Saturday, April 20, 2019

Trade war with China – easy to win?

A trade war is won by the country that can tolerate more pain.

Image Credit: AP

Trump and his supporters are convinced that we can easily win the trade war against China. After all, we buy ~$500 billion of goods from them, and they buy only $130 billion of goods from us. So the logic goes, “they need us more than we need them!” But is it that simple? Let’s analyze.

Tariffs are basically sales tax. This not only affects the manufacturers, but also re-sellers and consumers.

So, if a laptop made in China suddenly becomes 25% more expensive because of Trump’s tariffs, U.S. retail stores and middlemen such as Best Buy and Amazon also suffer. U.S. consumers will now either pay more or have to forego some of the products they like. Also, look at who supplies the parts for those laptops – Japan, South Korea, Taiwan and even U.S. manufacturers (Intel, Nvidia and others). All of them will lose money in this scenario.

Similarly, there are countless American corporations – think clothing, shoes, accessories, toys, auto parts, home appliances, electronics and more – which manufacture goods in China and import them. A 25% tariff will decimate their businesses.

Thus, attacking China also means hurting many of our allies and ourselves.

China is not like Russia or Iran who can be sanctioned without any repercussion to the U.S. economy. China’s economy is deeply intertwined with the US economy, which means that China won’t be easily bullied by U.S. tariffs or sanctions.

China’s leverage and attack plans

China is the largest buyer of US soybeans and a significant buyer of other U.S. agricultural/farm products (corn, sorghum, pork, beef, fish etc.). So, China can impose punitive tariffs on these U.S. items, and switch to other countries – for example, get soy from Brazil, corn from Argentina, sorghum from Nigeria and so on. Losing China as a customer is going to cause a lot of pain for US farmers, especially if EU, Canada and Mexico also target those same U.S. farmers. Here’s China’s strategy: hurt red states’ Trump-supporting farmers who will then put pressure on politicians to end the trade war.

China has issued a list of 600+ U.S. products that will be targeted by July 6. Here is the highlight:

China has leverage over some of the biggest American corporations such as Apple, Walmart, GM etc. Imagine if, in retaliation, China shuts down Apple’s assembly factories or stops shipment of products to Walmart for a month . That will crush those mega corporations as well as the U.S. stock market. It will take a long time – months or even years — for Apple and Walmart to find other countries who will be as cheap, efficient and reliable as China.

There are numerous U.S. corporations that have large operations in China. GM manufactures and sells more than 4 million cars in China (while it sells only 3 million in the U.S. and fewer than 10 million globally). Similarly, various food, retail and hospitality enterprises – think Starbucks, KFC, McDonald’s, Sheraton, Hilton etc. – all make tens of billions of dollars of profit every year in China. A nasty trade war between U.S. and China will result in tremendous losses for these companies.

How many U.S. businesses rely on China to a significant degree? 50%? 75%? A complete breakdown of U.S.-China trade will devastate the U.S. economy, as empty shelves in the U.S. stores will mean many bankrupt businesses and furious American consumers. The U.S. will look like Venezuela, at least temporarily.

Let’s not forget that China holds more than $1 trillion of US treasuries. If the trade war truly escalates out of control, China can dump the U.S. treasuries and potentially disrupt our bond market as well as the value of the U.S. dollar.

Finally, many people don’t realize that China is our primary, if not the only, supplier of rare earth elements (REE), which are needed to make touchscreens, hybrid cars, MRI machines, missiles etc. China has a virtual monopoly on the mining, refining and processing of these minerals/metals. This gives China enormous retaliatory power.

China’s defensive strategy

First of all, China can mitigate the effect of U.S. tariffs by devaluing Yuan. China knows how to do this very well. “You increase the tariff on my product by 25%? I will decrease the value of my currency by 15%!”

A trade war is won by the country that can tolerate more pain. Thanks to the authoritarian government as well as social cohesiveness, Chinese can endure economic hardship a lot better than Americans. If China has to reduce their pork consumption because of embargo on U.S. soybeans, people won’t be marching on the streets of Beijing. Can’t expect such good behavior in America!

Conclusion

The U.S. has to negotiate mutually acceptable trade deals with China, EU and others. A tit-for-tat trade war will be a painful drag on the entire global economy. And there won’t be any winners.

Americans should be concerned about excessive trade deficit, but it’s a complicated issue. As I explained in my previous article, (1) the official trade deficit numbers are misleading (2) U.S. elites created a financial system that requires other countries to have trade surplus with the United States, and (3) without reasonable trade deficits, the U.S. dollar can’t be a global currency and the U.S. can’t be a superpower!

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