President Barack Obama embarks on his first tour of Asia since taking office, including a much-hyped three-day visit to China. Tensions are flaring on trade issues ranging from tyres, steel and chickens to intellectual property rights, climate change policy, and broader economic matters like exchange rates and deficits. Meanwhile, the Americans are concerned about China's stance on possible US-led sanctions against Iran, not to mention its expanding naval presence in the South China Sea. At the meetings, both sides will seek to smooth out the ruffles: Pledging cooperation despite differences and denouncing protectionism will be the order of the day. So why would Washington want to escalate tensions now?

The answer lies in Obama's domestic situation. The president has come up against a series of intractable problems that easily could spiral into crises for his administration – from the pending decision on US strategy in Afghanistan, to the showdown over Iran's nuclear program, to relations with Russia. Domestic woes, too, have piled up, including unemployment and the debate over health care reform.

But there is one sure way that the Obama administration can unify its core constituency – from union workers to human rights activists – and galvanize support when needed. And that is to take aim at China.

Stratfor provides intelligence services for individuals, global corporations, and divisions of the US and foreign governments around the world.

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