The next showdown between the US and China is at our doorstep, and Washington finally noticed

The US and China are preparing to enter a new, dangerous phase in their strained economic relationship, and in Washington, politicians are preparing for battle.

On Monday, the ranking member of the US Senate Finance Committee, Sen. Ron Wyden (D-Oregon) fired the first warning shot. In a statement, he accused China of distorting the commodities markets by flooding the market with goods, thereby suppressing price.

"Over the past few decades, China has used market-distorting subsidies and industrial policies to prop up their own industries and rip off American jobs," read Wyden's statement.

It continued:

Steel, tires, solar panels — the same story plays out over and over again. Too often, China's economy is not run by the markets — it's run by government committee. So even though its own State Council has called out the problem of "severe excess capacities," China clings to the same old, destructive policies.

Wyden's right: China has just begun to flood global markets with a glut of certain commodities — specifically, steel and aluminum, for now — that built up during the country's investment growth surge. This process is only going to expand to other commodities over time, and it's unclear when it will be over.

The thing is, what makes this a complicated issue is that China doesn't really have a choice in this matter. In fact, if it wants to become an economy that is actually driven by market factors rather than government planning, it has to sell all of this extra stuff it has lying around that it seems the world is no longer interested in.

This, ladies and gentlemen, is the making of a good old-fashioned economic showdown. No one tell Donald Trump.

Steely, damn

China is trying to move its economy from one based on investment to one based on domestic consumption. That means old growth drivers in the country's economy have to die. Unfortunately, these drivers — mostly in manufacturing and commodities-based industries that have built up a lot of debt and supply since China's slowdown started in earnest — have fewer places to be sold.

Of course, that doesn't mean China has turned off the machine. We're talking about massive industries employing millions of people that have to be wound down. Reuters reports that 5 million to 6 million Chinese people could be fired from coal and steel industries over the next few years.

People out of work is bad for the consumption-based model China is trying to build, and the slowdown happened faster than Chinese officials expected. So now, as they try to figure out how to shrink these industries as gently as possible, they're also firing them on all cylinders.

Aluminum is a great example. Check out this chart from Citi showing how production dropped off in early 2016, but then ramped up again:

Reuters/China Daily China Daily Information Corp - CDIC

As Citi pointed out, this is the reversal of an agreed-upon production cut. Now, the bank expects China to have a surplus of aluminum in 2016. Some of that will feed the beast that is China's property market, which is also ramping up again to keep the economy going.

But part of that will also head out to the rest of the world.

"Chinese aluminum exports surged in March to 420kt, up 17% yoy and 50% mom, as restarts occurred," Citi analysts wrote.

Steel has a similar story. Prices have rallied from 2015 lows, mostly on a revival of China's bubbly property market, where sales of commercial and residential — excluding affordable housing — surged 60% from this time last year. Prices in first- and second-tier cities are surging. That usually leads a construction boom.

Conversely, other sectors where steel is used are just seeing "meh" demand.

"Among the six end-use sectors for domestic steel demand, both property construction and infrastructure saw steel demand continue to improve significantly in April, with the former approaching previous peaks in April 2014 and August 2013 and the latter significantly higher than previous peaks," wrote analysts at Macquarie in a recent note.

They continued: "The other four sectors, which are mostly flat steel product consumers, were however much calmer, with white goods and autos orders dropping moderately, while demand from shipping and machinery improved only slightly."

Reuters/China Daily China Daily Information Corp - CDIC

You can also see this in the fact that export demand has ticked up much less than domestic demand. Meanwhile, steel prices are still low.

Bringing it home

For better or worse, politicians around the world are starting to pick up on this issue. In the UK, politicians railed against Tata Steel when it rejected a reconstruction plan that would've stopped it from being sold abroad.

In the US, United Steel has said that it will lay off a quarter of its nonunion workforce because of "depressed steel prices and unfairly traded imports."

That is why Wyden wrote his letter.

It said:

In my judgment, the U.S. is badly in need of a safeguard against this economic tidal wave. That's why I'm standing in lockstep with my friend Leo Gerard and the United Steelworkers, who today filed a petition for relief under Section 201 of the Trade Act of 1974. Without an immediate economic balm, the U.S. is in danger of losing thousands of good, family-wage jobs across the country.

And you know how the US needs its good-paying jobs these days. Both sides have a lot to lose here, and this going to get worse before it gets better.

Check out the full text of the letter below:

Wyden Statement on Senate Floor on Chinese Aluminum Market Manipulation

As Prepared for Delivery

WASHINGTON — Senate Finance Committee Ranking Member Ron Wyden, D-Ore., delivered the following statement on the Senate floor today calling on the administration to stand up to China’s market-distorting trade policies and support a new case by the United Steelworkers to defend U.S. aluminum producers:

Over the past few decades, China has used market-distorting subsidies and industrial policies to prop up their own industries and rip off American jobs. Steel, tires, solar panels — the same story plays out over and over again. Too often, China’s economy is not run by the markets — it’s run by government committee. So even though its own State Council has called out the problem of “severe excess capacities,” China clings to the same old, destructive policies. And today I want to address what’s happening now with China’s huge overcapacity of aluminum.

The amount of aluminum Chinese smelters are churning out has gone up by more than 1,200 percent in a decade and a half. In 2000 they produced 2.5 million metric tons. In 2015, China produced 32 million metric tons. When you create a glut of aluminum production the way China has, you send the markets into turmoil and do enormous harm to workers in the U.S.

I spoke last week at a public hearing held by the U.S. Trade Representative and the International Trade Commission about how the overproduction of steel in China is an urgent threat to steel jobs here in America. While China’s steel mills are churning out more steel than ever, American steel towns are suffering or worse. Thousands of jobs nationwide have been lost just in the last year. Even though one third of all steel produced today has no buyer, China continues adding to the glut by producing more steel.

The same story is playing out in the case of primary aluminum: there’s a huge overcapacity in China driven by market distorting government policies. And it unleashes a chain of events that ends in economic devastation across this country. Global aluminum prices have plummeted, undercutting American firms. Between the start of 2011 and this upcoming June, the lights will have gone out at nearly two thirds of the aluminum smelters in the U.S. More than 6,500 jobs will have been lost. And you can bet that sooner or later, the damage will ripple downstream through the entire aluminum industry, which employs nearly three quarters of a million Americans either directly or indirectly.

In my judgment, the U.S. is badly in need of a safeguard against this economic tidal wave. That’s why I’m standing in lockstep with my friend Leo Gerard and the United Steelworkers, who today filed a petition for relief under Section 201 of the Trade Act of 1974. Without an immediate economic balm, the U.S. is in danger of losing thousands of good, family-wage jobs across the country.

It’s my view that the administration should act in this case as soon as possible to defend our workers and businesses from economic ruin. The U.S. and our trading partners must ramp up the pressure on China to stop overproduction. And our trade enforcers must take on the trade cheats using every tool in the box — including the ENFORCE Act, the Leveling the Playing Field Act, and the other measures my colleagues and I on the Finance Committee fought to get signed into law over the last year.

I firmly believe workers in Oregon and across this country can compete with anybody in the world. But the U.S. cannot afford to sit idly by and watch China’s destructive policies cause our aluminum industry to be wiped out. Enough is enough. The Steelworkers are standing up and fighting back, and I’m committed to standing with them.

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