China-U.S. trade wars: What's at stake

NEW YORK (CNNMoney) -- China and the United States are the world's two largest economies and arguably each other's most important trading partners.

And now, it seems the two countries find themselves on the brink of a trade war.

The U.S. Senate, in a rare show of bipartisan agreement, passed a bill Tuesday that would slap steep taxes known as tariffs on imports from nations with undervalued currencies. It is a provision aimed squarely at China's yuan, and it prompted harsh attacks from Chinese officials.

"Should the proposed legislation be made into law, the result would be a trade war and that would be a lose-lose situation for both sides," said Vice Foreign Minister Cui Tiankai. "It would be detrimental to the development of economic ties and might have an adverse impact on bilateral relations."

But despite overwhelming support in the Senate, the bill might never become law as House Speaker John Boehner has signaled his opposition to it.

"I think it's pretty dangerous to be moving legislation through the United States Congress forcing someone to deal with the value of their currency," Boehner said.

President Obama has also questioned whether he would sign the bill, saying he didn't want to pass "symbolic" laws that would be slapped down by the World Trade Organization.

Is China's currency undervalued?

For years China has intervened in currency markets to keep its currency, the yuan, essentially pegged to the dollar through a fixed exchange rate.

The Chinese briefly allowed the yuan to start appreciating starting in 2005, but it stopped when the financial crisis hit in 2008. In June 2010 it again allowed the currency to start rising slowly in value. It has gained almost 7% versus the dollar since then.

But experts claim that if the currency had been allowed to trade freely like the euro or many other major currencies, it would be much stronger today. Critics of China's policy estimate that the yuan is still undervalued by 25% to 40%, even with the recent rises in value.

What's wrong with an undervalued currency?

The low value of the yuan has kept Chinese exports very cheap, and gave Chinese businesses an edge in competition with U.S. companies.

The Economic Policy Institute, a liberal think tank, estimates that the United States has lost 2.8 million jobs since 2001 because of the growing trade deficit with China.

One way that China keeps the currency value low is by using its trading profits to buy up U.S. Treasuries. That helps to keep the cost of borrowing low for the federal government and for U.S. businesses and consumers. But it also means that China now holds $1.2 trillion in U.S. government debt, more than any other country in the world.

What products do the U.S. and China trade?

The value of the Chinese currency has helped China become the largest source of imports to the United States, sending $255.5 billion of goods to the U.S. between January and August of this year. That has resulted in the United States having a $189.3 billion trade deficit with China -- the largest of all U.S. trading partners.

Figures from the Commerce Department show that the top imports ranked by dollar value in the first seven months of this year are computers ($28.8 billion), cell phones and other telephone equipment ($18.8 billion), office equipment and printers ($10.2 billion), and televisions ($6.6 billion).

Meanwhile, U.S. exports to China include soybeans ($4.8 billion) civilian aircraft ($3.3 billion) motor vehicles ($2.9 billion) and electronic circuits and chips ($2.4 billion).

While Chinese exports to the United States dwarf U.S. exports to China by nearly a four-to-one margin, the $66.1 billion of U.S. exports still makes China the No. 3 market for U.S. goods, behind only Canada and Mexico and ahead of Japan or any single country in Europe. And those figures don't include sales that U.S. companies get from products they produce in China for the Chinese market. For example, General Motors (GM, Fortune 500) now sells more cars in China than in the United States.

What other issues are at stake?

Currency values and tariffs aren't the only area of dispute between the two countries.

Despite the attractiveness of Chinese consumers to U.S. businesses, those who want to sell in China find the country is far from a level playing field.

Foreign companies are often required to set-up joint ventures with Chinese firms before the can start doing business there. And China is instituting new "indigenous innovation" rules that U.S. companies say force them to transfer their own technology to their Chinese partners.

U.S. companies also complain that China's laws do not protect their intellectual property, and pirating is a common problem. Last month Treasury Secretary Timothy Geithner charged that the Chinese government has "made possible systematic stealing of intellectual property of American companies." He also complained about other rules on doing business in China.

Financial services in China are still mostly out of reach for non-Chinese banking firms. And Chinese companies typically have an edge in the massive public works projects that the government controls.

Chinese officials have been critical of the drawn out U.S. debate over controlling the budget deficit and the downgrade of the U.S. debt it holds. State-run media in China attacked the fight over raising the U.S. debt ceiling as "dangerously irresponsible."