Last week I asked if a Trump, China conflict could lead the U.S. into recession? The point of the question was how important the Trump and China relationship was to the U.S. economy. In one short week, Trump has antagonized China on two more fronts. Seemingly, he is deliberately trying to instigate with China. That is a very high risk move with little upside for America.
Tying Taiwan to Chinese-American Trade
President-elect Trump’s opening gambit with China was his acceptance of a telephone call with Taiwan’s President Tsai Ing-wen. This was a departure from decades of accepted protocol that the U.S. leadership ought to contact Taiwan through Chinese channels. This was a clear breach of the agreed upon “one China” policy.
This weekend, Trump indicated that the United States might not adhere to the “one China” policy without trade concessions from China. This is sure to further infuriate China, which has already flown a nuclear bomber over the South China Sea in recent days.
Trump said in an interview on Fox News,”I fully understand the ‘one China’ policy, but I don’t know why we have to be bound by a ‘one China’ policy unless we make a deal with China having to do with other things, including trade…”
While many would agree with Trump’s thought process, the reality is that the U.S. and China have been tied at the hip since Nixon. There simply isn’t much that China can do for America on changing trade patterns, except over a long period of time as they become a more consumer economy
Trump went on to say, “I mean, look, we’re being hurt very badly by China with devaluation, with taxing us heavy at the borders when we don’t tax them, with building a massive fortress in the middle of the South China Sea, which they shouldn’t be doing, and frankly with not helping us at all with North Korea…”
While I can not definitively say that the President-elect is wrong about what he is saying and doing, his approach so far has been a clear departure from the past. The terms of that past were agreed upon and have led to clear benefits for both nations. Reopening the entire relationship to get a slightly larger piece of the pie, could backfire with us getting a smaller slice or even the pie shrinking altogether.
Trump is Wrong About Chinese Currency Manipulation
One of Trump’s key complaints about China is that they manipulate their currency to maintain a price advantage on trade goods. Here his mistake is huge.
For the past two years, China has been keeping their currency artificially priced higher, not lower. One of their core motivations was get the Yuan to be included in the IMF’s Special Drawing Rights (SDRs). That has now occurred.
To achieve their goal of keeping the Yuan higher, the Chinese sold U.S Government Treasuries that were largely purchased just after the financial crisis. There was likely some backroom deal between the U.S. and China on this matter.
The Federal Reserve printed trillions of dollars from 2009 to 2014. There needed to be a buyer of much of that U.S. debt. The big buyer until early 2014 was often China. It shouldn’t be expected that China would want to hold the U.S debt forever.
The dollars created by the Fed were pumped into the financial system creating liquidity. In the past two years since the end of QE, the Chinese selling UST debt has created liquidity. A reduction of liquidity in global financial markets could drive the dollar into bubble territory.
So, while China has in fact devalued in the past year, it has done so in a minimalist way. The impact on trade has been negligible. By and large the biggest influence on trade has been technology. Studies and surveys show that about three-quarters of American job losses have to do with technology, not offshoring or outsourcing. That does not absolve China, or the bonus seeking corporate executives, however, it should put things into a little more perspective.
It is ironic that Trump would accuse China of currency manipulation when the U.S. Federal Reserve expanded their balance sheet by trillions of dollars. This is not to defend China, I’m only seeking to recognize the facts. And the facts are that China hasn’t manipulated their currency anymore than America has.
A Trade & Currency War?
While the developing Trump administration has stated that there will not be a trade war, I am not so sure. China is not taking what is going on well. They have already filed a legal challenge with the World Trade Organization to the U.S. and EU not treating it as a “market economy.”
Once again, I will point out that China is not the little brother anymore. China has FIVE times as many people as the United States. It is growing its economy at around 6-7% per year. With only about 1/5th of their people in the middle class, it is only a matter of time before the Chinese economy is larger than the United States.
Preserving the relationship with China so that American will have access to the Chinese market, even if not full access, is very important. China is going to have a billion person consumer class within a generation or two. That is enough growth to support significant U.S. exports.
It is worth noting again, the United States is the LARGEST exporter in the world. If we lose access to some of China’s market, that will impact S&P 500 companies dramatically. About 40% of earnings for the S&P 500 constituents comes from overseas trade.
As I pointed out in the MarketWatch article linked at the top of the page, if the Chinese decide to be firm with the United States, they have the means to. As America’s largest creditor, they can choose how to handle that debt. They can sell it off which raises the value of their currency. They can hold it which raises the value of ours unless engage in more QE. They can exchange it for oil with Saudi Arabia which would alter the equation dramatically.
Frankly, if the Trump administration pursues an aggressive policy with China, which appears likely, I expect that China and Saudi Arabia will engage in an oil deal. The impact of this would be profound. Saudi Arabia would now hold even more U.S. debt and could raise the price of oil substantially. By the time we were pumping enough oil the U.S. would be in recession.
Many will say that such an attack on the American economy is suicide for China or Saudi Arabia. I disagree. It would be a direct assault on American hegemony and the Trump administration. To think that they will not meet fire with fire is naive and arrogant. The unfortunate impact of such a trade and currency war would be a much faster decline of U.S. economic advantages and the dollar falling off its perch as global reserve currency into just another constituent of the IMF’s SDRs. Why is this important? Much of American’s standard of living comes from the dollar being strong and widely traded around the globe. Any reductions in dollar strength below the range it just broke out of will reduce American standard of living.
The Difference Between Micro Thought and Macro
The idea that a businessman is somehow more qualified than most politicians to handle economic policy is likely wrong. Why? Because business people for the most part operate within their microeconomic bubble. They cut deals and do business that is specific to their enterprise. They do not have much macroeconomic experience.
The difference between micro and macro thoughts is much like the difference in thought between an athlete and a coach. The athlete knows how to do his (or her) job and has some understanding of the jobs of the other athletes. However, the coach can see all the moving parts and learns how to get the most out of each piece. Businessmen do not always have that perspective as they deal within one or few organizations, not a global economy comprising billions of people and dozens of key government and central bank actors.
I don’t know if President-elect Trump will be able to adjust to the macroeconomic environment that has far more moving pieces than what he’s been used to. In the past, as a real estate developer or TV star, he was able to put his hands directly on all parts of the equation. That won’t be the case in a rapidly moving, self-interested, but globally connected world.
President Trump’s handling of the China relationship will likely be the defining issue of his Presidency. If he handles it well, then we might indeed see above trend growth for years. It could in fact insulate America from the “slow growth scenario” that I have posited. However, if China is motivated to become confrontational and punitive, then not only will President Trump’s entire presidency fail, then most Americans will suffer a set-back in standard of living.