Walk Softly and Carry Less Debt

By itself, the possible sale of Unocal Corp. to the Chinese firm CNOOC is hardly a big deal. Even if it were to happen (which seems to be growing less likely), Unocal accounts for only a couple tenths of 1% of global oil production.

But the very idea of such a sale raises a huge question: Despite the substantial benefits provided by trade and international investment, how much American economic interaction with China is too much? At a time when China is the world’s most impressive rising economy, yet still an autocratic state with, among other things, a declared willingness to use force against Taiwan under some circumstances, the United States needs to know where to draw the line.

There are three broad ways by which economic interaction with China could create a strategic threat to the U.S.

First, China could obtain advanced technologies not otherwise available to it that could increase its military capabilities quickly and dramatically.

Second, by becoming a critical source of key commodities, China could gain leverage over the U.S. that would allow it to coerce us in a crisis. (It is principally this worry that motivates opponents of Unocal’s possible sale to China National Offshore Oil Corp.)

Third, through design or by happenstance, China could gradually develop a type of economic relationship with the U.S. that would contribute gradually to our own decline, and hence its relative rise in the international pecking order.

All three of these scenarios deserve to be taken seriously. But, in fact, it is only the last one that should cause the U.S. angst at the moment.

Consider the other two possibilities first, though. It clearly would be worrisome if China gained from abroad the kinds of advanced military capabilities that it cannot yet build at home. These could include sophisticated command-and-control aircraft and other advanced military communications systems, stealth technologies for planes or submarines, or state-of-the-art supercomputers.

Unfortunately, Russia is selling some of these kinds of defense systems to China. But for the moment, at least, Europe has retained its ban on arms sales to China, Israel has been dissuaded from further transactions by pressure from Washington, and the U.S. is well prepared to stop such transfers by a combination of export-control laws and the Treasury Department’s Committee on Foreign Investments in the United States. The situation clearly bears further vigilance. But in policy terms, our strategy is already clear and already in place.

The second possible concern relates to the leverage China could wield against the U.S. in a crisis, perhaps dissuading us from coming to Taiwan’s defense. In theory, it could do so by dominating production of a necessary industrial good, cutting off the flows of critical natural resources on which our economy depends, or cutting off the flow of dollars by which we are currently financing our budget deficit.

But in practice, China is not in a strong position to do any of these things, and will not be anytime soon. For instance, though it accounts for about 20% of global computer product production, this is primarily not in top-of-the-line machines. And there are still several other major suppliers that could pick up the slack if Beijing threatened an embargo.

As for Unocal, the fact is that China still controls much less of the global energy production market than it requires in imports to sustain its own economy. Even with Unocal, most of its oil imports would come from companies owned by others.

And even in regard to the trade deficit, although China does indeed hold lots of dollars, this is not necessarily a major vulnerability of the United States. There is a form of double jeopardy at work; China now depends on U.S. Treasury bonds as much as we depend on it buying those bonds.

So the real concern is the last one— gradually becoming a hollow economy, living far beyond our means as we import far more than we export and as we build up huge debt-to-GDP ratios?

The peril needs to be kept in perspective: China is hardly buying up the United States with the dollars it earns from trade. Its net investment in hard assets in the U.S. as of last year was less than $1 billion, compared with U.S. assets of $15 billion in China.

But the U.S. net investment position against the rest of the world is indeed worsening, with foreigners now owning about $2.5 trillion more in U.S. assets than we collectively hold abroad. And because of the trade deficit, this figure is increasing by half a trillion dollars a year at present — still well under 1% of total U.S. assets, but substantial nonetheless.

The bottom line is clear: We need to reduce our budget and trade deficits, and do so soon.

Although vigilance about China is always warranted, the proper tool for rebalancing our economic relationship right now is neither tighter investment rules nor protectionism, but U.S. fiscal policy and further Chinese currency reevaluation.