U.S.-China: President Trump's "America First" Gambit

posted by Karim Pakravan on October 14, 2018 - 3:09pm

As the Chinese return to work after the Golden Week holiday, the country’s leadership faces  multiple interrelated challenges:  an economic slowdown, a weakening currency, a sharp stock market correction, as well as an escalating economic and diplomatic Cold War with the United States. The Chinese currency has lost 9.5% against the US dollar since its high of CNY 6.26/USD in early April. The Shanghai Composite Index declined by 25.5% between its 2018 peak on 1/25 and mid-September, and again by another 2.4% after the end of Golden Week.  Manufacturing slowed down, with the Caixin  PMI-Manufacturing falling to 50.2 at the end of September—50 is the tipping point between expansion and contraction.  In response, the Chinese monetary policies have introduced a modest monetary stimulus, reducing the banks’ reserve requirement for the fourth time this year. 

The Trump administration, fresh from the completion of the ”new-and-improved” NAFTA, (aka the United States, Mexico, Canada Agreement, USMCA), is turning its attention to China, hoping to exploit the challenges faced by the Chinese to escalate the trade war and force the Chinese government to yield to U.S. demands.  The key question is whether the U.S. gambit will work.  In the meantime, we are witnessing the two countries getting deeper in a tit-for-tat trade war, Furthermore, the Trump administration is broadening the scope of its attacks on China. Recently, Vice President Pence launched a tirade against China, stating that Beijing has “….has  chosen the path of authoritarianism, mercantilism and aggression”. The United States has even considered denying Chinese students visas and President Trump has publicly (and without any proof) accused the Chinese for interfering in the 2018 Mid-Term elections in favor of the Democrats.

China has responded to the first round of tariffs imposed by the United States with tariffs of its own, carefully calibrated in particular to hit the economy of the red states that supported Trump.  At the same time, China has declared that it is open to negotiations, only to face a tactical delay from the United States.  However, the situation is unlikely to resolve itself. On one hand, public opinion in the United States is broadly supportive of a get-tough attitude on China, and on the other, China is unlikely to fold under pressure.  While the U.S. economy is in a strong position and can absorb the shocks of a trade war, specific sectors are likely to suffer more.

Despite the economic slowdown, the Chinese is equally prepared for a trade war.  While exports slowed down somewhat in 2017, they have recovered, and the trade balance remains in a comfortable surplus.  Moreover, China’s dependence on trade, as measured by Trade Intensity (the ratio of the sum of imports and exports to GDP) has declined by about a third in the past five years, from 45% to 34%. Foreign exchange reserves, after declining from their peak of almost $4 trillion in mid-2014 until the end of 2017, have stabilized around $3 trillions.  Furthermore,  China has the option of letting its currency depreciate faster in order to offset the impact of tariffs on its competitiveness. Finally, China holds an estimated $1  trillion in US  Treasuries, raising the specter of a “nuclear option”, whereas the Chinese massive sale of their U.S. Treasuries would cause a dollar crash and a surge in U.S interest rates.  Nevertheless, such a course of action is unlikely.

While the U.S complaints against China are widely shared by its main allies, the Trump administration’s go-it-alone approach is finding  little global sympathy.  In fact, the Trump’s “America First” strategy of simultaneously ignoring and bullying the United States allies has weakened considerable Washington’s global clout. The European Union and China are cooperating to uphold the Iran nuclear deal and help Iran evade U.S. sanctions.  Furthermore, in the long run, the Chinese are presenting a credible (albeit in its first stages) challenge to the U.S.-centered global financial architecture). The indiscriminate use of sanctions as a political tool, including against U.S. allies, will accelerate the search for alternatives to the US dollar, and in the long run erode America’s “exorbitant privilege.”[1] In the short-term, both countries are able to inflict costs on each other’s economies, although those costs will be sectoral rather than broad-based.   The mutual pain is likely to increase when the Trump administration  adds another additional tariffs in January, a move that the Chinese will most certainly match.  Moreover, tariffs are unpopular in the global financial markets, as reflected by the sharp recent gyrations in both the U.S.  and Chinese stock markets. In the long-term, , the disruption of supply chains and the search for new markets and partners by the Chinese will have an adverse impact on U.S. corporations.   Bottom line, the Trump gambit on China looks increasingly risky, with significant adverse consequences for both the global and the U.S. economies.

[1] The “exorbitant privilege” was a phrase coined by a French Minister of Finance in the 1960s,  referring  to the dollar’s dominant position as the main international currency, which has allowed the United States to “print” the international currency and run chronically large external deficits.