To talk of a trade war between the United States and China is to misunderstand the magnitude of what the world economic order is confronting. Think of it as Brexit on a global scale. Just as Britain is struggling to separate itself from the European Union, America and China are struggling to separate their huge economies from one another. Not only are the economies involved in this latter separation much larger and much more consequential for innocent bystanders, there is also the added feature of a geopolitical rivalry between a dominant and a rising power, the sort of rivalry that Harvard’s Graham Allison argues has often resulted in military conflict. So replace “trade war,” which is only one aspect of the current conflict, with “decoupling.” America has decided to end its reliance on China as a pool of cheap labor and goods, which has brought with it the decimation of many of its industries and communities and the filching of its intellectual property. China, in its turn, wants to end its dependence for economic growth on the vast American market, a vulnerability Trump or a successor can exploit to prevent China from realizing its goal of displacing the United States as the dominant economic and military world power.
As you read this, Xi Jinping, China’s warlord-in-chief, is closeted with his subordinates, developing a strategy to cope with Trump’s tariffs and other barriers to China’s goods. With his southeastern flank in Hong Kong under threat from protesters, Xi must demonstrate his ability to restore order there while at the same time keeping his state-run economy on course to dominate the industries of the 21st century and eventually displacing America as the leading power in the Asia-Pacific region and, eventually, in the world.
Tariffs are only one weapon in this battle, and a tariff war is one America cannot lose unless it lacks the political will to bear the costs that every victor in every war must tolerate. After all, China needs the massive U.S. market more than the United States needs China’s much smaller one. Another weapon is placing limits on purchases of the adversary’s products. Trump is limiting government purchases of Huawei products, partly for reasons of national security, partly as a bargaining chip in the tariff battle.
China has banned all purchases of American agricultural products, most notably pork and soybeans. The aim is to inflict so much pain on farmers, an important component of the Trump core, that they will abandon the President next year and elect someone who will be willing to strike a deal that allows China to continue the unfair trading practices that our elites found acceptable for so many decades. Zippy Duvall, the Georgia farmer who heads the American Farm Bureau Federation, describes the ban as “a body blow” to America’s farmers. In 2017 their sales to China totaled about $20 billion. Those sales fell to $9 billion in 2018 and were running at an annual rate of about $7 billion in the first half of this year before the ban was instituted.
Another weapon is currencies. Because it cannot win a tariff war, China is using a managed decline in its currency to neutralize the effect of U.S. tariffs. Peter Navarro, the hardest hardliner by far of all the President’s lieutenants, estimates that devaluation of the yuan has just about offset any sales-depressing increase in the price of Chinese goods caused by Trump’s tariffs. Perhaps more important, by first allowing its currency to fall and then stabilizing it, China demonstrated the powerful effect that weaponizing its currency—the U.S. Treasury has labeled the People’s Republic a “currency manipulator”—can have on the U.S. economy, especially share prices and interest rates.
From President Trump’s point of view a currency war—competitive tit-for-tat devaluation—has one advantage: Control of the currency weapon is siloed in the White House. Unfortunately for the President, his Exchange Stabilization Fund has little firepower: about $100 billion with which to buy currencies in a market in which $4 trillion in dollar trades occurs every day. China’s central bank commands $3 trillion, with more available if needed.
The power of China’s devaluation weapon is clear: Allowing the yuan to fall roiled stock markets and forced other nations to follow suit. But it is not without fallout in China itself. When the yuan was allowed to plunge in 2015-16, capital flight required China’s central bank to draw $1 trillion from its reserves to stabilize the yuan. Although the central bank expresses confidence that it can prevent a repetition with more sophisticated controls, Xi cannot rule out the possibility of significant leakage. China will also be forced to pay more for the dollars it will need to buy oil and other commodities that are traded in dollars, and to pay contractors on Xi’s globe-girdling “Belt and Road Initiative,” most of whom will not accept yuan. And its heavily indebted companies, the largest of which have loans denominated in dollars, will find it more expensive to pay interest and principal due on those borrowings.
Many observers do not see the decline in the yuan relative to the dollar as evidence of “manipulation.” They see it as a normal adjustment, reflecting the relative strengths of the two economies, and in part the effect of Trump’s tariffs. They point out that several other currencies have recorded similar currency devaluations as a response to the greater strength of the American economy. The fact that Trump believes he can have a strong economy—the strongest in the world—and a weak dollar reflects the fundamental ignorance of economics that rears its ugly head when he claims that China, not the American consumer, is bearing the cost of his tariffs. Trump’s defenders deny that he is ignorant of how economies work, and instead attribute his statements to considered mendacity, or to bad advice from Navarro. As is often the case, The Lindsey Group consultancy summarized the danger best in a note to its clients:
The world economy could enter a kind of death spiral if a world leader [unnamed], perhaps advised by someone [unnamed] who does not understand . . . basic economics . . . imposes a tariff, sees the currency adjust, and then gets angry because of a mistaken belief that the currency movement is “manipulation,” at which point the angry leader imposes another tariff, and the targeted country’s currency declines again, at which point the world leader gets even angrier. . . .
The President rejects the idea that the yuan’s fall is a natural result of the greater strength of the U.S. economy and of his own tariffs, even though he claims that our economy is very strong and China’s is seriously battered by his tariffs. And, ignoring or unaware of the danger described by The Lindsey Group, and unlike Presidents of the past, he says he wants a weaker dollar. “As your President, one would think that I would be thrilled with our very strong dollar. I am not!” Trump tweeted last week. He believes a weaker dollar would stimulate exports, and raise the cost of imports. He might be right. But it would also
- raise the cost to businesses of imported supplies,
- make Americans poorer when they shop for foreign-made goods,
- raise the interest rate investors will charge the government when it borrows to finance the trillion-dollar deficits it is running, and
- produce the currency realignment he finds so offensive.
The list of countries that have enriched themselves by forced devaluations is somewhere between very short and non-existent.
Meanwhile, decoupling proceeds.
- Once America’s top trading partner, China dropped to third place, behind Mexico and Canada, in the first half of the year.
- The value of foreign direct investment and venture-capital deals between the two countries has shriveled to its lowest level in five years.
- China, which has exhausted its tariff arsenal because it was buying so little from the United States, is considering widening its ban on purchases of American products, further curtailing the already-constrained operations of American firms in its country, and refusing to sell the United States minerals crucial to the manufacture of smartphones and missiles.
- Trump, who has threatened to impose 10 percent tariffs (25 percent might appeal to him on a bad day) on imports from China not yet subject to tariffs, is also extending the list of Chinese firms that are non grata in America, and making it more difficult for Chinese students to obtain visas to develop skills they can put at the service of the People’s Republic.
To borrow from Frank Sinatra, if that ain’t decoupling, it will have to do until the real thing comes along.
Both Presidents have their eyes on the calendar. October 1 marks the 70th anniversary of the People’s Republic of China, a date which Xi does not want to also mark a Tiananmen-style put-down of the Hong Kong protests and a major recession in the PRC. One year and a month later, America’s voters will decide whether to grant Xi his wish for a different adversary or endorse Trump’s plan to re-order U.S.-Chinese economic relations. A possibility is a Mar-a-Lago currency accord, modeled after the 1985 Plaza Accord, pursuant to which leading trading countries manipulated the dollar down. Even if such a truce is struck, the decoupling sought by both men will continue apace. Neither Trump nor Xi can retreat without losing his grip on his constituency: voters in the case of Trump, the powerful Communist elite in the case of Xi. Oh yes—and without abandoning his vision of his country’s future as the dominant player in a new world order.