Economy

So Far, the Big Trade War Loser Is China, Not the U.S.

The end result could be a fracturing of the global economy.

Photo Credit: William Potter / Shutterstock

Trade wars are neither easy nor costless, in spite of the insouciant assertions of President Trump to the contrary. But it is also the case that those who predicted that the far-sighted mandarins who guide China’s economic policy would win this battle might be similarly guilty of misplaced confidence. It’s early days, but so far the constellation of economic data that has come out of both countries suggests that it is China, not the U.S., which is bearing the brunt of this particular skirmish. And so long as the U.S. economy continues to grow, the corollary is that we should stop regarding these protectionist measures as temporary aberrations in America’s internationalist policies, especially on free trade. Rather, this is the new normal: an expression of a rabid 19th-century-style nationalism, reversing decades of globalization and shifting the worldwide economy into a series of competing regional blocs and alliances in the process. Maybe even a new Cold War (with China this time, not Russia).

Beijing has just reported its weakest quarterly official growth figure in a decade, and its currency has recently fallen to its lowest level since 2017. The 6.5 percent year-on-year growth reported for the third quarter is the official figure, and Chinese officials themselves have long conceded that many of their economic measuring sticks are doctored (which means that the unofficial, but real, number is probably much worse).

By contrast, the U.S. economy has remained relatively robust and shows little sign of a slowdown yet. The fact that the recently imposed tariffs in this growing trade war have not yet caused any significant economic dislocation domestically will likely embolden Trump and his trade team to up the ante as far as sustaining additional pressure on China, or to consider similarly aggressive action against other countries that conduct policy in a manner Trump considers deleterious to American trade interests. This will play well in swing states considered crucial to the president’s ongoing political success.

In the post-World War II period, the U.S. economy has remained the largest and most powerful in the world. Certainly it has long been the most developed consumer market, access to which has represented the crown jewel for any aspiring exporting nation. But until Trump, previous administrations have been somewhat more circumspect in resorting to aggressive protectionism to bludgeon better reciprocal terms for American businesses. Yes, the Reagan administration demanded export quotas from Japan’s automobile manufacturers, and George W. Bush and Barack Obama occasionally resorted to anti-dumping measures against China, notably after its entry into the World Trade Organization (WTO), which wrought devastation on the American manufacturing sector (particularly in the Rust Belt states). But these were all considered temporary measures; the underlying ideological assumptions of globalized free trade, and the so-called “Washington Consensus,” remained largely unchallenged as benign ends in and of themselves.

The focus of liberalization and deregulation of trade, however, began to change in the 1990s, reflecting Washington’s changing policy preferences, notably privileging finance over manufacturing via increased services liberalization, in exchange for continued access to the U.S. consumer goods market. Fighting for manufacturing interests basically went out the window after the Plaza Accord, under which then-Treasury Secretary James Baker managed to secure a devaluation of the dollar in order to improve America’s export position.

By the time Robert Rubin became Treasury Secretary, he regularly articulated a strong dollar policy, evincing little concern for U.S. manufacturing interests. Rubin espoused this belief on the grounds that a strong dollar attracted more portfolio flows to the U.S. capital markets, thereby sustaining the boom in American bond and equity markets, (a primary objective of the former Goldman Sachs co-chairman). Certainly the hardline stance adopted by “The Committee to Save the World” at the height of the 1997–98 Asian Financial Crisis, for example, was in part motivated to ensure that the emerging Asian markets crisis could be exploited in order to lever open their markets to the likes of Goldman Sachs, JPMorgan Chase, Citi, and a host of other financial interests. Nary a word for U.S. manufacturers. Indeed, America’s Asian Cold War allies were shocked at the manner in which the U.S. ruthlessly exploited the crisis for the benefit of Wall Street (failing to appreciate that the end of the Cold War had essentially eviscerated the basis of the bargain whereby American trade policy accommodated a huge increase of Southeast Asian exports to the U.S., to underwrite the latter’s ongoing prosperity and ensure that its bloc remained firmly within the U.S. sphere of interest as it fought to contain the spread of global communism).

The substantial falls of the Asian countries’ currencies relative to the greenback during 1997 considerably added to their dollar-based funding requirements (which exacerbated their economic distress). Blowback came later for U.S. manufacturers, as the greenback’s strength significantly eroded the position of U.S. exporters, resulting in a massive increase in the American current account deficit by the early 2000s. Furthermore, the hardline stance of the Treasury and Fed reinforced the Asian Tigers’ mercantilist instincts. Having seen Rubin, and then Larry Summers, hang them out to dry at the height of the 1997–98 crisis, these countries were determined never to be put in that position again and therefore deliberately kept their currencies weak well after their economies had recovered, building up huge trade surpluses and further obliterating what was left of U.S. manufacturing competitiveness (prompting yet another commission to examine the after-effects, but without actually implementing a change in trade policy).

In spite of the shift in prioritizing services over manufacturing, and the discarding of the old Cold War quid pro quo, there remained throughout successive administrations a broader philosophic agreement about the virtues of free trade as a benign end in and of itself, rather than a means to end. Under Donald Trump, and his trade representative, Robert Lighthizer, that has all changed. Trump has always viewed trade as a zero-sum game in which there is one clear winner and one clear loser. He tends to focus on bilateral trade relationships, as a means of establishing which countries are playing the U.S. for patsies. Trump has even resorted to taking out full-page ads in his favorite media adversaries, the Washington Post and New York Times, to signal his new aggressive, unilateralist approach on trade.

Similarly, Lighthizer, who has immersed himself for decades in the fine details of U.S. trade policy, is not averse to using “executive orders, diplomatic pressure, and legal measures like… Section 232 [of the Trade Expansion Act, which empowers the U.S. president to impose tariffs on national security grounds, as]... legitimate tools for unsettling existing arrangements and pushing partners to the negotiating table. Lighthizerism is no roadmap for retrenchment but a blueprint for recapturing what is seen as a lost edge for U.S. manufacturing on the world stage.” He has also been very dismissive of the prevailing “conventional wisdom” that implicitly assumes trade liberalization in and of itself would induce countries like China “to become more and more Western in… [their] behavior—almost as if... [they] were merely a more exotic version of Canada.”

When you start from the premise that free trade in and of itself is not an unalloyed good, but part of an “America First” strategy to make American manufacturing great again, or even allow free trade considerations to be superseded by national security considerations, it almost invariably follows that trade negotiations will be less benign and more aggressively unilateral, even with so-called allies (as both Justin Trudeau—“that punk little kid running Canada”—and Angela Merkel are now learning). Moreover, the lowest possible cost considerations (the usual endgame in a trade negotiation) might well not represent the primary objective in the overarching framework of a new agreement with Trump. Trade policy under Trump is designed to revive U.S. manufacturing, so as (in the words of Reihan Salam) “to steer U.S. firms to build resilient supply chains based in the Americas, not in China’s industrial heartland.”

Trump’s position vis-à-vis Beijing is not rocket science. The administration has simply taken the view that a large economy with a trade deficit has greater bargaining power than smaller economies with trade surpluses (in spite of its growth, China is still smaller in market exchange rate terms). By cutting the overall trade deficit, the big deficit country stimulates domestic growth and employment via import substitution. Meanwhile, the surplus nation loses a big chunk of its foreign market, leaving it with an overbuilt export sector. Moreover, it is politically easier to build new factories in the former deficit country than to have mass layoffs and idle factories in the former surplus country. That is what the president means when he says that “trade wars are good and easy to win.”

The dirty secret of globalization-driven cheap-labor offshoring is that it has boosted profits by much more than it has lowered consumer prices. The claim is that consumers will be hurt, but in the first instance, it is likely that the huge profit margins of the offshoring firms get whittled down first. They’ll still make profits, but not the same kinds of windfalls from cheap labor. That’s also one of the implicit quid pro quos embedded in the corporate tax reform.

Right now the Chinese leadership is trying to figure out whether they try to appease Trump or wait him out (and use all their Wall Street allies of convenience to make their case and help elect a Democrat in 2020). Much to Beijing’s consternation, the usual carrot/stick approach of making concessions/threats on financial services or farm goods haven’t worked. Wilbur Ross, Robert Lighthizer, and Peter Navarro are not Bob Rubin, Larry Summers, Hank Paulson, or Tim Geithner.

In the interim, no doubt China’s leadership will continue to react to U.S. trade pressures by making life increasingly difficult for some U.S. firms with extensive Chinese operations. Its policymakers will also continue to offset the adverse consequences of the trade shock by retaining its existing policies of expanding credit and infrastructure spending to support economic growth, adding to their debt build-up in the process. Beijing may continue to allow the RMB to decline to offset the impact of rising tariffs, although here China’s economic mandarins have a fine line to tread, as too much devaluation could engender more capital flight from the country, turning a managed currency decline into a rout, which would be highly inflationary (and, hence, politically destabilizing). Treasury Secretary Mnuchin has also recently put their monetary authorities on notice not to pursue further this gambit (the Treasury Secretary can always declare China a “currency manipulator,” which would open the way for further retaliatory action on the trade front).

Longer term, Beijing will continue to try to build a larger domestic market and develop a Chinese system of international markets (less dependent on the U.S.). But that is a multi-decade project, ill-suited as a short-term buffer against a trade shock.

The real risk to Trump’s trade strategy, however, is that if taken too far or aggressively, it could ultimately turn into an “own-goal” for the U.S. Screwing hitherto friendly trade partners and weakening multilateral organizations, such as the WTO or NATO, deprives the U.S. of the goodwill and functional alliances they could use to confront China, contain North Korea, etc. When the European and Chinese leaders start teaming up to confront America, or the next crisis in the Middle East hits, it may be useful to have some friends, but the way things are going today, the U.S. might find that “America First” has become “America Alone.”

This article was produced by the Independent Media Institute.

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Marshall Auerback is a market analyst and commentator.