Donald Trump’s trade wars: what China should do next

One response on Beijing’s part would be to recognise the risk of a broader clash

Philip Stephens

China has changed the world. It has been too slow to understand that it has also changed the world’s view of China. These are unsettling times for Beijing. Until now China’s rise has been on its own terms. There have been bumps and squalls and the occasional stand-off with Washington, but mostly the west has been distracted or amenable. Chinese leaders have grown used to getting their own way. Now, China’s feet are being held to the fire.

There is a temptation to imagine that party chiefs have a carefully worked-out strategy in response to the latest package of punitive tariffs announced by US president Donald Trump — the equivalent of a $25bn tax on Chinese exports to the US. It is axiomatic among much western commentary that China always thinks three moves ahead. The signs now are otherwise. Those reading the runes in Beijing say the leadership has been caught badly off guard.

Years of deep research into the way America works have been confounded by Mr Trump’s wilful unpredictability. Beijing’s intelligence is weak. The high-level contacts in Washington and beyond — so carefully cultivated by Chinese officials — did not include the hardliners now setting the pace in the president’s inner circle. Beijing has for years studied the inter-agency process of US decision-making only to discover that to know by heart how US administrations usually work is not to know what Mr Trump will do next — or why.

The US president is by nature volatile — witness his bomb-you-hug-you approach to North Korea’s Kim Jong Un. There is more to China’s discombobulation, however, than confusion wreaked by Mr Trump’s crudely mercantilist view of trade balances or the inconstancy of White House decision-making. Beijing should look also to the change wreaked by its own behaviour.

During the past several years China has reshaped the dynamics of its relationship with the west. This reaches well beyond Washington. Ask most European policymakers what they think of a Sino-American trade war and they will tell you that Mr Trump’s approach is dangerous and counterproductive — it will end up in lose-lose, rather than win-win. Yet behind their hands these devoted multilateralists and free traders will admit a certain satisfaction that someone has “stood up” to Beijing.

Not so long ago most western governments looked at China through the lens of rich market opportunities. Some still tilt in that direction. But, in Europe at least, Beijing’s growing assertiveness, a suspicion that it is using its financial clout as a tool of geopolitical coercion and its unabashed appropriation of western technology has changed the mood. China suddenly looks a strategic threat as much as a market opportunity.

Xi Jinping cannot complain he has been blindsided. China’s emperor-president has cast off the stylised humility of his predecessors to celebrate both his personal power and China’s global status. Foreign critics are brusquely dismissed for failing to appreciate “the fact” of China’s rise. The People’s Liberation Army shows off its prowess in the disputed South East China seas. The Belt and Road Initiative sees Beijing building strategic outposts across Asia and into Africa. Its investments in the weaker economies in eastern Europe fit a suspicion in Brussels that it is pursuing a policy of divide-and-rule.

None of this is to say that Mr Trump’s trade tariffs are a rational response. If retaliation leads to further escalation the world eventually will stumble into a full-scale trade war and economic slump. Beijing, however, would be foolish to underestimate the curious coalition that one way or another finds itself standing behind the US president. There are plenty of China hawks who disagree profoundly with Mr Trump’s views on trade, but welcome any opportunity to rein in Beijing.

An intelligent response on China’s part would start by recognising the risk of a broader clash. Unsurprisingly, Mr Xi has felt the need to respond to the latest tariffs, but there is retaliation and retaliation. In its measured form it leaves open the road to a resumption of serious negotiations. Waiting it out until after the US midterm elections in November would provide room to assess how far Mr Trump is being driven by short-term political pressures.

On the other hand, a more aggressive reaction would open the door to those in Washington who want to impose a permanent set of restrictions and restraints on economic relations between the two countries. There are those in the west with fond memories of the COCOM rules against technology transfers to the Soviet Union during the cold war. Today’s American technology companies have deep interests in China. But Beijing would be the bigger loser from a spillover to the technology sector of the present dispute.

The harder task for Beijing will be recognising that to a significant extent it has been the author of its own predicament. Western business leaders, trade negotiators, commercial lawyers — they all have a story to offer of promises made and broken in Beijing, of unreasonable obstacles to doing business, and the loss of precious intellectual property. If China wants to win arguments in Washington it needs friends in the American business community.

For the first decades of its rise, “ hide-and-bide” modesty gave China control of its own story. Hubris has handed the pen to its critics. Great power status, Mr Xi might reflect, has its own traps.

America can no longer carry the world on its shoulders

Relative decline and domestic exhaustion create an opening for realpolitik

Janan Ganesh

Germany’s Angela Merkel, left, and Donald Trump of the US, second right, at the Nato summit in July. Trump’s infidelity to the postwar system is disquieting but perhaps he is doing through choice what future presidents will do through necessity © Reuters

To become a “normal country” is the dream of more than one republic. The world is familiar enough with the German case. Having atoned for the war and put Europe first, its next step as a common-or-garden nation is to pursue its narrow interests without embarrassment.

Because he is so peculiar, we cannot credit that Donald Trump’s project is the normalisation of his own country. For all their shock value, that is what his foreign policies amount to: the restoration of the US as a selfish state among selfish states, not an over-worked governess with the entire free world as her mewling wards.

This realpolitik can be self-defeating. It misses the national interests that are served through such nominally high-minded works as the Paris climate accord. But it is still more coherent than its critics. Liberals chafed at American power until its threatened retreat, at which point Nato and the Washington Consensus on trade became sacraments to be saved from populist menaces. As for mainstream Republicans, at least Mr Trump does not go in for mystical hokum about the US as a special nation ordained to uphold freedom.

Realism has more going for it, though, than internal coherence. It also fits the external conditions. To lead a world order takes a nation in the full plumage of its powers. That is a better description of the US in 1948 than 2018, much less 2048. Mr Trump’s infidelity to the postwar system is disquieting, but perhaps he is doing through choice what future presidents will have to do through necessity.

Pax Americana is not the natural order of things. It is a phase born of the most extreme circumstances. The US accounted for a third of the world’s output when it set up the Bretton Woods institutions, revived Japan and secured Europe. Because its absolute power remained so awesome, we forget that its relative position began to decline soon after. It now accounts for about 20 per cent of global output. It does not have the wherewithal to underwrite the democratic world forever. At some point, a president was going to construe the national interest in narrower terms. The most recent three were elected on a pledge to do so.

Whether Mr Trump-as-statesman understands the relative decline he has lived through — he was born in 1946 — Mr Trump-as-politician understands something just as relevant. The taxpayer still awaits the peace dividend that was said to be in the mail when the Berlin Wall turned to debris.

The US has spent most of the post-cold war era in expensive conflicts in another hemisphere. These “forever wars” rolled on as the home land endured a financial crash and the kind of infrastructure that should be beneath the dignity of the nation that built the Hoover dam.

The two trends — relative decline and domestic exhaustion — have created the best atmosphere for realpolitik since the post-Vietnam years. The difference is that this time it should last, as China and other powers trim America’s room for manoeuvre.

There is no demand for isolation. There is plenty for a focus on interests over values. Mr Trump’s is the first (and therefore the worst) attempt to service that demand. There was no need to humiliate allies as blameless as Canada or to impose, as his government did this week, new limits on the annual intake of refugees. But the underlying logic of selfishness will outlast him. Realists smell a chance to temper the crudities of America First into a serious, interest-led, foreign policy. The foremost among their academic tribe, John Mearsheimer and Stephen Walt, each have books out to encourage their nation’s retirement from “liberal hegemony”.

Even if the coming realism turns out to be an over-correction, a correction was due. Not long ago, George W Bush could describe freedom as the “design of nature” and Barack Obama could, with equal nonchalance, say that the arc of history bends towards justice. The arc of history does not bend towards anything. There are things to miss about these presidents — their personal class, their seasoned cabinets — but this teleological gibberish is not one of them. The postwar record suggests that ideals get the US into trouble more often than cold calculation does.

Richard Nixon said that a leader can, at most, “give history a nudge”. He or she cannot alter the course of history so much as quicken a trend that is already in train. The structural trends of the world demand a more self-interested US over time. Each of Mr Trump’s broken treaties and tariff rounds can be read as a nudge towards that destiny: a bid to make America normal again. His successors will do it better. But they will do it.

Trump’s Currency Confusion Continues

Jeffrey Frankel  

trump visits china

CAMBRIDGE – Next month, the US Department of the Treasury is due to submit to Congress its biannual report detailing which countries, if any, are manipulating their currencies to gain an unfair trade advantage. For his part, President Donald Trump is already accusing China of doing so, as he did throughout the 2016 election campaign. And he is reportedly trying to influence the Treasury Department’s deliberations.

What has changed since the last report in April? That document, like similar reports written during the previous two administrations, did not find China guilty of manipulation. In fact, the last time the Treasury Department declared China (or anyone else) a manipulator was in 1994.

The reason for this is simple: China does not meet the three criteria that Congress has set for determining currency manipulation. It has not been persistently intervening in foreign-exchange markets (at least not to push down its currency), and it is not running an overall current-account surplus greater than or equal to 3% of GDP (its surplus in 2017 was 1.3%).

China does meet the third criterion: a bilateral trade surplus with the US in excess of $20 billion. But Congress was wrong to set the bilateral balance as a criterion in the first place. The huge US trade deficit worldwide is sufficient to explain the bilateral deficit. China accounts for 15% of the world economy, so even its proportionate share of the US’s $600 billion deficit would be $90 billion – well over the $20 billion threshold. Yes, the bilateral deficit is much higher than even that level; but that is partly because China’s exports to the US contain so many imported inputs.

So, as of April, China had met just one of the three congressional criteria, and thus did not qualify as a currency manipulator. (Germany, India, Japan, South Korea, and Switzerland each met two criteria.) Since then, the renminbi has depreciated by 6% against the dollar. But that is because the dollar itself has appreciated by 7% on a broad average basis against its trading partners’ currencies.

Exchange rates do not always accord with economists’ models. But in this case, the dollar’s appreciation can be explained by Trump’s own economic policies.

For starters, Trump and congressional Republicans have pursued a massive pro-cyclical fiscal expansion, producing virtually unprecedented peacetime budget deficits in the absence of a recession. This expansion includes the tax cuts passed in December, rapid increases in government spending, and recent proposals for further tax cuts.

Macroeconomic theory predicts that such policies will drive up interest rates, attract capital from abroad, and strengthen the dollar. That is what happened when the US had a similar fiscal-monetary mix under President Ronald Reagan in 1981-1984.

Moreover, Trump has launched a trade war by imposing import tariffs on America’s major trading partners. Most recently, he announced tariffs on another $200 billion of Chinese exports, to take effect on September 24. He thinks this will improve the US trade balance, but does not understand that if foreign exporters are cut off from the US market, they will not have the dollars to buy US goods.

A tariff-induced reduction in US imports can be offset in a number of ways. Most tangibly, other countries can retaliate against the US by imposing their own tariffs on, say, US agricultural exports. But even if they don’t, measures that make it harder for foreign exporters to earn dollars will create a dollar scarcity, which, in an environment of floating exchange rates, will automatically boost the greenback’s value. Trump’s escalation of the trade war over the course of 2018 appears to have had the effect on the dollar predicted by economic theory.

To be sure, China did hold down the value of the renminbi ten or 15 years ago. Alongside rising trade and current-account surpluses, the People’s Bank of China (PBOC) maintained a policy of intervening in the foreign-exchange market to dampen appreciation, thereby amassing huge foreign exchange reserves. But China then adjusted its currency policy. The renminbi appreciated by 37% between 2004 and 2014, at which point its undervaluation had been eliminated.

In 2014, capital started to flow out of China and the currency started to depreciate, perhaps owing to a slowdown in the Chinese economy, relatively strong growth in the US, and a corresponding shift in their respective monetary policies. Just as the PBOC had intervened to dampen the appreciation of the renminbi from 2004-2014, it began intervening to dampen its depreciation after 2014.

This pattern of intervention is called “leaning against the wind.” The PBOC spent a record-setting $1 trillion trying to stop the renminbi’s slide after 2014. If Chinese authorities had acceded to US demands and allowed the market to determine the exchange rate, the renminbi would have depreciated further still, and US exporters would have had a harder time competing.

Eventually, US politicians came to understand this basic fact. The last one to grasp it was Trump. As late as April 2, 2017, Trump labeled the Chinese the “world champions” of currency manipulation, only to reverse his position a week later, telling The Wall Street Journal, “They’re not currency manipulators.” After that, he let the subject rest for a year, before reprising his original accusation this summer.

As it happens, the year during which Trump stopped accusing China of pushing down its currency was also the year that China suspended its efforts to propup the renminbi. Its foreign-exchange reserves stopped declining in 2017. But now the Chinese have resumed their efforts to defend the currency, just when Trump is renewing his accusations. To slow the renminbi’s depreciation, the PBOC recently signaled that it will apply a so-called counter-cyclical factor in its daily “fixing” of the currency against the dollar.

Why does Trump keep getting things backwards? It is not just his perverse personality. Trump makes the charge when the renminbi depreciates, which also happens to be when the PBOC intervenes to support it. What he misses are two fundamental drivers of that depreciation: his own fiscal and trade policies.

Jeffrey Frankel, a professor at Harvard University's Kennedy School of Government, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He is a research associate at the US National Bureau of Economic Research, where he is a member of the Business Cycle Dating Committee, the official US arbiter of recession and recovery.

Justin’s note: The U.S. economy is booming.

According to the government, U.S. GDP (gross domestic product)—a broad measure of economic growth—rose by 4.2% year-over-year. That’s the highest mark in four years. U.S. wages are growing at the fastest rate in nine years. Unemployment is at its lowest level in 18 years. And jobless claims are at a 48-year low.

This is great news for everyday Americans. That’s obvious. The question is… how much longer can the U.S. economy fire on all cylinders?

So I got Doug Casey on the phone to get his take…

Doug Casey on the U.S. Economy

Justin: Doug, what are your thoughts on the economy? Is it as strong as the government says?

Doug: Well, to start, I must admit that no one is more surprised than I am that things are holding together as well as they are.

I was convinced that zero percent interest rates and QE 1, 2, 3, and 4—the response to the meltdown that started in 2007—would bring on a disaster sooner, not later. They’ve caused people to borrow more and save less, which is a formula for poverty. But, so far, the most obvious result has mainly been booming stock, bond, and property markets. The rich have gotten a lot richer, while the middle class has slipped down only slowly.

The last ten years are a classic example of how something can take much longer to happen than you expect. But once the inevitable gets underway, it's going to happen much more quickly than you expect.

But should you really trust the statistics that the U.S. government puts out? I don’t. At least not much more than anyone could trust Argentine statistics when the Kirchners were in office.

There's always a political slant to the way these things are computed, and the way they're presented.

Look at the so-called unemployment rate, currently 3.9 percent. That’s supposed to be an eighteen-year low. But the number of people working, as a percentage of the total population, is much lower than in the past.

There are numerous definitions of what constitutes employment and unemployment. And with over 50% of the population receiving direct government benefits of some type, all the numbers are flexible.

Justin: It sounds you don’t trust these numbers or, at the very least, take them with a grain of salt. If so, how do you assess the economy’s strength? What sort of things do you look at?

Doug: To be honest, like most people, I live in a bubble. We all live in our own little subcultures. We can't really be sure what's going on in the world at large. Most of us are just milder versions of Jim Carrey’s character in The Truman Show. We don’t know much beyond what we’re shown on TV, or read in various media. How reliable is that?

How reliable were the CIA’s statistics about the Soviet economy? They were less than worthless.

How good were S&P’s credit ratings in 2007? Not very. How much does Tesla’s $300 stock price say about the company’s prospects? I’d say next to nothing.

Even when you talk to another person, what you hear has been filtered by their own psychology.

Beyond that smiling face, underneath the social veneer, what’s the real story? Government statistics certainly can’t tell you…

But I look around. How many houses or buildings are being constructed? When I go to an airport, I pay attention to how busy it is. It seems nobody goes to shopping centers anymore, including me.

Some years ago I’d hop a freight train to see how the other half lives. Now I hop a jet plane to see what’s happening on the other side of the globe. But I don’t kid myself—most input is anecdotal, transitory, and illusory.

That said, things are holding together. There aren’t mobs in the streets with torches and pitchforks. At least not yet.

Justin: And what is the glue? Is it the Federal Reserve’s easy-money policies?

Doug: Absolutely. Monetary policy—how much money they print, how much credit they create, and how much it costs—isn’t just the elephant in the room. It’s the brontosaurus in the room.

The question is, where have the trillions of dollars that they’ve created gone? The answer is into the financial markets. It's why the stock market has been going to new highs every day. All that money the Fed’s created has gone into the stock market. It’s gone into the bond market.

And it’s gone into the real estate market. Nobody “needs” stocks and bonds. But everybody needs a dwelling of some type, and many Americans can’t afford one because a lot of that money has driven housing prices up a lot faster than wages. Believe it or not, there really are hobo jungles in 21st century America. There are lots of “homeless” living on the streets. We used to call them bums, although I think that term has become politically incorrect.

We’re still in the eye of the gigantic financial/economic hurricane we entered in 2007. The question is: When are we going into its trailing edge? Well, interestingly, the amount of debt in the world has expanded hugely since 2007, when financial institutions started failing. They failed because they had too much debt. Now there's even more debt. There's more automobile debt. There's a lot more student loan debt. There's more mortgage debt. More consumer debt.

There's much more government debt.

Justin: Don’t forget corporate debt.

Doug: Yes, much more corporate debt, too. Corporations have borrowed not to build new factories, but to buy back their stock. Why? One reason is to make management stock options valuable.

The whole situation is worse, and the timing is much more on the edge, than it was back then.

Interestingly, the Federal Reserve is now trying to reel in all the money that it created at the height of the crisis, trying to normalize things. They're trying to both raise interest rates and reduce the money supply. At the same time the government is running a trillion-dollar deficit.

It can’t possibly end well.

Meanwhile, all the money that was created to bail out failing corporations is filtering down from the financial markets into the regular economy. But, with the financial markets at manic highs, rich people don’t care if the price of a hamburger goes up.

The rich, especially in cities like New York and Washington, have gotten much richer in recent years.

They stand much closer to the fire hydrants of money that the government’s created. They get to drink their fill before it trickles down to the little folks in flyover country. That’s one thing.

The other thing is that the Federal Reserve’s low interest-rate policy has made it much easier for people to service high levels of debt. This wouldn’t be possible if interest rates were normal.

I mean if you had to pay 8% to finance your new SUV you're going to be much less likely to buy it than if you can finance it at 0% or 1%. It’s especially perverse in that people actually used to pay cash for cars, once upon a time. Then they financed them for two years. Then three. Now it can be for seven. Or they lease. So what was once a minor asset has become a major long-term liability. The whole U.S. economy is based on debt.

Justin: This obviously can’t go on forever, though.

Doug: Right. This is all a moving paper fantasy that will come to a bad end. I see two ways it ends.

One, it will end with a credit collapse—all this debt is defaulted on. All that funny money that's been created out of nowhere simply disappears. That can happen because today’s money is simply credit. It no longer represents a specific amount of gold. It's merely an accounting fiction. We could easily have a catastrophic deflation. The remaining dollars would go up in value, for a while.

On the other hand, the government could succeed in keeping things together, by printing more money. But then we’ll have much higher levels of inflation. And that’s going to devastate the average guy more than anybody else.

Justin: And why is that?

Doug: The average guy who gets ahead tries to produce more than he consumes, and save the difference. But his savings are dollars. If the dollars lose value rapidly, he might as well not have saved. That’s very destructive for the very fabric of society.

Justin: So I think we both can agree that the Fed has played a huge role in propping up the economy. But how much credit should the last two presidents get? As I’m sure you’re aware, Trump uses positive economic data to pat himself on the back.

But Obama recently did the same thing. He basically said, “Don’t forget that the economic recovery began under me.”

How much credit should either Trump or Obama get?

Doug: That's a very good point.

Obama should get zero credit. The economy collapsed under the disastrous Baby Bush regime. It recovered solely because of the huge infusion of credit from the Fed—which really just put off the inevitable. Apart from that, all of Obama’s actions were economically destructive.

In fact, Trump deserves some credit for things holding together. One of the most important things is his attempt to cut regulations. Another is his reduction in taxes. His limiting the tax deductibility of consumer interest and state income and property taxes took away indirect subsidies people were getting in high-tax places like California, New York, Illinois, and Massachusetts. On the negative side, he’s wasting hundreds of billions on the military. And could quite possibly start an international trade war.

I'm just afraid of what's going to happen if things come apart in the next year. Since Trump is associated with capitalism, a collapse would be blamed on the free market. Then an overt socialist could easily be elected in 2020.

Justin: Why are you so concerned by that? What would be so different if things fell apart, say, two or three years from now?

Doug: As much antagonism and actual hatred as there is against Trump, the economy is one thing he’s got going for him. If the economy really falls apart—and I believe it will—the political and social consequences in the U.S. will be extremely serious. The democrats will try to impeach him.

All kinds of things could happen when the Greater Depression resumes, and millions more Americans lose their jobs, their savings, their pensions, and are kicked out of their houses the way they were back in 2008 and 2009.

Justin: Not to mention, the Fed is in a very precarious position right now. It kept rates incredibly low for so long. And that, as you mentioned, blew a bubble in all sorts of financial assets. So it must be careful not raise rates too quickly and risk popping those bubbles.

Any chance they pull that off?

Doug: I don't think so, quite frankly. They’ve painted themselves into a corner and created many problems in the process.

For one pension funds everywhere are underfunded and in a lot of trouble. And that's true even though most of the stock and bond markets are at all-time highs.

So, interest rates go up, stock and bond prices go down. If they squeeze the bubble that they've blown up, the air in the bubble just goes to a different place. So, no. I don't see any way out of this.

People have already forgotten how unpleasant it was back in 2008 and 2009. They also have no idea why it happened to start with. But it happened because government fiscal and monetary policy created distortions and misallocations of capital in the economy. So, it's much more serious now than it was back in 2007. And the consequences are going to be much worse.

Justin: Thanks for taking the time to speak with me about this, Doug.

Doug: You’re welcome.