This is Trade War I. The main event is going to be the Second Trade War.
“I will do such things, what they are yet I know not, but they shall be the terrors of the earth.”
To King Lear’s threat Donald Trump would add, “Maybe.” That describes what is going on in his confrontation with China’s Xi Jinping, for whom he professes high regard, and of whose lifetime tenure he is enormously jealous. The sound and fury notwithstanding, the threatened 25 percent tariffs (totaling $50 billion on some 1,300 Chinese products) and China’s retaliatory tariffs could not cripple either the $19 trillion U.S. economy or the $12 trillion Chinese economy-although there will be casualties on both sides, among them producers in the states won by Trump in 2016 (which are a special Chinese target).
The list of 1,300 products to be hit with tariffs presumably consists mainly of products that can readily be obtained from countries other than China. Trump knows that even winners in trade battles (in wars of all sorts) pay a price. He says he is willing to watch share prices drop a bit if this war heats up, since the long-term gains would be worth the cost.
If Trump ups the proposed tariffs by another $100 billion in response to China’s “unfair retaliation”-as he is threatening to do-Xi will have difficulty responding as China, which only imports $130 billion worth of goods from America, won’t have enough additional imports to penalize. Since we import $506 billion in goods and services from China, they need our market more than we need theirs. “In a serious economic battle, the U.S. wins. There is no question about that,” says Derek Scissors, a scholar at the American Enterprise Institute.
For now, Trump says “We are not in a trade war with China.” It would have been more accurate to say we have only now decided to oppose China in the trade war it has been waging for years.
The major danger is an unintended escalation of tit-for-tatting. Neither Xi nor Trump can walk away from this confrontation without being able to claim victory. Xi cannot afford to lose face so soon after becoming president-for-life and Trump must satisfy a noisy political base angry with him for signing on to a profligate budget (and continue to see a great negotiator in the mirror when he shaves and constructs his coiffure in the morning).
Investors are bewildered, witness the 700-point round-trip the Dow took before ending 230 points higher on Wednesday, as traders responded to the rumor du heure. Odd, that confusion, since there’s no mystery as to what is going on. Trump’s art of the deal is being applied to trade, just as it has been to North Korea. It starts with a bellicose, Learesque tweet, threatening to bring down the world trading system (or bomb North Korea). That is followed by a more measured policy statement by the president or an administration member, announcing tariffs, but not just yet (or in the case of North Korea, that it’s diplomacy first, military action second). Finally, the threatened parties-China’s Xi or North Korea’s Kim Jong-un-agree to come to the negotiating table, which was Trump’s goal in the first place. Final outcome to be determined.
It’s a long road from threatening “terrors of the earth,” to negotiating a mutually acceptable compromise, a path the president likes to travel because he thinks it produces a favorable result for his side-and because it is all eyes on him during the road to a compromise. Companies will be able to air their complaints at a public hearing on May 15 and have until May 22 to raise objections. That will be followed by a 180-day period during which the government will decide its next move. Affected industries have unleashed their lobbyists, hoping politicians-turned-lobbyists and a history of campaign donations will protect them from harm. Trump has promised to drain the Washington swamp, but this battle over trade is the stuff that breeds and fattens the crocodiles of K Street. Or is it alligators? No matter.
Chinese and American negotiating teams will soon meet and are likely to come up with a deal. Xi has named his economic czar, Liu He (Harvard), to head China’s negotiating team. Liu’s second, vice finance minister Zhu Guangyao says, “Now it’s time for negotiations.” Ours is led by Treasury secretary Steve Mnuchin (Yale), with trade representative Robert Lighthizer acting as his second. The duelists, pens and computer models drawn, have already exchanged position papers. There is talk that China has already agreed to lower its 25 percent tariff on American cars to 10 percent, and to open its financial sector to majority-owned American firms.
All of this is a sideshow. Tariffs cannot have a major effect on the size of the U.S. trade deficit, which rose in February for the sixth straight month, to a near 9.5-year high. So long as we suck in imports with a huge budget deficit and low personal savings, we will run trade deficits. And economists agree that bilateral trade deficits are meaningless-even countries with overall trade surpluses run deficits with some of their trading partners.
The important, enduring factor that has surfaced in recent days is a change in the politics of trade. Even Trump’s critics now agree that a major change in our trading relations with China is necessary. Hopes that China would become a rules-abiding member of the trading system have been dashed. Jamie Dimon, CEO of JPMorgan Chase and a free trader to his core, says that China, now the second largest economy in the world, should no longer be preferentially treated by the World Trade Organization as if it is the developing country it was when welcomed to membership-largely at the urging of the United States.
The real battle will come when America decides not to allow China to dominate the industries of the future by flaunting the rules that have governed the international trading system since the end of World War II. Xi’s “Made in China 2025” plan calls for subsidizing firms in industries of the future with cash and cheap bank credit; forces U.S. firms to turn their intellectual property over as the price of doing business in China; pushes state-owned or dominated companies to acquire technology-rich American companies; and steals American IP valued at as much as $600 billion every year.
Those tactics, unopposed, can easily reduce America to second-class status in the next decade. Give Trump credit: He knows that. For him the tariff fight is merely a warm-up to the main event. If he can re-order our entire relationship with China in this round, he will. If not, round two, or another duel, or whatever metaphor suits you, will be the one to watch.