U-T Special Report / The Dragon Awakes

Foreign investments, global demand for cheap goods and labor give China the fastest-growing economy in the world By Dean Calbreath UNION-TRIBUNE STAFF WRITER

March 20, 2005

SHANGHAI, China – Jostling with the crowds in

downtown Shanghai, it's easy to understand why

economists predict that China soon will displace the

United States as the world's biggest consumer nation.

Gleaming storefronts along neon-lit Nanjing Street are

laden with luxury goods by Ralph Lauren, Polo and

Prada – and many are the real thing, not the bootlegged

knockoffs sold on the cheap in the city's side streets and bazaars.

"A few years ago, nobody in China knew Lancome, Burberry or Louis Vuitton," said Annie

Wang, editor of a Shanghai fashion magazine. "Now they know everything and want everything."

The glitzy brands are just one sign of China's rapidly growing economic clout.

In the past decade, foreign investments and worldwide demand for cheap goods have turned

China's economy into the fastest-growing across the globe. It is expanding three times as fast as

the U.S. economy, four times as fast as Europe's and nearly nine times as fast as Japan's.

Some economists predict that by 2015, China will have enough spending power to become the

world's primary engine of economic growth, unseating the United States, which has held that

role since the end of World War II. By 2040 – and perhaps much sooner – China may have a

greater gross domestic product than the United States, giving it the world's No. 1 economy. It

now ranks at No. 3.

Although China's growth has been accelerating for some time, only recently has it become clear

how wide-ranging the repercussions are:

A construction boom in China – which is on pace to build the equivalent of a Houston or a

Philadelphia every month to keep up with rising population – has led to tight supplies and

higher prices for concrete, lumber, copper and steel throughout the world.

Christina Aguilera/UNION-TRIBUNE

Skyrocketing purchases of automobiles in China helped push global oil prices to near record

levels last year. With more than 2.4 million new drivers hitting the road in 2004, the country

guzzled 6.5 million barrels of crude a day, displacing Japan as the world's second-biggest oil

consumer. But it remains far behind the United States, which consumes 20.5 million barrels a

day.

China's cheap labor costs have lowered prices worldwide for such diverse items as televisions,

toys, T-shirts, kitchen appliances, athletic

shoes and power tools. The Morgan Stanley

investment bank says U.S. consumers saved

up to $600 billion over the past eight years by

buying Chinese imports.

China's manufacturing prowess also has

resulted in massive layoffs throughout the

world, as factories either were shut down or

moved to China to be competitive. The

Economic Policy Institute, a liberal-leaning

think tank in Washington, D.C., said the

United States is losing more than 2,000

factory jobs a month because of the shift of

work to China.

Many observers compare China's growth rate

to Japan's rise in the 1960s and 1970s,

emerging from the ruins of World War II to

become the world's second-largest economic

power.

But such comparisons underestimate China's

growth.

"China represents an entirely different future

than Japan did," said Ted C. Fishman, a

former currency trader who recently wrote the book "China Inc.: How the Rise of the Next

Superpower Challenges America and the World."

"China has an incredible domestic market which Japan never had. That will allow China to keep

growing instead of stagnating. And where Japan hit us very strongly in a few market sectors,

China is big enough to hit the whole world from every direction."

Money pouring in

Propelling China's growth is a steady stream of foreign investment attracted by the country's

seemingly inexhaustible pool of 1.3 billion workers and its growing body of consumers.

Economists note that even if only 8 percent of China's people made a middle-income salary, that

THE DRAGON AWAKES

Long an economic backwater, the world's

most populous country is becoming a

powerhouse with global economic clout.

Sunday: The effects of China's emergence as an economic superpower.

China's rise: The blueprint China's evolving ties with the United

States Imbalance of power U.S., Europe criticize yuan as an unfair

trade weapon Export boom tips balance of trade with

the United States

Monday: China's demand for building

materials drives up prices worldwide

Tuesday: Flexing power through trade

would still amount to 100 million people – a base of consumers almost as big as the entire U.S.

middle class.

Last year, foreigners invested $60 billion in the Chinese mainland and more than $30 billion in

Hong Kong. It was the second year in a row that the mainland displaced the United States as the

world's most popular investment locale.

The impact of that investment is magnified by the artificially low value of China's currency.

Economists estimate that one Chinese yuan can buy as much in China as $4.60 can buy in the

United States, so $60 billion worth of investments there has the same impact as $276 billion in

the United States.

Since China opened its economy to international trade in 1978, foreign investments have totaled

more than a half-trillion dollars, helping fuel one of the greatest industrial expansions the world

has ever seen.

Each year, between 15,000 and 20,000 manufacturing facilities are built in China, mostly with

foreign capital or with funding from China's debt-ridden banks, which have run themselves into

technical insolvency to keep the boom going.

Those factories draw several million workers a year from the poverty-stricken countryside –

typically young women in their late teens or early 20s who work for two to three years before

returning home to marry.

Although the factories pay workers an average of less than $1 an hour, they form the backbone

of China's economic expansion, enticing Western companies to invest in the country. To an

extent that has not been seen in other low-wage havens, such as Mexico or Thailand, China has

succeeded in using its factories as a base to create a viable middle class of managers, engineers

and designers. Chinese colleges pump out 325,000 engineers a year, while the country's

elementary schools prepare students for jobs that prize innovation over rote learning.

"When I was a child, we never learned much about science," said Wang Yongmei, who teaches

fifth and sixth grades in Yancheng, 300 miles northwest of Shanghai. "But our students are very

active with science, computers and information technology. And they are learning a lot of

English – writing essays about their daily life, families and friends."

Nationwide, this growth in the population of educated workers has helped boost salaries an

average of 250 percent over the past 10 years. The greatest growth has come in coastal cities,

such as Shanghai and Shenzhen, where salaries have nearly quadrupled. Although wages are

still low by U.S. standards – averaging $7,310 a year for a white-collar worker in Shanghai –

they are enough for Chinese consumers to start buying the accessories of modern life.

Nearly 82 percent of Chinese own a color television, compared with 40 percent in 1994. Nearly

two-thirds have a land-line telephone, compared with 10 percent a decade ago. Nearly half have

a videodisc player, according to a recent Gallup survey.

Golf as indicator

Although much of the nation still is impoverished, there is a growing element of wealth.

Such wealth is evident at the Mission Hills Golf Club in Shenzhen – the world's largest country

club – 90 minutes north of Hong Kong.

Although half of its members come from Hong Kong, as many as 3,000 come from the mainland

– entrepreneurs, factory owners and business executives with the money to pay the club's

minimum fee of $25,000 a year, which is enough to pay the average annual salaries of 25

Chinese factory workers.

Every weekend, Chinese entrepreneurs can be seen wandering through 10 lush 18-hole courses

designed by such greats as Jack Nicklaus, Ernie Els, Nick Faldo and Vijay Singh, or browsing

through the pro shop to check out equipment made by Callaway, Bridgestone and Titleist.

"There's a trend in China for picking up golf," said Mission Hills member William Hong, a

nattily dressed real estate agent who handles retail properties in Shanghai and Shenzhen. "For

me, golf is a multifunctional tool. Getting into the high-end lifestyle helps you meet wealthier

business people. It's easier to judge whether they're of good background."

Hong is a typical self-made entrepreneur, parlaying his one-time job as a public relations

manager for a real estate company into a thriving business for himself. He meets most of his

investors and clients on the course.

"In the past, you could meet business contacts through your bank or through the government,

but it could take a lot of time to know if they're financially sound," Hong said. "If you meet

people here, it saves a bit of time to dig out their history. If a person has the time and money to

play golf, it probably means they're financially stable. I can also project that kind of image."

A few dozen businessmen have each spent $1.8 million to $2.2 million on multistory homes

overlooking the golf course – mansions with pools, wine cellars, cinema rooms, saunas, billiards

parlors and hidden servants' quarters. The houses are in gated communities with names such as

Knightsbridge, Mayfair and Rosedale.

"Some of them are not even into golf," said Winky Wong, a spokeswoman for the club. "They

just like the environment."

Factory life

The wealth at the Mission Hills Country Club is a stark contrast to the low wages in the factories

in Shenzhen.

The widening gap between rich and poor has led to more worker protests, especially in

Shenzhen and the surrounding Guangdong province, home to many of China's export-oriented

factories. By official count, there were 833 worker protests in Guangdong last year involving 1

million workers, prompting the government to order factories to pay $84 million in back wages.

"There are a lot more protests than there used to be," said Susan Shirk, a former U.S. deputy

assistant secretary of state for China who now teaches international relations at the University of

California San Diego. "But so far the government has done a very effective job of dealing with

them: siding with the protesters, paying them off, blaming local officials for any problems and

then throwing the protest organizers into jail."

Zheng Juan is a typical worker. Zheng grew up on a farm in rural Anhui province in southeast

China and started factory work as soon as she graduated from high school.

In her first job, Zheng often toiled from 8 a.m. to 10 p.m. gluing together shoes at a shoe factory,

working every Saturday and most Sundays, and earning three days of vacation per year.

"It was very bad," she said.

Working such hours nearly every day with little vacation also violated Chinese labor laws, which

are seldom enforced.

Now 20, Zheng works for a Taiwanese-owned subcontractor for a major American athletic-shoe

maker. The hours are much better, she said, since Verité – an Amherst, Mass.-based labor rights

organization – began working with the owners to keep the factory in compliance with Chinese

law.

Zheng still works six days a week for about $90 to $120 a month, depending on how much

overtime is involved. But she gets Sundays off and works no more than 36 hours of overtime a

month. The company does not charge Zheng for the rough-hewn bunk bed in a 250-square-foot

dorm room that she shares with five other workers. Other factories charge workers as much as

half their monthly pay for such lodgings.

"Our factory is like a home," Zheng said recently while dining with friends in downtown

Shenzhen. "I've got very good wages and very good working hours."

Qing Zhang, who heads Verité's operations in China, says Zheng's positive feelings about her

factory are not unusual, despite the low wages and overtime.

"These kids from the countryside remind me of my parents' generation," Qing said. "Kids in the

cities expect a lot nowadays: high pay, ability to go overseas, ability to criticize the government.

But workers in small towns have no sense of entitlement."

Even so, she adds, workers from the countryside are increasingly apt to protest as the gap

between rich and poor widens in China.

Back in Shanghai, Wang, the fashion editor, also worries about the increasing divide between

rich and poor.

At a karaoke party with friends – twentysomethings in China's rising middle class – she watched

as they puffed on Mild Seven cigarettes and ordered bottles of VSOP cognac, Baileys Irish Cream

and Johnnie Walker whiskey, some of which cost more per bottle than an average worker in the

countryside makes in a week.

Wang listened as a young office worker wondered how much flirting she should put up with

from her married, middle-age boss in order to get ahead. She eavesdropped on a venture

capitalist boasting about the amount of foreign investment money he has been able to attract.

"In the old days, there was a noble quality to not having much wealth in China because everyone

knew that everyone else was in the same situation," Wang said. "That noble quality is gone.

People have realized how poor they are. And right now they are very focused on building

capital."

U-T Special Report / The Dragon Awakes

China's rise: The blueprint

By Dean Calbreath UNION-TRIBUNE STAFF WRITER

March 20, 2005

"It is glorious to get rich."

When the late Chinese leader Deng Xiaoping first uttered those words in 1978, China was one of

the poorest nations on Earth.

Nearly one-quarter of the population – 250 million people – did not have proper food or

clothing. Much of the country lacked electricity, running water or even outdoor toilets. One out

of 300 people owned a telephone. Fewer than 5 percent of households had refrigerators or

washing machines.

Today, China has a consumer class that soon could rival that of the United States. Its highways

are jammed with automobiles. Middle-class homes are equipped with DVD players and laptop

computers. Stores are full of shoppers seeking the latest goods. Although poverty still plagues

the countryside, salaries there have doubled in the past 10 years and tripled in the cities.

So how has China expanded its economy when other countries, such as Mexico and India,

remain burdened by overwhelming poverty? Here are a few answers:

1. Acquiring knowledge

As foreign firms entered China, Beijing pressured them to share their technologies with Chinese

partners. To launch a factory in China, manufacturers often were required to set up research

labs or sponsor technical training programs, such as the telecom schools that Qualcomm,

Motorola and Ericsson run in Beijing.

Christina Aguilera/UNION-TRIBUNE

Armed with new technologies from abroad, the Chinese have begun building domestic firms that

can compete in the global marketplace, such as the ZTE and Huawei wireless firms and Haier,

which makes refrigerators and other major appliances.

The emphasis on acquiring knowledge goes beyond technology. It also entails picking up

business skills that were lost during the Maoist era.

Niko Canner, head of the Katzenbach Partners management consulting firm in New York, said

China emphasizes having its executives learn Western management skills – either by working at

foreign firms or studying for master's degrees in business administration.

"There's a mentality among Chinese MBAs that's different than anywhere else in the world," said

Canner, whose firm is tracking the careers of more than 100 Chinese MBAs. "In a way that's

unique to China, they view professional management as an ethical calling, which will help China

become a better place and fulfill its destiny."

2. Impetus for change

Deng launched his reforms at a critical time in China. After three decades of unremitting poverty

under communist revolutionary leader Mao Zedong, including a decade of severe political

repression under the Cultural Revolution, the public was soured on Maoist appeals to "Serve the

people and build the revolution."

"The Cultural Revolution left China particularly demoralized," said Susan Shirk, a professor of

international relations at the University of California San Diego who recently wrote a book on

China's economic policies. "Deng was looking for a way to rebuild popular support for the

Communist Party's rule, and he felt the party needed to prove it could deliver economic growth."

Although Deng twice had been persecuted during the Cultural Revolution for not being

sufficiently hard-line, he was no wild-eyed reformer. Among other things, he supported the

shooting of protesters in Tiananmen Square in 1989. But he realized that if the Communist

Party was going to stay in power, it would have to improve the lives of the people. The only way

to do that would be to allow more economic freedom.

3. Openness to foreigners

One of Deng's first steps was to open China to outside investment, reversing Mao's ban on

foreign-owned factories. Deng's move was not immediately popular.

"Even 10 years ago, people were worried that foreign companies would come in and occupy

China like armies," said Wang Ping, who heads the Chinese operations of Germany's Henkel

Loctite Co. "But we needed jobs, and our capital was limited. So the government said let's invite

them in and let them make money as long as they hire our people and pay taxes."

By the late 1970s, manufacturers from the then-British colony of Hong Kong began opening

factories in special economic zones in China. But the flood of foreign investments really took off

in the mid-1990s, when multinationals such as Motorola and Sony launched Chinese operations.

To a large extent, China's modernization has been fueled by investments from abroad. Foreign

companies are investing $60 billion a year in the Chinese economy, employing millions of

workers.

"Now," Wang said, "nobody complains about the foreigners."

4. Central planning

Even after China opened its markets, the government retained a strong role in economic

development. It can raze farmlands or old neighborhoods easily to pave the way for factories and

new housing. And it can unilaterally decide where to establish business clusters: designating

Datang as a factory town for socks, for instance, while nearby Shengzhou specializes in ties.

In the once-rural city of Yancheng, this style of planning is on display in the showroom of the

Municipal Development Planning Commission, where a massive model of the city covers about

one-third of an acre on the building's ground floor.

The map does not show what Yancheng looks like now, but rather what it will look like in 10

years, showing the roads, factories and apartment houses that will be built as the city more than

triples in size from 300,000 to 1 million people.

"The municipality has decided that autos will be the mainstay of the city," city spokesman Xu

Xiaoyuan said as he pointed to the model of an automotive plant on the map.

Korea-based automaker Kia operates a factory in town, and there are a handful of auto

equipment suppliers. The government has spent $25 million laying the groundwork to help Kia

expand: building a bridge, roads, a power plant, water mains and gas lines. The government is

training local farmers for new careers as autoworkers. And it is working to bring other auto-

related companies into town.

Each big city in China has a scale model like Yancheng's, serving as a tangible goal of what the

future will look like. That kind of planning mystifies Americans, who are used to a more laissez-

faire approach. So far, the Chinese appear to be hitting most of their goals.

U-T Special Report / The Dragon Awakes

As U.S. trade gap balloons, China soars with more high-tech products and leaves behind its cheap-export reputation

By Dean Calbreath UNION-TRIBUNE STAFF WRITER

March 20, 2005

YANTIAN, China – A dozen years ago,

Yantian was a tiny fishing village

surrounded by a brush-covered

shoreline, known only to weekend

beachcombers from the nearby

industrial city of Shenzhen.

In the past decade, the fishing village

has exploded into a megaport that

handles more cargo containers than

New York or Long Beach, and it is one of

the most humbling examples of what the

growing trade imbalance between China

and the United States really means.

When cargo ships leave Yantian's sprawling docks, they are laden with 20-foot containers of

toys, garments, furniture and other goods, mostly bound for the United States. When the ships

return from abroad, 70 percent of the containers are empty.

There are so many empty containers that the port has set aside a special platform to speed them

through customs, so they can be refilled quickly with export items and shipped back overseas.

"If empty cargo containers were a product, they would be our largest export to China, which sort

of begs the question of who is the advanced country and who is the developing country," said

Bob Baugh, who heads the Industrial Union Council of the AFL-CIO.

"China imports raw materials from us and exports finished goods," said Peter Schiff, president

of Euro Pacific Capital in Newport Beach. "That's what America used to look like not too many

years ago. But judging from our trade activity, now we look like a colony and they look like the

empire."

The U.S. trade gap with China has been widening ever since Deng Xiaoping opened his nation to

foreign trade in 1978. From 1978 to 2001, Chinese exports rose more than 15 percent a year –

ANDREW WONG / Getty Images

THE OLD: When China opened to foreign markets, it specialized in

low-skilled factory work, such as the work still being performed at

this textile mill. By the late 1990s, it dominated world production

of such goods as shoes, toys and clothing.

nearly twice as fast as U.S. exports and easily besting the performance of any other major

economy.

That was just for starters.

Since China entered the World

Trade Organization in 2001, its

exports have grown more than 30

percent a year, helping China

unseat Germany last year as the

world's third-largest trading

power behind the United States

and Japan.

Last year, the U.S. trade deficit

with China soared 31 percent to

$162 billion – the biggest

imbalance ever recorded between

any two countries. Seven years ago,

the U.S. trade deficit with the entire

world was lower than its current

deficit with China.

"China's export growth represents extraordinarily fast-paced integration for an extraordinarily

fast-paced economy," said Edward Gresser, director of the Progressive Policy Institute in

Washington, D.C.

Gresser said the United States has never had 30 percent export growth except after wars: 1946,

after World War II; 1919, after World War I; and 1866, after the Civil War. The only two-year

period of such growth was 1815-16, after the War of 1812.

"China's growth makes the competitive world a lot tougher for the U.S.," Gresser said.

In the early days of Chinese trade, most Chinese exports were cheap, low-quality, labor-

intensive products such as toys, shoes and clothing. As with many developing countries, China's

chief tool for attracting foreign manufacturers was to offer low-wage semi-skilled labor,

bolstered by an artificially low currency.

The salary and benefits of a Chinese factory worker average about 92 cents an hour, according to

a 2004 study by the Goldman Sachs investment firm. That compares with $1.20 in Thailand,

$1.70 in Mexico and $21.80 in the United States.

But Goldman Sachs may be overestimating. A study commissioned late last year by the U.S.

Bureau of Labor Statistics estimated that the average Chinese factory worker makes 64 cents an

hour, including benefits.

The low wages have drawn businesses from around the world to China. Between 15,000 and

20,000 new manufacturing facilities open each year in China – mostly subcontractors to U.S.

FREDERIC J. BROWN / AFP/Getty Images

THE NEW: China's factories have become increasingly high-tech. They now make most of the world's TVs, cell phones and computers - and account for nearly all of the growing U.S. trade deficit in high-tech products.

and other foreign firms. Many of the factories are more modernized than their rivals overseas,

giving them a competitive edge. Nearly half of Chinese factories are less than 10 years old,

compared with less than 10 percent of U.S. factories.

"While America's industrial base continues to erode, China has been investing steadily in new

plants and equipment, adding state-of-the-art production capacity," said Jim Pinto, founder of

Action Instruments, who now works as a business consultant in San Diego. "America is just not

investing in machinery the way that China is."

More than 1.7 million U.S. factory workers have lost their jobs to China over the past 15 years,

according to the Economic Policy Institute in Washington, D.C. The rate of job losses has been

increasing steadily: 70,000 per year between 1989 and 1997; 105,000 per year between 1997

and 2001; and 234,000 per year since China entered the World Trade Association in 2001.

As long as only low-skilled jobs were being transferred to China, relatively few politicians or

economists complained. They maintained that the United States could ship its low-wage work

overseas while keeping a lead in high-tech industries.

"For the past few decades, the Western world assumed that it could let countries like China do

all the cheap, low-cost manufacturing while the West concentrated in more knowledge-intensive

industries," Pinto said. "But that's not true with China. They're coming up with companies that

can challenge Cisco, which has some of the best technologies around. And they're competing in

biotech and a lot of other areas, too."

Cisco, the world's largest computer networking company, is facing tough competition from

China's Huawei, which has teamed with 3Com to produce rival equipment.

China now produces half of the world's DVD players and digital cameras, more than one-third of

its personal desktop and laptop computers, and about one-fourth of its mobile phones,

televisions and car stereos.

In Shenzhen, the toy and clothing production lines that feed the ports of Yantian are being

supplemented with new high-tech campuses exporting telecommunications and electronics

equipment.

"In the past few years, we've really pushed forward the intellectual life of Shenzhen so that we

can industrialize our intellectual property," said Zhang Hengchun, deputy director-general of

the Shenzhen High-Tech Industrial Park, one of five government-supported science parks in the

city.

Zhang said his park exports more than $3 billion in telecommunication and high-tech products

each year, more than half of which were produced and developed within the park rather than

being contract work farmed out from abroad.

Even in Shenzhen's low-tech factories there are signs that a high-tech revolution is taking place.

Many of the factories offer computer classes to help their workers prepare for their next jobs.

Luo Yong, a 19-year-old from rural Jiangtze province, said she took her job in a Shenzhen shoe

factory specifically so she could take advantage of its after-hours computer training classes.

"My parents, who worked in the fields, weren't satisfied with the education I was getting in the

countryside, especially since our school didn't have any computers," Luo said. "I figured I would

get more exposure to computers in Shenzhen. I'd really like to work in computer design."

The latest trade figures demonstrate how China is expanding more into high-tech trade. As

recently as June 2002, the United States exported more high-tech equipment than it imported.

But that trade advantage no longer exists. Last year, the United States ran a record $37 billion

tech deficit, with 99 percent of the deficit attributed to China.

At a time when U.S. colleges are reporting declining enrollments for engineers, Chinese colleges

are churning out 350,000 engineers a year, which suggests that greater technology deficits are

in store in the future, as China pushes more of its own products onto the market.

Politicians in Washington are becoming vocal about the trade gap. A dozen senators last month

a measure to impose tariffs on China unless it begins to boost the value of its currency, the yuan,

to alleviate the trade deficit.

So far, the White House has voiced lukewarm support for revaluing the yuan, although it

opposes the idea of tariffs. Its main tools for fighting the trade deficit have been anti-dumping

suits, which accuse the Chinese of exporting goods below the cost of production.

In the past several years, the White House has filed anti-dumping suits involving a wide variety

of items, including socks, bras, televisions, shrimp, furniture and steel.

The drawback of anti-dumping suits is that they only affect companies that are headquartered in

the targeted country – in this case, China.

The bulk of the U.S. trade deficit with China does not come from Chinese companies.

Between 60 percent and 80 percent of the goods China exports to the United States are the

products of such companies as Adidas, Sony, Mattel, Walt Disney, Dell Computers or other

multinationals that have set up shop in China to take advantage of its low costs. Those

multinationals would not be affected by anti-dumping rules.

"China is unfairly singled out because it is at the end of the production chain," said Gordon

Hanson, an economist at the University of California San Diego.

The recent rumbling about tariffs and dumping in Washington suggests that trouble is brewing

over the trade deficit. The attacks on China are reminiscent of the "Japan bashing" that occurred

in the late 1980s, when labor unions and politicians pushed "Buy American" campaigns to

counter cheap Japanese imports, going so far as to smash Japanese TV sets on the steps of the

Capitol.

Few pundits envision that happening with Chinese goods.

Because the United States has moved so much of its factory work overseas, whole categories of

goods are almost entirely made abroad, including textiles, toys, televisions, computers and DVD

equipment.

If consumers tried to "Buy American" goods in those categories, they would come away empty-

handed, because most no longer are made in the United States. Fewer than 10 percent of

Chinese imports compete directly with U.S.-produced goods.

"The problem is not that foreigners shun American products, but simply that America is not

producing any that are worth buying," said Euro Pacific Capital's Schiff. "We're working hard

these days, but we're not producing anything. All that China is doing is being our enabler,

providing us with goods as we don't produce anything."

U-T Special Report / The Dragon Awakes

China's evolving ties with the United States 1949 People's Republic of China is

born after a bloody civil war

between Communists and

Nationalists, who retreat to Taiwan.

The United States recognizes

Taiwan, but not the mainland.

1956 Private property is banned.

1959-61 The Great Famine kills

millions of Chinese. Historians say

the famine was exacerbated by

China's collective farm policies.

1966-69 The Cultural Revolution

devastates China.

1971 Ping-Pong matches between

the United States and China renew

ties between the nations.

1972 President Nixon visits China,

shifting U.S. focus toward Beijing.

1976 Communist leader Mao

Zedong dies. The Gang of Four,

blamed for many of the excesses of

the Cultural Revolution, is arrested.

1978-79 Deng Xiaoping takes

unofficial control of China,

loosening bans on private property.

An early experiment with free

speech, the Democracy Wall, is

born and fades. President Carter

establishes full diplomatic ties with

Beijing.

1985 Mikhail Gorbachev takes

command in the Soviet Union,

beginning a long wave of reforms

throughout the communist world.

1987 Anti-government protests

lead to shake-up of China's

Politburo.

1989 Chinese army cracks down on

protesters in Tiananmen Square,

killing many demonstrators.

Relations between China and the

West temporarily chill.

1997 British colony Hong Kong

reverts to Chinese control. Deng

dies.

1998 Premier Zhu Rongji stresses

policy of economic pragmatism.

2000 United States grants China

permanent normal trade relations.

2001 China enters the World Trade

Organization and secures the 2008

Olympics for Beijing.

2003 President Hu Jintao and

Premier Wen Jiabao take charge,

representing the first generation of

leaders with no adult memories of

China's revolutionary period.

President Bush works with China to

resolve nuclear issue in North

Korea and warns Taiwan against

provoking Beijing.

2004 The Bush administration

launches a series of anti-dumping

lawsuits against Chinese imports.

Former Chinese Foreign Minister

Qian Qichen attacks Bush's foreign

policies for their "cocksuredness

and arrogance."

LOOKING AHEAD

2010 China joins the Association of

Southeast Asian Nations, or

ASEAN, in creating the world's

largest tariff-free trade zone, with

an 11-nation region of more than 2

billion people. (Source: ASEAN)

2014 China outstrips Japan as the

world's second-largest economy.

(Source: Goldman Sachs)

2015 China surpasses the United

States as the primary driver of the

global economy, based on strength

of consumer spending and the rate

of annual growth. (Source: Fred

Alger Management)

2020 China and ASEAN create

unified political and economic

community, similar to the

European Union. (Source: ASEAN)

2022 China becomes the second-

largest airline market, with five

times as many air passengers as

today. (Source: Airbus)

2025 China outstrips the United

States as the world's largest

automobile market. (Source:

General Motors)

2034 Chinese bank deposits

surpass deposits in the U.S.

(Source: HSBC Bank)

2039 China outstrips the United

States as the world's biggest

economy. (Source: Goldman Sachs)

2050 The Chinese economy could

be 75 percent bigger than the U.S.

economy. (Source: Harvard

economist Jeffrey Sachs)

U-T Special Report / The Dragon Awakes

U.S., Europe criticize yuan as an unfair trade weapon

By Dean Calbreath UNION-TRIBUNE STAFF WRITER

March 20, 2005

Over the past 10 years, as the Chinese economy galloped forward, one key item was frozen in

place: the value of the yuan, or renminbi, known in China as "the people's currency."

Since May 1995, the yuan has traded at a rate of about 8.28 to the dollar.

While the yuan once was praised as a model of stability on the often volatile Asian continent, it

now is being attacked as an unfair trade weapon.

From the European Parliament to Capitol Hill, critics say China has unfairly rigged the yuan to

keep its exchange rate low, giving it an unfair trading advantage against other currencies.

"China's refusal to play by international economic rules cripples our ability to compete on a level

playing field," Sen. Charles Schumer, D-N.Y., said last month he introduced a bill to impose

tariffs on Chinese imports unless Beijing raises the value of the yuan.

So far, Chinese officials have balked at the pressure, which comes not only from Congress but

from the leaders of the European Union and the Group of Seven industrialized countries.

"China needs more time to reform its banking and financial systems to pave the way for

reforming the currency policy," Zhou Xiaochuan, governor of the state-run People's Bank of

China, told reporters after a meeting of the G-7.

Zhou reiterated – as Chinese officials have many times in the past several years – that he

eventually would like the yuan to trade more freely, but not if it will jeopardize China's growth.

Developing countries often strive to keep the value of their currencies low in order to make their

products attractive to outside buyers. Japan began its meteoric economic rise in the 1960s by

keeping the value of the yen low.

That has become more difficult over the past several years, as the value of the dollar has plunged

because of massive U.S. trade and budget deficits. The plunge in the U.S. dollar has meant a rise

in such currencies as the Canadian and Australian dollars, the British pound and the European

euro.

Some countries – notably China, Japan and South Korea – have used their own currencies to

buy vast amounts of U.S. dollars in order to keep the value of their own currencies from rising.

To keep the value of the yuan low, China has built a $600 billion foreign currency reserve,

including $194 billion in U.S. Treasury bills. Only Japan holds more securities, with $712 billion.

Together, Japan and China finance the bulk of the U.S. debt.

Economists estimate that China's reserves keep the yuan undervalued by 15 percent to 40

percent.

"That's the largest export subsidy – and the largest transfer of wealth – in the history of

mankind," said Peter Morici, a University of Maryland economist.

The low value of the yuan makes Chinese wages and real estate prices seem lower than their

actual value in the Chinese market.

Economists at the World Bank estimate that $1 worth of yuan can buy as many goods in China

as $4.60 could buy in the United States, so a Chinese worker making the average salary of 92

cents an hour would have the purchasing power of a worker making $4.23 an hour in the United

States – well below the U.S. minimum wage of $5.15 an hour.

To help alleviate that gap, Schumer and his allies on Capitol Hill say China must begin acting

within the next six months to boost the yuan by 15 percent to 40 percent. If it does not, their bill

would impose a 27.5 percent tariff on Chinese goods.

Some voices in Washington urge caution. Former U.S. Treasury Secretary Robert Rubin last

month that a massive revaluation in China could hurt U.S. financial markets and the dollar by

discouraging China from buying U.S. securities.

"You wouldn't want them to stop buying dollars," Rubin said. "That could be awkward."

Even if Beijing decides to revalue the yuan, it is unlikely to let it rise anywhere close to 40

percent, for fear of throwing the economy into recession. The best guesses on Wall Street are

that China may revalue between 5 percent and 7.5 percent. Morici said such a move would be

"inconsequential."

Even if China revalued the yuan by 40 percent, U.S. companies would have difficulty competing

on wages. The average U.S. factory worker makes in two weeks what the average Chinese worker

makes in a year. If the yuan were revalued by 40 percent, it still would take a U.S. worker less

than three weeks to make an annual Chinese salary.

U-T Special Report / The Dragon Awakes

Boom felt across globe China's voracious appetite for materials drives up costs in West

By Dean Calbreath UNION-TRIBUNE STAFF WRITER

March 21, 2005

SHANGHAI, China – From the Cloud 9 bar atop the world's highest hotel, a visitor can get a

bird's-eye view of the world's largest construction boom, which has fueled price increases and

market disruptions around the globe.

Just 15 years ago, the Pudong area of Shanghai consisted of little more than dilapidated housing

and muddy patches of ox-plowed farmland. Now it looks like downtown Manhattan.

From Cloud 9's windows on the 87th floor, visitors can pick out some of Pudong's more

flamboyant buildings: the Oriental Pearl, Asia's tallest TV tower, which is studded with glass

spheres that house stores, restaurants and museums; the sprawling Opera House, with separate

venues for folk music, Chinese opera, classical music and Western opera; and the Science and

Getty Images

Chinese mills in cities such as Baotou are producing steel at such a rapid rate that China soon could be producing enough to meet its needs

Technology Museum, one of the world's biggest, featuring an indoor rain forest and a 230-foot-

tall geodesic dome.

And that's just one neighborhood in one Chinese city.

Each month, China needs to build the equivalent of a Houston or a Philadelphia just to keep up

with population growth. Each year, Shanghai – about the geographic size of the city of San Diego

but with 10 times the population – constructs or renovates 200 million square feet of building

space, about the same amount as all the office space in New Jersey.

To fuel that boom, and to feed its hungry factories, China uses more than two-fifths of the

world's annual output of cement, one-third of its iron ore, one-quarter of its lead and steel, and

more than one-fifth of its copper, aluminum and zinc.

The country's unprecedented demand for raw materials has had far-reaching effects, helping

drive up the price of raw materials last year and creating short-term shortages throughout the

world.

When victims of the 2003 San Diego County wildfires tried to rebuild their homes, some were

told the price of wood had risen because of demand from China. And when the Sweetwater

School District in Chula Vista wanted to repair some of its facilities last year, it had a hard time

finding cheap concrete because so much was being used by China.

"A number of factors affected construction costs and timelines, but not the least was the

tremendous demand for concrete and steel from China," said Bruce Husson, Sweetwater's chief

operating officer.

Partly because of the price increases in raw materials, Husson said, some contractors submitted

bids last year for almost twice what the projects were budgeted for.

"We had to slow down a number of (contract) awards because we couldn't afford such exorbitant

prices," he said.

To most consumers, perhaps the most visible effect of China's growing demand is the recent rise

in worldwide oil prices, as an ever-increasing number of Chinese switch from bicycles to

automobiles.

More than 2 million new drivers hit the roads in China last year – helping make China the

world's No. 2 consumer of oil, after the United States – and the number of new drivers is

increasing at double-digit rates each year.

"The unexpected demand from China helped push crude oil prices above $50 a barrel," said Joe

Sparano, president of the Western States Petroleum Association. "You have a market of 1.3

billion people that has suddenly discovered the automobile."

Although China represents only 8 percent of the world's oil demand – compared with 25 percent

for the United States – its thirst is increasing exponentially and represents 50 percent of the

growth in the market.

Steel and concrete

China is not the only reason

for last year's shortages and

price increases. War,

terrorism and political

disruptions helped push up

the price of oil. Hurricanes

and plant consolidations

also put a crimp on building

materials. Renewed

production by North

American factories chewed

into metal supplies. In

California, the demand for

construction materials was

also driven by a spate of

public works projects.

Unlike one-time events that roil the marketplace, China's demand for raw materials represents a

growing source of pressure that could affect commodities for decades to come.

"Over the long term, China's appetite for commodities and energy suggests that prices will rise,

which will mean less spending power for the U.S. consumer and slimmer profit margins for U.S.

companies," said Zachary Karabell, senior economic analyst and portfolio manager of the China-

U.S. Growth Fund at Fred Alger Management.

There have been positive side effects of China's expansion. It has created a new market for

suppliers of raw materials from Chile to South Africa and has breathed new life into the copper

mines of Arizona, cement plants of California and steel mills of Pennsylvania.

As recently as three years ago, U.S. steel mills were in crisis, facing low-cost competition from

China and other foreign locales. Some U.S. companies, led by the venerable Bethlehem Steel,

filed for bankruptcy. Others shut down their mills and blast furnaces. Nationwide, steel mills

were running at 78 percent capacity.

The situation was so bad that steel companies persuaded the Bush administration to go against

its own laissez-faire inclinations and briefly impose trade barriers against Chinese and European

steelmakers.

As China's construction boom took off over the past five years, the global steel market tightened,

prices rose and steel mills in the United States revved up to 94 percent of capacity.

File photo / AFP / Getty Images

A billboard advertises construction of a business center in Beijing. The building boom in China has put a pinch on raw materials worldwide.

"In a relatively short period of time, most of the mills that had gone idle came back on line," said

Nancy Gravatt, spokeswoman for the American Iron and Steel Institute. "All the steel mills were

working fast and furious to meet the needs."

Thanks largely to demand from Asia, the U.S. steel mills should be humming for at least the next

two years, according to a recent report from the International Iron and Steel Institute.

The cement industry saw a similar increase in demand. At the peak of the market last year, all

118 cement plants in the United States were operating at close to 100 percent capacity, and even

then they could not keep up with demand. Last fall, 35 states including California were suffering

cement shortages, causing delays for some construction projects, according to the Portland

Cement Association.

"Last year was really a nightmare for a lot of projects," said Ben Sabati, who oversees cost

control at Vanir Construction Management, a Sacramento specialist in such public projects as

schools, hospitals and ports. "Many contractors couldn't get the materials they wanted."

He estimated that the cost of materials in the United States rose an average of 15 percent to 25

percent, compared with 3 percent to 5 percent in previous years. Although several factors

contributed to the price increases – rising demand for steel in U.S. factories, the need for

construction material after Florida's hurricanes, steel mill and cement plant closures – one of

the biggest reasons was China.

"A lot of cement that the U.S. typically buys from Asia was diverted to China," Sabati said. "And

China's demand for steel caused shortages in anything having to do with steel – steel structures,

metal struts, sheet metal."

The shortage of materials has eased since last summer, but prices are still higher than before.

Larry Zolezzi, president of San Diego's LZ Construction, said that before the demand began

rising in 2003, he could buy a yard of concrete for about $78. As demand peaked last year, the

price soared well above $100. And even though prices have abated, they still range between the

upper $80s and upper $90s. For some materials, such as plywood, which tripled in price last

year, costs have not come down, he said.

"With all these price rises, you could easily see a 15 (percent) to 18 percent increase in the cost of

a house," Zolezzi said. "When you're talking about a product worth $300,000 or $400,000, that

could be a significant increase in price."

Dave Konstantin, who heads K-Co Construction in San Diego, said the continuing price

increases make it hard to calculate costs when writing a contract for clients.

"The prices I quote one day don't benefit me two months later," he said. "It's very difficult to

quantify beforehand how high prices are going to rise. We constantly have to raise our prices

with customers to keep our profitability. It's brutal."

Cooling the boom

The Chinese government also worries that its red-hot growth rate could lead to bigger and

longer-lasting worldwide price increases, sparking inflation not only in the United States and

other countries, but in China itself.

To slow demand, Chinese officials have been raising interest rates, which has cooled

construction a little. But foreign investment and skyrocketing exports have counteracted the

government's lukewarm measures.

"Everyone knows Beijing is trying to slow things down. And everyone knows it won't succeed,"

said Anthony Chan, senior economist for JPMorgan Fleming Asset Management. "The bottom

line is they can't slow the economy too much. They have between 70 million and 100 million

people who don't have a job, so they're still under a lot of pressure to grow fast."

For America's cement and steel industries, the long-term solution is to ramp up production to

meet an anticipated rise in demand. U.S. cement companies plan to expand their manufacturing

capacity by 17 million tons by 2009, roughly an 18 percent increase in domestic capacity.

They will run into tough competition from China. The country already dominates the global

cement landscape, accounting for 37 percent of the cement produced, followed by India and the

United States. By 2006, China is expected to produce 340 million tons of crude steel a year,

representing 30 percent of world production.

While China's demand for steel is increasing at 11 percent per year, production is growing at an

even hotter 20 percent. That means China soon could be producing enough steel to meet its own

needs and swamp the global market with cheap exports. That would lower prices for U.S.

consumers – especially given the low value of the Chinese currency – but would throw the U.S.

steel industry into another slowdown.

"If we get back to a situation where there's excess capacity on the market, China's low currency

and the fact we have few trade barriers could once again make the U.S. an attractive place for it

to dump steel," said Gravatt, the steel industry spokeswoman. "That could be our one area of

vulnerability."

U-T Special Report / The Dragon Awakes

Flexing power through trade China gains diplomatic clout as opinion of U.S. in Pacific Rim weakens

By Dean Calbreath UNION-TRIBUNE STAFF WRITER

March 22, 2005

YANTAI, China – For nearly 60 years,

the United States has been the economic

engine of the Pacific Rim – able to use its

financial ties to Japan, South Korea and

most nations of Southeast Asia to exert

its will throughout the region.

But that era is drawing to a close.

In 2003, China overtook the United

States as the biggest trading partner of

South Korea. Last year, China became

Japan's biggest trading partner. By the

end of this year, it is likely to become the

dominant trader with the Association of

Southeast Asian Nations, or ASEAN, a

10-nation bloc stretching from the

Philippines to Cambodia. By the end of 2006, China could become Australia's chief partner,

leapfrogging the United States and the European Union.

That economic prowess is beginning to turn into political clout, as Chinese President Hu Jintao

and Premier Wen Jiabao conduct a "charm offensive" throughout the region – offering to erase

trade barriers with friendly nations. And the fact that the Bush administration seems to be

ignoring most of east Asia while concentrating on Iraq and the Middle East has helped Beijing,

diplomats and analysts say.

"The U.S. is losing the competition for influence in Southeast Asia," Tommy Koh, Singapore's

ambassador-at-large, said earlier this year. "The winner, at least for the time being, is the

People's Republic of China."

Walk through downtown Yantai, a busy port on China's northeastern seaboard, and you get a

good idea of how rapidly China is becoming the main hub of business in the Pacific Rim.

Twenty years ago, Yantai was a little-known backwater largely closed off to the rest of the world.

Foreigners who visited the port at the time say the only people they saw on the streets were

bicycle-riding Chinese workers clad in Mao caps and jackets.

Getty Images

President Bush's focus on the Middle East has aided President Hu Jintao and China's efforts to boost political clout and trade in Asia.

In the past few years, Yantai has become a major port of call for Pacific shipping and a humming

manufacturing center for South Korea and Japan.

Such South Korean businesses as Hyundai, Daewoo and LG Electronics have launched factories

in Yantai, drawn by the region's cheap work force. So many Korean executives call Yantai home

that the city has set up a Korean-language school for their children.

Japanese firms include the Atsugi sock company, which produces 50 million socks a year – most

of which are exported back to Japan.

"I feel a lot of similarity between Japan of the 1960s and China of today," said Hideo Sasaki, a

Tokyo transplant who oversees the factory.

Companies from many nations, including the United States and members of the European

Union, have opened factories in China. And along the Pacific Rim, China is using the trade ties

to establish stronger political relationships with its neighbors. And China seems to be filling a

vacuum created by the United States' shrinking reputation in the region.

Asians still talk about the contrast between visits by Bush and Jintao to Australia in late 2003.

Bush used his speech before the Australian parliament to push for more support of the war in

Iraq, eliciting boos from some parliamentarians, who had to be forcibly removed from the hall.

Hu used his speech to call for "deeper and broader" trade ties between China, drawing a much

more positive response.

"China in general has a smile diplomacy for Southeast Asia, whereas we have a seemingly

unidimensional approach that can lead to complaints," said Ralph Cossa, president of the Pacific

Forum of the Center for Strategic and International Studies in Honolulu.

"You hear a lot of people in Asia saying, 'The Chinese come in and tell us how wonderful we are

and how wonderful they are. The Americans come in and hector us all the time and tell us how

we need to do more against terror, terror, terror.' "

Cossa said the U.S. diplomatic corps is stretched thin when dealing with Asia. Only one assistant

secretary of state is responsible for the Asia-Pacific region, including North Korea, he said.

"And when you've got a nation that's threatening nuclear war compared to a lot of other nations

that are relatively peaceful, you know where your priorities are going to be," Cossa said.

On the other hand, China's "smile diplomacy" has its limits.

The smile comes off when dealing with Taiwan, which has had an autonomous government

since the Communist Revolution of 1949. Early this month, the Chinese government enacted a

law authorizing the use of military force against Taiwan if it ever formally declares

independence. If China invaded, the United States and Japan likely would be drawn into war to

defend the island.

China's hard-line stance on Taiwan has helped drive Japan closer to the United States. As China

unveiled its anti-independence law, Japan joined with the Bush administration to oppose

European arms sales to the mainland and stressed that it would not tolerate an invasion of

Taiwan – its strongest statement on the issue in decades.

China's heavy-handedness on Taiwan extends to nations that are overly friendly with the

government in Taipei. When Singapore's then-Deputy Prime Minister Lee Hsien Loong visited

Taiwan last July, Beijing cut off official visits and exchanges with Singapore and delayed talks on

a free-trade agreement. Bilateral talks between Beijing and Singapore – which since has

appointed Lee prime minister – did not get back on track until last month.

"China is in a kinder, gentler mode. But if you do something not on Beijing's agenda, they're not

hesitant to take you to the woodshed," Cossa said.

Image problem

China's diplomatic initiatives have been aided by the low opinion that many Asians have of the

Bush administration.

The war in Iraq, the U.S. refusal to sign the Kyoto environmental pact and the nuclear crisis in

North Korea – which many Asians believe has been mishandled by the White House – have

contributed to that negative image.

In Indonesia, for instance, 54 percent of poll respondents said in February that they have a

negative opinion of the United States, despite the large amounts of cash and assistance that

Americans have donated for tsunami relief. In 2003, 83 percent of Indonesians had a negative

opinion of the United States.

In South Korea, long one of the United States' closest allies, 39 percent of poll respondents last

year said the United States is the biggest threat to their security. By contrast, 33 percent named

the country's long-standing enemy, North Korea, and 12 percent said China.

Reflecting that mood, more than half the legislators elected to South Korea's parliament last

year say they believe their nation's relationship with China is more important than the one it has

with the United States.

South Koreans stress that they are not anti-American. Their attitude reflects their feelings about

Bush administration policy. But shifting trade ties are drawing them closer to China at the same

time that they are feeling alienated from the United States.

In the past two years, South Korea's growing trade with China has accounted for 98 percent of

the increase in its gross domestic product. Without Chinese trade, South Korea's economic

growth would have been close to zero.

The shift in trade ties has created a wide opening for China. One of China's chief goals is to exert

regional influence through trade deals, bringing nations closer to its fold by making it easier for

them to cater to its market of 1.3 billion people.

China's most ambitious goal is a pact to erase trade barriers with ASEAN, which aims to build an

Asian community of nations resembling the European Union within the next 15 years.

Under a free-trade pact signed in November, China and ASEAN plan to start cutting trade

barriers in July. By 2010, China plans to drop all barriers with Brunei, Indonesia, Malaysia, the

Philippines, Singapore and Thailand. That would create the world's biggest free-trade zone, with

more than 2 billion people. By 2015, the other members of ASEAN are slated to join the pact.

"That's a rather ambitious schedule, especially considering the fact that China's never signed a

free-trade agreement before," said Edward Gresser, director of the Progressive Policy Institute

in Washington, D.C.

"Even so, you get the feeling that China and other Asian governments are intensely involved in

setting up legal and public policy frameworks that do not include the United States and are

likely to put us at a long-term policy disadvantage."

Beyond trade

Some observers question how much good the trade deals will do.

Like Japan, South Korea and the United States, the nations in ASEAN, are already losing large

numbers of jobs to China because of its low-wage policies. The ASEAN agreements will

accelerate the job losses by removing all trade barriers, said John Tkacik Jr., a research fellow

on China policy with the Heritage Foundation, a conservative think tank.

"In the end, manufacturing in ASEAN will be swamped by duty-free competition from China,

and investment in ASEAN will shift to China," Tkacik recently told a congressional panel.

Nevertheless, China's dealings with ASEAN are extending beyond trade to include closer

diplomatic and political relations.

The November accord also involves increased political and security talks, military trust-building

activities, and cooperation in such fields as investment, finance, agriculture, energy and

information technology.

By contrast, the United States has stayed on the sidelines.

Partly because of its antipathy for the dictatorial government of ASEAN member Myanmar,

Washington not only has declined to sign a friendship treaty with ASEAN but also stays out of

the bloc's annual summit meetings, which draw such nations as China, Japan, Korea, India,

Australia and New Zealand.

As Koh sees it, "The U.S. needs to revamp its public diplomacy in Southeast Asia, in order to

redress the serious deterioration in public support for the U.S. and its policies."