China’s Trickery and Global Trade Wars
A global trade war is now underway. Many nations are involved, but the prime antagonists are the world’s most consequential ‘frenemies’, America and and China.
China created the caustic conditions for a trade war by systematically and sassily dumping dirt-cheap commodities on world markets. It also steals billions worth of U.S. intellectual property (IP) every year through cyber espionage and other nefarious means. Fed up and furious, President Trump fired the first shots with tariffs on steel, aluminum, solar panels and dishwashers. China retaliated with comparable measures. Trump countered with further tariffs on $50 billion of Chinese imports. China then slapped levies on U.S. goods to match Trump’s $50 billion. The POTUS added another $100 billion like a resolute poker player with a good hand and lots of chips. At this stage, China can’t keep besting the US in a tit for tat trade spat — otherwise the People’s Republic will unravel economically and politically.
The Middle Kingdom only imports about $150 billion of U.S. exports. At that rate, they’ll run out of goods to impose tariffs on. Trump can keep going because the U.S. imports so much more from China than they buy from the U.S. (hence the enormous deficit amounting to $380 billion). But the Chinese are obsessed with projecting an aura of strength — they hate ‘losing face’ or 丢脸 ‘diūliǎn.’ Chinese President Xi has just been named essentially dictator for life. He doesn’t want to start out his new autocratic regime by capitulating to the prickly US President. So he needs another option. For China to keep fighting, it will need an asymmetric response; the Chinese need to fight the trade war with something other than tariffs.
China holds over $1.2 trillion of U.S. Treasury securities. Some analysts say China can dump those Treasuries on world markets with impunity and drive up U.S. interest rates. This exogenous jolt would increase mortgage rates, impair the U.S. housing market by making funding costs more dear, and possibly drive the U.S. economy into a recession. It would also trigger crash dynamics across world bourses. Analysts call this China’s “nuclear option” when it comes to fighting a financial war with America. There’s only one problem. The ‘nuclear option’ is a dud. If China chooses to unload its vast Treasuries holdings, the PBOC and CIC would inflict unholy harm on their fixed-income (and cross-asset) portfolios because any spike in rates would reduce the market value of their remaining positions.
Also, there are plenty of buyers around if China became a seller. Those Treasuries would be bought up by Japan, U.S. banks, or even the Fed itself. If China pursued an extreme version of this Treasury liquidation, the U.S. President could stop it with a single phone call or tweet to the Treasury. That’s because the U.S. controls the digital ledger that records purchases/ownership of all sovereign bonds. America could simply freeze the Chinese bond accounts in place and that would be the end of that. So, don’t freak out when you hear about China dumping U.S. Treasuries. China is stuck with them. It has no nuclear option in the Treasury market.
But that doesn’t mean China is out of bullets in an all-out financial war. China cannot impose reciprocal tariffs because it buys far less American goodies than America gets from China. The Middle Kingdom cannot dump US Treasuries because there are ample buyers and US authorities could restrict China’s accounts if things got ‘too convex‘ in the debt markets. But China could use a real ‘nuclear option’ to counteract the trade war by fighting a currency war. That is, it could debase the yuan to achieve its geo-economic goals.
If President Trump imposes 25% tariffs on Chinese goods, China could simply devalue their currency by an equivalent 25%. That would make Chinese goods cheaper for U.S. buyers by the same amount as the tariff. The net effect on price would be unchanged and Americans could keep buying Chinese goods at the same price in dollars. The impact of such a massive devaluation would not be limited to the trade war. A cheaper yuan exports deflation from China to the U.S. and makes it harder for the Fed to meet its inflation and interest rate targets.
Also, the last two times China tried to devalue its currency (August 2015 and December 2015), U.S. stock markets crashed by over 11% in a matter of a few weeks. So, if trade frictions escalate, don’t worry about China dumping Treasuries or imposing tariffs. Keep your eye on the RMB, China’s currency and ‘dirty-peg’ to the US dollar. That’s where China will exact revenge on ‘hegemonic America.’ When it does, U.S. stock markets will be the first victims. Maybe you think that’s unlikely because it would be such an extreme reaction by China. But you have to think like China’s governing elite, mainly Xi Jinping and Yi Gang, China’s overlords who take this stuff deadly serious. They go to the heart of the government’s very legitimacy.
China’s economy is not just about generating jobs, goods and services. It is about the Darwinian quest for a Communist Party that faces an existential crisis if it fails to deliver growth. The overriding imperative of the Chinese leadership is to avoid societal unrest and to exercise power over the masses by any means necessary. If China stumbles economically or encounters a financial crisis, Big Daddy Xi could quickly lose what the Chinese call ‘The Mandate of Heaven.’ That’s a term that describes the intangible goodwill and popular support needed by emperors to govern China (a political and cultural convention that has persisted for the past 3,000 years). If The Mandate of Heaven is lost, a Chinese ruler can fall victim to violent revolt and political upheaval.
Up to half of China’s fixed asset investment (FAI) is a complete waste. It does produce jobs and utilize inputs like cement, steel, copper and glass. But the finished product, whether a city, train station or sports arena, is often a ‘white elephant‘ that will remain unused. Chinese growth has been reported in recent years as 6.5–10% but is actually closer to 5% or lower once an adjustment is made for the endless zombie investments. The Chinese economy is littered with ‘ghost cities and ‘phantom returns’ resulting from mal-investment and a deeply flawed development model. Yet the commies in charge huff and puff but fail to fully comprehend that America holds the high cards.
What’s worse is that these ‘white elephants’ are being financed with debt that can never be repaid. And no provisions have been made for the maintenance that will be required to keep dud assets in ‘functional form’ if demand does rise in the future, which is unlikely. Essentially, China is on the edge of economic chaos without sufficient FDI and trade with America (as well as trade with other advanced industrial economies). On the one hand, China has sustained growth for the past eight years with excessive credit and leverage, wasted infrastructure investment and endless Ponzi schemes. ‘Socialism with Chinese characteristics’, born out of China’s kleptocratic proclivities and skitzo ideology, isn’t the rave party that Xi & Co. imagined. Its success is predicated on access to the American market and non-Chinese IP. Barring access to those things, China’s economy and political system will tank.
The Communist leadership knows this, but they had to keep the growth machine in full grind to create jobs for millions of migrant workers scooting from the backwoods to the cities. The big dog commies must also foster job growth for the millions of low-skilled laborers that have already infiltrated China’s urban areas — a stressy imperative, no doubt. The two key ways to curb debt are deflation (which results in write-offs, bankruptcies and unemployment) or inflation (which results in theft of purchasing power, similar to a tax increase). Both policy instruments are unacceptable to the Communists because they lack the political legitimacy to endure either unemployment or inflation. Either pursuit would cause social unrest and unleash revolutionary potential.
China’s internal contradictions are catching up with it. The country has to confront an insolvent banking system, a real estate bubble, proliferating defaults, diminishing ROI, and a $1 trillion wealth management product Ponzi scheme that is starting to fall apart. A moderately devalued yuan would give China some wiggle room in terms of using its $3.12 trillion of reserves to paper over some of these problems. A maxi-devaluation might be the best way to avoid the social unrest that terrifies China. But such ‘beggar thy neighbor’ behavior would rankle regional players and vex geo-economic rivals, including China’s biggest trading partners.
If that happens, possibly later this year in response to President Trump’s realpolitik/protectionist policies, the effects will not be confined to China. A shock yuan maxi-devaluation will be the shot heard round the world as it was three years ago (both times, U.S. equities plummeted over 10%). China doesn’t have a trade war ‘nuclear option.’ But it does have a compelling weapon that will cause wide spread collateral damage and neo-mercantilist contagion. Yuk. The scary thing is that ‘trade wars’ usually morph into ‘currency wars’ and then culminate in ‘shooting wars.’
Images via Wikimedia Commons
VIVISXN MEDIA – Geopolitics + Trade Wars + China + Hegemony + Globalization