The Year of the Fire Rooster
My Chinese friends tell me that the auguries of the Chinese New Year are mixed. In Chinese astrology each zodiac year is associated with an animal plus one of the five elements. 2017 is the Year of the Rooster and its element is fire. This is the first such combination since 1957.
The rooster is proud and confident, hardworking and punctual. Fire is associated with brilliance, warmth and passion. So the enthusiastic rooster combined with fire could herald a year of solid achievement. On the other hand, the rooster is also associated with aggression and fire with war. Of course, it might not be a hot war with ships and guns – although the Trump administration takes an uncompromising view of China’s determination to militarise the disputed Spratly Islands in the South China Sea. Instead, it could be a trade war.
What is President Trump’s beef with China?
Mr Trump had some unflattering things to say about the Chinese during the presidential election campaign. One of the less offensive was that the Chinese are currency manipulators. And he outraged China by telephoning Taiwan’s President Tsai Ing-wen when he was President-Elect. This, said China, was in violation of the longstanding one China principle.
Fundamentally, Mr Trump believes that China has been given the best of the bargain over many years by being allowed to export cheap manufactured goods to the USA in massive quantities thus taking American jobs. And not just basic consumer goods such as the myriad of goods that we can buy in TK MAXX (TJX Companies Inc. (NYSE:TJX)). He cannot forgive Apple (NASDAQ:AAPL) for making nearly all of its smartphones, designed in the USA, in China.
It is critical to establish the strategic context of this trade war in-the-making.
The USA, still by far the largest economy in the world, has been the global hegemon since about 1942 and still controls the financial architecture of the global economy. It is still the global leader in almost all technologies and exerts unparalleled soft power through cinema, cable TV and the internet. But its share of global GDP has been declining and it has increasingly felt on the defensive as large parts of its population suffer static or even declining living standards. Now it has a brash new President, an outsider, whose whole mission statement is to break the rules and make America great again.
China, the second largest economy in the world, on the other hand, is an ancient civilisation-state which, after centuries of relative decline is now rising fast. The Chinese resent the way, as they see it, that the global financial system has been structured in America’s interest. Over the last 30 years China has built up a huge manufacturing base founded on export-led growth. Her growth rate is declining, but at around 6 percent is still nearly three times that of the United States. China’s GDP is expected to overtake that of the US in the mid-2020s. Even before that China is intent on becoming a preeminent military and strategic player. The South China Sea policy and the New Silk Road are part of that strategy.
It is historically inevitable that the defensive hegemon and the ancient empire rising will become adversaries – if they are not so already – although of course the leadership of both states hitherto have talked endlessly about cooperation. In the year of the Fire Rooster President Trump will attempt to prise the advantage towards the still mightier America. But President Xi Jinping will have an important year too as he prepares for the Chinese Communist Party’s 19th Congress in late 2017.
Wilbur Ross, Mr Trump’s nominee for Commerce Secretary, hitherto a big beast in private equity, is considered a trade hawk. And Mr Trump has nominated Peter Navarro, the author of Death by China, to lead the National Trade Council, a newly-created federal entity the main purpose of which is to reduce America’s trade deficit. Mr Navarro’s views have been described by one economist as “outside the mainstream”. He has also written a book called The Coming China Wars in which he argues that the Chinese leadership is an amoral tyranny which will stop at nothing to gain global domination unless confronted. But then Terry Branstad, Governor of Iowa (and the longest serving governor in US history), who is President Trump’s nominee for ambassador to China, is an “old friend” of President Xi.
A trade war with China and its consequences
Last year the US managed to rack up a trade deficit with the rest of the world of US$530 billion. Of this about US$366 billion or 69 percent was with China. Mr Navarro, if endorsed by the Senate, will see it as his task to reduce this. How might he go about it?
One scenario is that the US Treasury might formally brand China a currency manipulator. There is a case that China has kept the renminbi artificially low in order to stimulate exports over a long period. That would give the Commerce Department the cover to impose tariffs on individual Chinese products, if not all. Mr Trump himself mentioned a figure of 45 percent during a fiery campaign speech but we have no idea what Mr Navarro has in mind. This would not be unprecedented as the Obama administration imposed tariffs on Chinese steel of up to 522 percent in May 2016.
If the US were to impose tariffs then China would surely reciprocate. They might choose either to ban certain US products or to impose punitive tariffs of their own.
One primary Chinese target would be Boeing (NYSE:BA). Their airliners could be substituted by Airbus (FRA:AIR) aircraft. According to Airbus’s own forecast[i], China is poised to become the world’s leading country for passenger air traffic, and it is already a major market for the company. China is also home to a growing number of Airbus manufacturing and support operations including its first assembly line outside Europe – the A320 final assembly line in Tianjin. However, the lead times between order and delivery for airliners are protracted so adverse trade relations with China would not hit Boeing’s bottom line straight away.
It is historically inevitable that the defensive hegemon and the ancient empire rising will become adversaries…
The American automobile sector could also take a hit. The largest automobile exporters in the US are Ford (NYSE:F) and General Motors (NYSE:GM). In terms of agriculture, the Chinese import large volumes of soya bean and maize from the USA. It is not clear from where else they would obtain these foodstuffs if they chose to ban them – possibly they could turn to Brazil or Argentina. And American farmers would probably be able to find alternative markets for their products fairly speedily.
But at the end of the day, protracted trade wars hit surplus countries harder than deficit countries (as the British government well knows in respect of the EU). There would be some import substitution on the part of American consumers and possibly some of those gaudy baubles for sale at TK MAXX might no longer be available. There would probably be increased inflation in the US and increased unemployment in China. The former may give the Fed the excuse to raise rates again while the latter would make the Chinese authorities less willing to rein in excessive credit creation. (The domestic assets of the Chinese banking system have tripled in size since 2010 and are still growing at about 20 percent per annum – more than three times the rate of economic growth[ii]).
If Mr Trump and his team do succeed in trimming America’s excessive trade deficit with China, the Dollar, already rampant, might strengthen further, especially if combined with the fiscal stimulus of an infrastructure renewal programme. Over the last year the People’s Bank of China has maintained the renminbi within a narrow band against a basket of currencies, though it has depreciated very modestly against the Dollar.
The irony is that if America “wins” its trade war with China the substantial fall in the renminbi because of the credit bubble, anticipated by economists such as George Magnus, might happen sooner.
The war of words with Germany
In the famous interview with Michael Gove[iii] Mr Trump said that the EU was “basically a vehicle for Germany”. My interpretation of this is that he believes (as many of us do) that the Eurozone has been constructed by the Germans in order to sell their manufactured goods to the European periphery with which they run huge surpluses without the risk that an appreciating Deutsche Mark would ever make their goods uncompetitive. The result is that Germany runs a permanent surplus with the peripheral states which in turn become increasingly financially stressed.
On 31 January Peter Navarro told the Financial Times that the Euro is “an implicit Deutsche Mark”[iv]. He said that Germany “is using a grossly undervalued Euro to exploit the US and its EU partners”. He claimed that Germany was the major impediment to a US-EU trade deal and pronounced the TTIP trade deal dead (as I predicted last week). Frau Merkel dismissed the comments, saying that Germany could not influence the strength of the Euro as the ECB was entirely independent.
These comments suggest that the Trump administration’s approach to trade will focus as much on currencies as on tariffs. Germany, as well as China, may soon be branded a currency manipulator. And at a meeting of pharmaceutical leaders on 31 January President Trump accused Japan and China of using monetary policy to drive down their currencies. “They play the devaluation market while we sit here like a bunch of dummies” intoned the President. Evidently, no one had the gumption to point out to the President that the US Federal Reserve has been using monetary policy to manipulate the Dollar throughout his lifetime!
The President has already suggested placing a 35 percent tariff on BMW (FRA:BMW) cars manufactured in Mexico and then exported to the US. Germany’s trade surplus with the USA last year exceeded US$60 billion. Meanwhile, last year, Germany overtook China to become the world’s largest surplus country.
Mr Trump’s real game plan
It is evident from further remarks made by Mr Navarro that what he and his team aspire to do is to shake up the structure of the entire global economy which, as they see it, is no longer working in America’s interests (but rather for China’s and Germany’s). Mr Trump and Mr Navarro want to repatriate the entire supply chains on which US multinational companies rely. So Apple should not only be assembling iPhones at home in America, but all of the components they use should be manufactured in America too. For that to happen, Mr Trump’s administration will revolutionise business taxation and regulation.
One proposal already before Congress is to prevent companies from deducting import costs for the calculation of taxable profit, while at the same time making all revenues from exports tax-free. General Electric (NYSE:GE) has hailed this proposal as putting them, at last, on an equal footing with their international competitors. In contrast, Walmart (NYSE:WMT), a major importer, has said that as a result of the “border adjustable” proposal they might have to raise their prices by up to 20 percent – a claim dismissed by Mr Navarro as “globalist”.
Mr Trump and Mr Navarro want to repatriate the entire supply chains on which US multinational companies rely.
Mr Trump is not against international trade; he just wants to make sure that jobs are not exported in the process of trading. If that means a policy of economic nationalism, then that makes America more like the Chinese and the Germans, not less. That said all those lost manufacturing jobs that the Trumpists talk about are probably gone forever. When those supply chains are repatriated to America, they will be pullulating with robots and a small number of highly skilled workers. And the gaudy baubles that the workers buy at TK MAXX will be more expensive. But that’s a problem for another day.
The terrible twins
In Trump-world China and Germany are the real bad guys because they run massive permanent structural surpluses with their trading partners, and particularly with the USA. That is not stupid. John Maynard Keynes wrote about the malign role of surplus countries in The General Theory (1936). Huge current account surpluses by export megastars force deficit countries into massive debt in order to maintain demand in line with output. The Germans can get away with this with Greece and elsewhere. But they are not going to get away with it with Uncle Sam. China and Germany have to be forced to rely more on domestic demand and less on external demand. The only country that has the muscle to force them is the USA.
President Fire Rooster
For the superstitious amongst you, 1957 was not a great year for China. It was the start of the “Anti-Rightist” movement which was Mao’s trial-run for the Cultural Revolution that followed. About 300,000 writers, artists and lawyers were victimised and many slain. The Great Chinese Famine took hold one year later…
Conventional media have underestimated Mr Trump since he first threw his hat into the presidential ring. He is probably the most ambitious President of modern times, at least since John F Kennedy. And now he is not only in the driver’s seat but has his foot hard down on the accelerator. Whether he will arrive at the promised destination is a good question. He has a good chance, though he is likely to run over a pair of twins along the way.
[i] See: http://www.airbus.com/company/worldwide-presence/airbus-in-china/
[ii] See: If Trump means to start a trade was, China cannot afford to back down, by George Magnus, The Times, Saturday, 31 December 2016, page 47.
[iii] The Times, 16 January 2017. The full transcript is available at: http://www.thetimes.co.uk/article/full-transcript-of-interview-with-donald-trump-5d39sr09d
[iv] Trump trade chief accuses Berlin of using weak euro to exploit US, Financial Times, 01 February 2017, page 1.