Of trade wars and trade bores

Last week in Quebec it was six against one: President Trump stood accused of starting a trade war. But another way of looking at it is that China has been conducting a trade war against the G-7 for the last 30 years.

Method in his madness

At the Quebec summit, which ended in acrimony last week, President Trump told fellow leaders that the USA had been a piggy bank that everyone’s robbing. The six were incensed about President Trump’s 25 percent tariff on steel and 10 percent on aluminium imports from the EU and Canada into the USA which went live at midnight on 31 May. Identical tariffs on Japanese exports have been in place for more than two months now.

Mr Trump’s policy is much more intended to rectify America’s trade deficit with China than that with Europe. But, in the past, Mr Trump has branded both China and Germany as currency manipulators. China, so Trumpists believe, is running a massive trade surplus with the USA because its currency, the renminbi (yuan), is undervalued; and the trade deficit with Germany arises because the Germans have adopted an artificial currency – the Euro – which is valued at less than a resurrected Deutschmark would be worth. Moreover, both China and the EU impose higher tariffs on US imports than are imposed on Chinese and European exports into the US.

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The UK is not Mr Trump’s target; though we have been caught in the crossfire, since trade policy is determined by Brussels for all member states of the EU. Canada will be one of the hardest hit as 90 percent of the country’s steel exports go south to the USA.

America’s allies – as was evident at the G-7 meeting – were offended not only by the unfriendly and (as they see it) unprovoked unilateral imposition of tariffs on their exports, but also by the justification of that action. In principle, Mr Trump should have laid the proposal to impose tariffs before Congress – something that Congress might well have rejected, not least because, even in Republican circles, most Congressmen are free-traders. However, Mr Trump circumvented Congress by making the trade issue one of national security – something that states are allowed to do (though normally in extreme circumstances) under WTO rules.

Canadian Prime Minister Justin Trudeau responded by saying that the idea that Canada poses a threat to the national security of the US was an affront to the Canadians who died alongside Americans in two world wars. The President returned the compliment by tweeting from Air Force One as he left Quebec that Mr Trudeau was weak and dishonest.

I suspect that Mr Trump is more concerned about Canada (and Mexico) in the context of the NAFTA negotiations rather than in that of the G-7 or G-20. Mr Trump is demanding a revised NAFTA agreement that will raise the minimum wage for Mexican auto workers; he wants the minimum US-made content in imported automobiles to be raised; and he proposes to limit the new NAFTA deal to three years. Canada and Mexico are resisting these demands – so Mr Trump has opened up the battle on another front.

Steel: hard facts

China is by far the largest global producer of steel, with an output in 2016 of 808 million tonnes, compared with 162 million tonnes for the EU and 80 million tonnes for the US. America imports about 35 million tonnes of steel each year, Canada being its largest supplier.

Britain’s steel industry is tiny by global standards, having an output of around 7.6 million tonnes and just 31,000 workers – though it is a major part of the economy of South Wales where the Tata Steel (BSE:500470) plant is located. Of this, about 350,000 tonnes (less than 5 percent) were exported to the USA last year, though this included high premium, quality specialist steels. The new tariffs will undo recent additional competitiveness caused by the depreciation in the value of Sterling since the Brexit referendum.

That said, the specialist nature of the UK’s steel products will probably mean that American manufacturers will continue to buy them at the higher price. In contrast, they are likely to abjure Chinese output. Pronouncements by certain Labour MPs that this heralds the end of the UK steel industry are therefore groundless.

US steel union bosses initially praised Mr Trump for imposing tariffs on China. They were critical, however, of the decision to remove Canada’s exemption. This is not surprising as 225,000 of the United Steelworkers Union 800,000 North American members reside in Canada. The action against Canada – with which the USA enjoys a special relationship with the longest undefended border in the world – may turn out to have been a mistake. But it surely has something to do with the mutual personal antipathy between the Canadian Prime Minister and the American President.

Globally, there is huge overcapacity in the steel industry. This is partly due to the fact that, in so many countries, the steel industry is still under state ownership and control. This is particularly true in developing countries which often seem to think that, for reasons of national pride, they need a lousy flag-carrying airline and smog-belching steel plants of dubious quality.

Economic impact

According to Wilbur Ross, the 80-year old US Commerce Secretary, the impact of these tariffs on the US consumer will be trivial. Even if harsh retaliatory tariffs are imposed by the EU, few Americans will notice the threatened export tariffs on peanut butter, New England cranberries, Bourbon whisky and Harley Davidson (NYSE:HOG) motorcycles. In fact, the latter’s share price rose nicely this week.

Most of the burden will fall on US manufacturers which use imported steel: there could even be job losses in steel-consuming companies. And government infrastructure projects – the bridges, dams and new airport terminals promised by Mr Trump during the presidential campaign – will get more expensive.

Mr Trump’s tariffs on steel and aluminium produced by the EU, Canada and South Korea are unlikely to bring back many jobs in the steel industry to the USA. Nor will it have any immediate impact on the trade deficit.

What then does Mr Trump want? He indicated at the Quebec summit that his goal was a trade regime which was tariff-free, barrier-free and subsidy-free – what we call on this side of the pond a level playing field. His economic adviser, Larry Kudlow (who unfortunately suffered a heart attack at the North Korea summit in Singapore), has said that Mr Trump simply wants reciprocity. According to WTO figures, US average trade-weighted tariffs are 2.4 percent. This compares with the EU’s 3 percent, Canada’s 3.1 percent, China’s 4.4 percent and Mexico’s 4.5 percent.

Mr Trump reportedly told President Macron that he wanted to drive German cars off the streets of New York. That might be good news for American automobile producers; but it would be bad news for American workers in BMW’s US assembly plants. America’s farmers are also nervous about the prospect of retaliatory tariffs.

The US could win a trade war with China

China has set the rules of the game for many years now. American firms that invest in China are obliged to team up with a Chinese partner to whom they must effectively donate their technology – even though this is technically against WTO rules. Sometimes called technology transfer, this often looks like technology theft – not least in the field of AI. Furthermore, China imposes heavy tariffs on a whole range of imports and has subsidised its exports, resulting in flagrant dumping. (Dumping, in economists’ terms, occurs when goods are sold abroad at less than their domestic cost of production).

For years America and the West as a whole (as embodied by the IMF, the World Bank and then the WTO) gave China an easy ride as it had the status of a developing country. It was assumed that, over time, a richer China would become a more open China. That evolution is now in doubt.

Last year, China ran a trade surplus in goods with the US of US$375 billion. That was more than two thirds of America’s entire global trade deficit of US$566 billion. America’s imports from China amount to 4 percent of America’s GDP; while Chinese imports from the US equal less than one percent of America’s GDP. But addressing these imbalances was never on President-for-Life Xi’s agenda. Indeed, he has proposed a slew of new state subsidies in the technology sector in order to develop China further as a technology hub.

Mr Trump has firmly set a SMART[i] goal concerning the Chinese. He is demanding that China cut its trade deficit with the US by US$200 billion by June 2020.

China’s ability to retaliate is limited. It could put duties on Bourbon whisky – which would no doubt go down badly in Kentucky, though affluent Chinese consumers would probably keep drinking the brew at higher prices. It could impose tariffs on Boeing (NYSE:BA) airliners – during Mr Trump’s visit to China last November, China signed a deal to buy 300 Being aircraft in a package worth US$37 billion. But the waiting time for a new Airbus airliner is currently about five years. So the pace of expansion of the Chinese aviation sector would have to slow. It could impose tariffs on US soy bean exports, or even ban them. But there are already plans in the US to support soy bean farmers in the event of a Chinese boycott. And the Chinese would be hard pressed to find alternative supplies from Brazil and elsewhere.

China’s initial response to the prospect of new tariffs was emollient. President Xi promised to lower China’s tariffs on US automobiles “significantly” from the current level of 25 percent. The US levies tariffs on Chinese cars, by contrast, of just 2 percent. China will allow financial firms and automobile manufacturers located in China to be more than 50 percent American-owned – but only if their Chinese partners agree. China has also agreed to ease its quotas on foreign movies. President Xi even sent his top economic aide, Harvard-educated Liu He, to Washington in mid-May for consultations.

China wants to be accredited the status of a market economy at the WTO, but the US has objected to this. In retaliation, China earlier this year threatened to treat the US as a non-market economy if the US did not drop its objections. One has to put all this in the context of China’s rise to great power status – a status that would threaten that of the US.

Surpluses and deficits – do they really matter?

Countries which export more than they import accumulate trade surpluses. They are normally thought to be more competitive than countries which run deficits. And yet, as a top economist at HSBC, Stephen King, author of Grave New World: The End of Globalisation, argues, nations which persistently run surpluses do not necessarily outperform those which persistently run deficits. Australia, which has carried persistent deficits, has had a higher growth rate than high-surplus Germany over the last four decades. In fact, Australia has not recorded a quarterly trade surplus since 1975, yet has been a benchmark in the growth stakes.

Keynesian economists (like Mr King) say that the US runs a trade deficit because its people consume nearly all of their incomes and don’t save enough. Because the US has more investment opportunities than can be financed by domestic savings, the country has to import capital from abroad. This is made easier in the US by the fact that the Dollar is de facto the world’s reserve currency – and given the insatiable demand of the Chinese and others for high quality liquid assets such as US Treasury bills.

With the abolition of exchange and capital controls, international finance is highly mobile. The willingness of foreign savers to hold Dollars effectively reduces the costs of capital in the USA. And demand for those Dollars tends to come from countries whose own domestic saving levels exceed local investment opportunities – such as China, Germany and Japan. In the case of Germany and Japan, the high savings rate is caused at least partially by demographic factors. Not so in China where the age structure of the population is younger but where the government has discouraged domestic consumption.

If this is right, then the solution to reducing the US trade deficit with China is that the US should increase its domestic savings ratio and the Chinese should reduce theirs. That might happen naturally as interest rates in the US return to more historically “normal” levels, thus incentivising saving for the first time in a decade. Additionally, if China were to open up its capital markets and to offer a level playing field to foreign investors, net capital flows out of China might be reduced substantially. That would also push up the value of the Chinese currency, thus reducing the trade imbalance with the US.

For much of the 20^th Century, the USA ran persistent trade surpluses – but that changed in the early 1980s. Interestingly, deficits are the norm across the English-speaking countries which have all developed vibrant service sectors. Nigel (now Lord) Lawson, when he was Mrs Thatcher’s Chancellor (Minister of Finance), used to dismiss poor trade deficit figures as “easily financeable”.

When is a trade balance truly “bad”? When it deteriorates rapidly. Greece’s economic crisis (2010) was foreshadowed by a deteriorating balance of payments, as was Spain’s financial crisis (2012). The UK experienced two balance of payments crises within three decades (1988 and 2008) which preceded recessions. Japan’s lost decade was preceded by a sudden reduction in its current account surplus.

In contrast to other countries, the US current account deficit sometimes diminishes rather than increases ahead of recessions. This is because a fall in the US trade deficit is correlated with a fall in global trade growth. But while the US is quite able to sustain trade deficits indefinitely, it cannot permit the deficit to rise as a percentage of GDP forever without America becoming entirely beholden to Chinese credit. That is what keeps Trumpists awake at night.

The great disruption

“We are seeing the seeds of a break-down in the post-war consensus”. This from Emeritus Professor Jim Rollo of Sussex University – a lawyer. But the financial markets have taken the so-called global trade war in their stride. True, there was a brief wobble in early trading in Asia on 1^st June, but the markets were unimpressed by the histrionics in Quebec when they re-opened on 11^th June.

Some commentators (I call them trade bores) have suggested that new US Tariffs plus a withdrawal from NAFTA could cost the US 2.6 million jobs – though the methodology by which they reach this estimate is unclear. According to The Trade Partnership, a Washington-based consultancy, retaliation by America’s trading partners could cost the USA 400,000 jobs. Such forecasts are based on highly questionable assumptions. To assess the issue in the round one has to see the bigger picture.

We are accustomed to the idea that Amazon.com (NASDAQ: AMZN) and its smaller rivals have disrupted the retail sector or that Facebook (NASDAQ: FB) and Google (NASDAQ: GOOGL) have disrupted print news media. In a similar fashion, President Trump’s style of politics and international deal-making is disrupting mainstream international diplomacy. Most conventional analysts would say that is a very negative development.

But there is another view. Under the post-Cold War dispensation since the collapse of the Soviet Union at the end of 1991 – what President George HW Bush called the new world order – China has made all the running. It has transformed itself from a poverty-stricken and peripheral nation into an economic and now a military superpower. And all along the way it has pleaded special treatment.

As I explained when President Trump was elected, the direction of travel is not necessarily in favour of protectionism and autarky, but of economic nationalism. This is exactly the chosen course of the Chinese for the last three decades or more. Most barriers to trade do not manifest themselves in the form of tariffs at all, but rather as awkward regulations that are difficult to comply with – so-called non-tariff barriers. One set of non-tariff barriers is embodied by the complex EU rules which determine how much of a finished product can originate from which country – which I shall have more to say about shortly.

The Chinese have structured their economy such that foreign investors and trading counterparts are always worse off than their Chinese partners. China has little understanding of win-win. And the mainstream political establishment in the West has accommodated her. How come, under the much-vaunted Paris Climate Accord, the UK and the US are required massively to cut their carbon emissions, while China – the biggest emitter in the world – hardly at all?

What Mr Trump is doing is not to start a global trade war per se: everyone knows that would be detrimental to global growth. Rather, he is trying to recalibrate the balance of advantage with the rising hegemon, China. If he succeeds, then Europe will have as much to gain as the USA.

Not that the European elites will thank him.

[i] In management science, a goal which is Specific, Measurable, Achievable, Realistic and Time-bound.