Hamish McRae: The humble bra poses a threat to world economy

The United States authorities do seem at last to accept that their current account deficit will have to be tackled. Improbably, the product that has tipped them into action is the bra.

There has been a surge of Chinese exports of bras to the US, displacing tradition suppliers in central America. This has led the administration into announcing that it will use a WTO provision to put a quota limiting the growth of imports of bras, evening gowns and knitted fabrics to an annual rate of 7.5 per cent.

It is early days of course, but the news troubled the foreign exchanges. While the dollar recovered sharply yesterday, it is still close to the three-year low against the yen and the all-time low against the euro that it touched earlier in the week. Among the many market concerns is the fall in the inward flow of investment funds into the States and, most recently, this announcement of trade quotas on Chinese fabrics.

For the US, the most important trading relationship now is not the one with the European Union, nor even those with its North American Free Trade Agreement partners but the one with China. In absolute terms, trade with China is still smaller than with the EU or Nafta but the growth is much faster. This matters hugely for the dollar and the US economy but it also matters for the rest of us.

There is a general perception that the world economy is flying on one engine: US consumer demand. Actually it is flying on two, for US demand is supplemented by Chinese demand. But for Chinese growth to carry on at its present rate, it needs to maintain its exports to the US.

Nearly half the additional GDP added to the world economy between 1995 and 2002 came from those two sources (see first graph), with China adding 25 per cent of the total, more even than the US. Real GDP growth in China during that period ran at more than 8 per cent (second graph), while imports have been rising even faster, at 12 per cent (third one). China has sharply increased its share of world imports from 2.5 per cent in 1998 to 4.5 per cent last year. It should pass Britain to become the world's third-largest importer (after the US and Germany) this year.

The figures are pretty stunning, not just for what they say - that we live in a bipolar world - but also for what they don't say - that neither the EU nor Japan is pulling its weight. Were the UK and other non-eurozone countries taken out of the EU figures, the European performance would be even worse.

The very latest economic news from Japan and Europe is more encouraging. Growth does seem to have picked up at last and there is a decent prospect of all four engines pulling the world economy along next year. The Bank Credit Analyst team that prepared those graphs thinks the recovery will be stronger than the markets expect over the next year or so.

But this does depend on the trading relationship between China and the US remaining in good working order. This latest spat, following US pressure on the Chinese to revalue the renminbi last month, suggests that trade tensions will rise rather than fall.

The core of the problem is that while the US has a huge trade deficit with China, now running at some $12bn a month, China has a large trade deficit with most of the rest of the world, and in particular the rest of South-east Asia. Chinese imports from South-east Asia are up 45 per cent on a year ago, with China now becoming Japan's second-largest export market.

It now imports oil, whereas 10 years ago it was a net exporter. It imports raw materials becoming, among other products, the largest importer of iron ore. As a result, China's overall current account position is not that far from balance, a surplus of only about 1 per cent of GDP.

That sort of imbalance would not warrant a revaluation of the currency, particularly since there is quite a large possibility that China will slip back to a current account deficit in the next year or 18 months.

So the China trade position looks different depending on where you sit. From an American perspective, here is this great low-cost producer, following an unfair trade policy by restricting imports and dumping cheap goods on us. From a South-east Asian point of view, here is a huge market for our products, the fastest-growing import market in the world. And from the perspective of a raw material or oil producer anywhere in the world, here is the country that will replace the US as the main source of demand and the main determinant of world prices.

But that prospect is in the future, albeit the near future. For the moment the concern must be that the spat between the US and China will grow into something more serious, for potentially it is even more dangerous than the row between the US and the EU over steel. We can almost certainly patch that one - John Snow has been making conciliatory noises on his visit this week - but the Chinese relationship could become much harder to control.

I don't want to defend Chinese trade policy for there are areas where it behaves in a highly protectionist way. Nor is its policy on intellectual property defensible.

The copying of Western products is not just a matter of the fake Rolex watches offered to tourists outside every hotel in Shanghai. It is much more radical than that: there are car factories in China producing clones of Volkswagen and other western cars, correct in just about very detail bar the badge.

But the fact remains that the sheer volume of imports is such that the country cannot be accused of failing to do its bit for the world economy, the charge that can be levelled at Japan. No country that increases its imports by 40 per cent can be accused of failing to spread demand to its neighbours.

So the problem of the US current account deficit - and the parallel problem of the declining dollar - is really an American issue rather than a Chinese one. The danger is that the Chinese authorities were unprepared for the US action and will overreact in return. Were they to do so, the bra war could come to be much more serious than the steel war and the world economy as a whole would suffer.

So what can the US do about its current account deficit? Well, the recent fall in the dollar helps a bit but the currency cannot carry the entire burden of adjustment. There are hopeful signs that US consumers, while not retrenching - that would be worrying - are slowing the growth of their spending. If the job market continues to improve that will add to confidence.

What the US, and indeed the rest of us, should hope for is a gradual shading back of the deficit. That would reduce the political pressure on the US authorities to pick trade fights with both the EU and China at the same time.

Meanwhile, it is ironic, is it not, that the trade battle with effete "old" Europe should be over steel, while the battle with robust "new" China should be over bras?