China’s three big advantages in a trade war

Why Xi holds all the cards.

ANALYSIS

China has chosen a  modest retaliatory strike to President Donald Trump’s threat to slap tariffs on  $US50 billion worth of Chinese imports to the US.

A hodge-podge of US exports worth about $US3 billion a year could now face tariffs.

China’s initial reaction is probably cautious because, as ever, it’s not clear how much of Mr Trump’s strategy is a negotiating feint, or how much he could follow through with even if he wants to

But if a trade war does get serious, China has several advantages:

1. Xi Jinping doesn’t have to face voters
Announcing tariffs will probably lead to a short-term bump in Mr Trump’s support. Most economists will point out the obvious flaws in his schoolboy economics, yet it's seen as tough and proactive. But how much appetite Americans will actually have for paying more for their cars (as the price of steel rises), or more for their iPhones or basically anything they can buy at a Walmart remains to be seen.

The president wants local manufacturing jobs to return to their 1960 level. But the truth is most are never coming back. They’ve been lost to automation and America’s transformation to a services economy. Apple doesn’t have American workers who screw iPhones together; it does design and market them and own all the IP and take all the profit, and create hundreds of thousands of jobs in apps.

Yes, Apple and others can be bullied into moving some manufacturing to the US (and offered some corporate tax cut carrots – though it’s notable nearly all the big tech companies already pay an effective tax rate below 21%) but it barely move the needle, and Mr Trump will need big results before he faces re-election battle in 2020.

More pressingly, the Republican majority in Congress – which can put a leash on the president, to a degree – faces the ballot box in November (when every seat in the House of Representatives and a third of Senate seats are up for grabs). Any economic pain or chaos from a trade war could be keenly felt at a time when by-elections and polls this year indicate Democrats are already poised to make gains.

China’s President Xi Jinping, who recently abolished term limits, faces no such limitation. Yes, to a degree he has to keep an inner circle of his party’s hierarchy happy but the ballot box and media is not a problem, nor are the banks. If it comes down to a war of attrition, he holds all the cards.

Yes, the repressive nature of the Xi regime would well ultimately bite him on the bum as a rising middle class gets restless. But revolutionary change is likely years or even decades away. Republicans face the ballot box in November.

The Dow Jones Industrial Average.

2. Wall Street is hurting
Wall Street just had its worst week in two years. In part, it was because of the president’s inability to reign in the federal deficit (despite his tweets about exercising a veto on Friday morning, he signed a $US1.3 trillion spending bill in the afternoon).

Another decline on Friday meant the Dow Jones Industrial Average has now fallen more than 1400 points over five days, a 5.7% decline.

We know Mr Trump cares. Despite his war-on-Wall Street rhetoric during the campaign, he’s constantly tweeted about the stock market on its up days.

3. Team Trump is not onboard
I’m guessing it’s career-limiting to disagree with Xi Jinping.

Of course, it can be career-limiting to disagree with Mr Trump, too, and he’s shown a recent propensity to surround himself with yes-men.

His top economic advisor Gary Cohn resigned (or was shown the door, according to Bloomberg) after opposing the steel tariffs.

The president touted Mr Cohn’s replacement, economist Larry Kudlow, as someone who had come around to his thinking on imposing tariffs as a negotiating tactic.

Yet it’s likely Mr Kudlow’s sympathy is superficial, and generated by his desire to out-manoeuvre rival Chris Liddell. The Wall Street veteran and CNBC commentator has held  conventional centre-right views on free trade his whole career. It seems unlikely he’s undergone a genuine conversion to a Bernie Sanders/Jane Kelsey/Trumpesque view that nationalism trumps the free market.

Even if Mr Kudlow has suffered a blow to the head and woken up with the same thoughts on protectionism as Andrew Little, Mr Trump's inner circle are still free-traders, from his son-in-law and senior advisor Jared Kushner to Mr Liddell (who last week was named deputy chief of staff).

Before Mr Trump signed an executive order (yet to be enacted) on steel tariffs, 103 Republican lawmakers sent him a letter opposing the move. Ordinarily, Congress’ approval would be needed for tariffs. With steel, Mr Trump claimed a security provision to avoid the need for a vote (he saw the possibility that the US would not have enough steel as it required for weapons, which could yet be challenged by the Senate). With other products, it could well turn into vote-by-vote trench warfare. 

China holds $US1 trillion+ in US debt
Mr Trump has had a few ideas about cutting spending but not the gumption to get them past Congress despite the Republican majority (Congress nixed all but 1% of his cuts to the Environmental Protection Agency, for example, and of course the effort to save hundreds of billions by repealing Obamacare of course went nowhere).  And in other areas, notably the military and security, he's dramatically increased budgets. Mr Trump pitches corporate tax cuts as a stimulus but red ink is possible during the lull before that kicks in, while personal tax cuts expire in 2025 (why so little faith?) and are give-and-take for many middle Americans as they lose the ability to claim against property and local taxes.

The net effect is that America's federal debt continues to pile higher.

The two biggest holders of US government bonds are China and Japan. Each has just over $US1 trillion.

This factor is probably a neutral factor.

China will not want the US economy to tank in a trade war to the degree that it could have difficulty repaying debt, or that Mr Trump would seize on some perceived "injustice" as a reason to default.

Any default, in typical Trumpian fashion, would be politically popular in the short term but cause long-term pain as all Americans paid for it in higher interest rates on future debt.

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