(Bloomberg Opinion) -- Don’t be surprised that China is sending its trade negotiators to Washington after all, having threatened to call off this week’s talks in response to President Donald Trump’s tariff threats. There’s one big, and perhaps overlooked, reason why Beijing must continue to pursue a deal with the U.S.: its critical need for dollars.
Consider how conditions have changed for China since officials sought to hammer out an accord a year ago. In May 2018, the economy was strong and Beijing saw little reason to yield to the Trump administration’s bellicose rhetoric. Nominal gross domestic product grew more than 10 percent in the first quarter of 2018 and hit 9.8 percent in the second. One year on, China’s economy is weaker and its need for hard currency has become more acute as external debt piles up.
Granted, the Chinese economy as a whole is less dependent on the external sector and the U.S. than it used to be – but it remains heavily exposed to this one relationship. In 2018, exports were equal to 18.3 percent of nominal GDP. Shipments to the U.S. amounted to 3.5 percent of GDP alone. By comparison, U.S. exports to China represent only 0.6 percent of GDP.
Wednesday’s trade figures underline that vulnerability. China’s exports dropped 2.7 percent in April, versus a forecast 3 percent increase, and imports unexpectedly rose by 4 percent. Shipments to the U.S. slumped 13.1 percent from a year earlier.
More important than the volume of trade is the surplus it generates. In 2018, China’s deficit with the U.S. was equal to 92 percent of its entire goods trade surplus. As a matter of economics, the bilateral trade deficit has little importance – contrary to what Trump often argues. But to China, the ability to generate hard international currency is vital.
China’s external debt stood at $1.96 trillion at the end of 2018 and has probably crossed the psychologically important threshold of $2 trillion since then. The country now needs more than $100 billion annually to service foreign debtors. The pressure to cover offshore borrowing and investing in hard currency is creating an increasing shortage of dollars in Chinese banks, which have been used for a variety of political purposes.
The need to generate dollars is affecting Chinese policy in multiple areas. Lending for Belt and Road projects has been falling by significant amounts as Beijing struggles to find greenbacks to fund the ambitious program. At a more mundane level, China is reducing the amount of hard currency consumers are allowed to withdraw.
China’s trade surplus with the U.S. expanded 10.5 percent (in yuan terms) in the first four months from the same period in 2018 – but for all the wrong reasons, as imports slumped by more than exports. Additional Trump administration tariffs would significantly curtail the trade balance, putting enormous strain on China to cope with U.S. dollar debts that need to be rolled over within the next 18 months.
Large swathes of the Chinese economy remain stagnant. Rapid growth in new total social financing and stalwart industries such as steel and real estate have ensured the headlines remain relatively upbeat. But trade is falling and consumer demand is weakening, with products from automobiles to appliances struggling. Official nominal GDP growth was 2.6 percentage points lower in the first quarter compared with a year earlier; unofficial data show even greater declines.
As long as Beijing refuses to make the yuan a freely traded currency, it will need to generate dollars. Beijing may not want to make a deal with Trump under these circumstances; it may have little choice.