Chinese Trade Deficits-Don’t bet the Farm or the Yuan

China’s trade minister recently said that China may see a trade deficit for March 2010. The combination of a Chinese March trade deficit and US saber-rattling on the need for stronger Yuan have many people seeing a turning point in the continuation of US trade deficits with China. Does March signal a trend reversal in the Chinese trade surplus?

There are many factors that have led to a US trade imbalance with China. On the US side of the equation we see a nation with a low savings rate that has spent more than it has produced. At the same time we have seen a number of changes and advantages built into the Chinese economy. China has lower labor costs, less environmental regulation, an improved infrastructure and control of its currency. What do you get when you combine all the above mentioned factors from both countries? Significant growth in Chinese exports over the last generation.

What investors need to understand is that China will sustain important trade advantages regardless of a March trade deficit or even some Yuan appreciation. Today Credit Suisse economist Dong Tao pointed out that US trade imbalances “Are a consequence of its overconsumption and shrinking manufacturing base” and said that an appreciation of the Renminbi would not have much of an impact “unless the US rebuilds its manufacturing base.

One important factor that may be driving a temporary narrowing a trade imbalance between the China and the US is labor costs. The Chinese have recently made substantial wage increases in important export manufacturing provinces, with China’s Guangdong province raising the minimum wage by over 20% recently. Wage hikes may pair Chinese trade surpluses for the moment-but they cannot continue forever. Should these wage hikes continue they would trigger a large move of exported goods to other Asian economies that have lower wages than China. A move that the Chinese will not allow to occur in a big way.

Therefore investors should carefully watch and dissect the March trade numbers out of China. But don’t bet the farm or the Yuan on it continuing.

Steve Gear