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    The US is running out of options while China plays the patient game

    August 2019

    If you want to understand the developing trade – and currency war with China, the first thing you need to realize is that nothing Donald Trump is doing makes sense. His views on trade are incoherent. His demands are incomprehensible. And he vastly overrates his ability to inflict damage on China while underrating the damage China can do in return.

    The second thing you need to realize is that China’s response so far has been fairly modest and measured, at least considering the situation. The US has implemented or announced tariffs on virtually everything China sells in the US, with average tariff rates not seen in generations. The Chinese by contrast, have yet to deploy anything like the full range of tools at their disposal to offset Trump’s actions and hurt his political base.

    China plays the patient game

    Why haven’t the Chinese gone all out? It looks to me as if they’re still trying to teach Trump some economics. What they’ve been saying through their actions, in effect, is:” You think you can bully us. But you can’t. We, on the other hand, can ruin your farmers and crash your stock market. Do you want to reconsider?”

    There is, however, no indication that this message is getting through. Instead, every time the Chinese pause and give Trump a chance to rethink, he takes it as vindication and pushes even harder.

    What this suggests, in turn, is that sooner or later the warning shots will turn into an all-out trade and currency war.

    About Trump’s views: His incoherence is on view almost every day, but one of his recent tweets was a perfect illustration. Remember, Trump has been complaining nonstop about the strength of the dollar, which he claims puts America at a competitive disadvantage.

    He even got the Treasury Department to declare China a currency manipulator, which was true seven or eight years ago but isn’t true now. Yet the very next day he wrote triumphantly that “massive amounts of money from China and other parts of the world is pouring into the US,” which he declared “a beautiful thing to see”.

    Um, what happens when “massive amounts of money” pour into your country? Your currency rises, which is exactly what Trump is complaining about. And if lots of money were flooding out of China, the renminbi would be plunging, not experiencing the trivial (2%) decline that US Treasury condemned.

    Oh well. I guess arithmetic is just a hoax perpetrated by the deep state.

    No Kowtowing for China

    Still, even if Trumps isn’t making sense, will China give in to his demands? The short answer is, “what demands?” Trump mainly seems exercised by China’s trade surplus with America, which has multiple causes and isn’t really under the Chinese government’s control.

    Others in his administration seem concerned by China’s push into high technology industries, which could indeed threaten US dominance. But China is both an economic superpower and relatively poor compared with the US; it’s grossly unrealistic to imagine that such a country can be bullied into scalling back its technological ambitions.

    Which brings us to the question of how much power the US really has in this situation?

    America is, of course, a major market for Chinese goods, and China buys relatively little in return, so the direct adverse effect of a tariff war is larger for the Chinese. But it’s important to have a sense of scale. China isn’t like Mexico, which sends 80% of its exports to the US.

    The Chinese economy is less dependent on trade than smaller nations, and less than a fifth of its exports come to America.

    So while Trump’s tariffs certainly hurt the Chinese, Beijing is fairly well placed to counter their effects. China can pump up domestic spending with monetary and fiscal stimulus; it can boost its exports, to the world at large as well as to America, by letting the renminbi fall.

    At the same time, China can inflict pain of its own. It can buy its soy beans elsewhere, hurting US farmers. Even a mostly symbolic weakening of the renminbi can send US stocks plunging.

    A coordinated response eludes the US

    And America‘s ability to counter these moves is hindered by a combination of technical and political factors. The Fed can cut rates, but not very much given how low they are already.

    We could do a fiscal stimulus, but having rammed through a plutocrat – friendly tax cut in 2017, Trump would have to make real concessions to Democrats to get anything more – something he probably won’t do.

    What about a coordinated international response?

    That’s in my opinion unlikely, both because it’s not clear what Trump really wants from China and because his general belligerence has left America with almost nobody willing to take its side in global disputes. So Trump is in a much weaker position than he imagines, and my guess is that China’s mini devaluation of its currency was as attempt to educate him in that reality. But I very much doubt he has learnt anything. His administration has been steadily haemorrhaging people who know anything about economics.

    So in my opinion this trade dispute will most probably get much worse before it gets better.