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Trump ratchets up trade war, threatening a currency war

Muhammad Mahmood | Published: August 10, 2019 20:52:25


President Donald Trump has now taken the US trade war to a new height with the threat to impose 10 per cent tariffs on an additional US$300 billion worth of Chinese goods from September 01 with the added warning that tariffs could go up to 25 per cent. This announcement came just a day after the China-US trade talks held in Shanghai on July 31 and described by the US as "constructive''. The decision is clearly designed to intensify pressure on China to reach a trade deal to the satisfaction of the US.

Trump's latest move brought an immediate reaction on Wall Street as stock markets around the world took a dive. But Trump dismissed the concerns about negative response in the markets by saying "not concerned at all''.

Besides announcing the additional tariffs on Chinese imports into the US, Trump further twitted "We look forward to continuing our positive dialogue with China on a comprehensive trade deal, and feel that the future between our two countries a very bright one''. He appears to have an amazing dark sense of humour as he added "if they don't want to trade with us anymore, that would be fine with me. Until such time as there is a deal, we'll be taxing them''.

Trump regularly boasts that tariffs on Chinese goods are financial windfalls but it is the US consumers who ultimately bear the burden of tariffs. The US$300 billion target list is mostly final consumer goods ranging from mobile phones to laptop computers, footwear and children's toys unlike the previous rounds of Trump's tariffs which were mostly targeted at intermediate inputs.  Trump's economic adviser Larry Kudlow told reporters that the impact on consumers from the latest tariffs would be minimal despite research shows it is the US consumers who bear the brunt of all import taxes. In fact, the tariffs will have to be paid by the US importing firms in the first instance, and then they will have to decide whether to pass that on to the US consumers in part or fully or absorb it.

Despite Trump's tariffs, US trade deficits continue to soar which runs counter to the narrative he has been pushing since he has assumed the office of presidency. In effect, the tariffs have failed to achieve Trump's main policy objective; US consumers and businesses continue to buy imported products but at higher prices.

The tariffs predictably failed to achieve what Trump thought they would do. However, his tariffs are having an impact on bilateral trade between the US and China - both imports from China and exports to China have declined. While both countries are doing less trade, the trade deficit persists and rising.

Because trade deficits are largely concentrated in the manufacturing sector, Trump believes his tariffs will increase the possibility of rebuilding US manufacturing and increasing manufacturing exports. He is recycling mercantilism, a long-time discarded doctrinaire view of a zero-sum world. He completely ignores that technology plays a much larger role in the relative declining importance of manufacturing than trade does. The US economy has been shifting away from manufacturing since the late 1970s to services. This is reflected in the country's trade balance where the US persistently runs trade surpluses in services. Trade statistics or even GDP (gross domestic product) are unable to fully account for the rapid changes in technology, especially digital technology and their impact on output, employment and trade.

In a way Trump has rewritten what success looks like for a US president. Instead of measuring success in terms of providing capable leadership and maintaining political and economic stability, he has created a divisive society by cleverly exploiting ordinary US citizens' economic anxieties and channelling those anxieties to foment racial and religious bigotry at home to achieve electoral gains and targeting China abroad for all its economic woes.

Trump's presidency is marked by aggressive confrontation both at home and abroad. At home his espousal of racial  bigotry not only resulted in the slogan of "send her back'' directed at Congresswoman Ilhan Omar right in his presence at a rally but now also in a racially motivated two mass murders taking place last weekend.  But more disturbingly, a section of the US press described these two racist mass murderers as two "disturbed'' young white men. The issue of racism in the US runs deep.

Trump's confrontational politics has destabilised the global economy and this policy is best exemplified in his trade war with China which he has now turned into a war of attrition. He thinks he can outlast the Chinese and force them to blink which is apparently nothing but daydreaming.

However, US diplomacy has always been to make other countries depended on it for major tradables like agricultural products, energy, information technology and military technology. This dependency enables the US to use trade sanctions to cripple economies which do not tow its line. Furthermore, the collapse of the Bretton Woods System in 1971 left other countries with no alternative but to invest their trade surpluses to buy US treasury bonds or other securities. At the same time, countries around the world hold the US dollar as their reserve currency given the predominance of the US economy in the global economy. All these create massive demand for the US financial assets which means the US pays very little for its foreign borrowings, almost like having a free lunch.

The Treasury bonds are US Treasury IOUs or more precisely loans to the US Government. This enables the Federal Reserve to maintain a low interest rate regime which in turn enables US investors to borrow at a cheap rate to buy up foreign commercial entities in areas such as manufacturing, agriculture, infrastructure, public utilities and banks. More importantly, it finances the US budget deficit, thus the current account deficit ends up financing the domestic budget deficit.

But China is a very different ball game because it has an economy with the strong presence of public ownership of commercial enterprises in the agriculture, manufacturing and services sectors. This poses a very strong deterrence for US investors to buy up Chinese companies including Chinese banks. Trump's trade war, as a consequence, has made  the role of the state in the Chinese economy the central issue, in particular opening up of the Chinese banking and finance industry. By doing so Trump has turned it into a broad-based economic and political conflict.

However, Federal Reserve Chairman Jeremy Powell pointed out repeatedly to the uncertainty caused by Trump's trade wars on multiple fronts as the main reason for cutting the Federal Fund rate by 0.25 percentage point. The rate cut is rather surprising in view of the very healthy US economy. This clearly indicates the rate cut has nothing to do with the real economy, but everything is to do with currency devaluation. Now the latest round of tariffs, many argue, might have been predicated on Federal Reserve's readiness to cut the rate again. Trump on many occasions has said that the dollar is "too strong''. In effect, he weaves monetary policy into the trade war. By doing so he is now moving toward a currency war as well.

As the Chinese economy is now slowing down while the US economy is performing well, the current value of  the yuan is no longer aligned with market fundamentals. More importantly, the trade conflict between the US and China has caused deterioration in China's trade balance which in turn has led to capital outflows. As capital outflows continue, that put downward pressure on the yuan. The recent depreciation of the yuan reflects that. But the US Treasury described the depreciation as "currency manipulation'' signalling that the trade war is escalating into a currency war.

With declining interest rates in the US, making borrowing cheaper, US investors need new markets to invest overseas for higher returns - in particular the Chinese market to buy up Chinese companies including banks. Trump is now getting more worked up to create a China of freewheeling market economy and free access for US investors buy up any Chinese business enterprises and get rid of its public enterprises and direct state involvement in the economy. But China cannot buy up US companies, the US then would use national security provisions to block that to happen.

Trump's doubling down on China might do the opposite as restricting imports without changing the underlying savings and investment levels would simply raise the value of the dollar causing exports to decline and imports to rise. But the trade war is more than fighting over the trade imbalance between the two countries. It is more about the future place of the US, the current global hegemon, in the changing global order facing a rising power. Economic and trade tensions between the two countries is likely to continue to the detriment of global economic growth and security unless the core issues are addressed and diplomacy replaces confrontation.

Muhammad Mahmood is an independent economic and political analyst.

muhammad.mahmood47@gmail.com

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