Frontier Insights... With the much-anticipated Chinese Yuan denominated futures scheduled to start trading on Monday 26th March, the US government has officially responded by firing a big shot across the bow on Friday 23rd March, with a multi-billion dollar trade war with China. Today, President Trump’s tariffs on China come into effect. Trump’s tariffs are expected to generate up to $60 billion in tax revenue for the US government, closely matching the latest US trade balance figures. And while Trump cites the growing trade deficit with China as the main culprit, along with his desire to ship back manufacturing jobs to America, the reality is, this is both a geopolitical move aimed at China and a domestic move aimed to secure support among his base of disenfranchised working class ‘deplorables’ ahead of mid-term elections.
The Economics
Some would argue that China started the trade war, with their protectionist policies, trade dumping and low exchange rate. However, as Trump touts that trade wars ‘are easy to win’, the economics of trade wars and tariffs are usually adverse not only for foreign exporters, but also for the domestic population (the US population in this case). Higher tariffs will be passed down to consumers in the form of higher prices, as businesses try to maintain profit margins. This will result in the US importing higher inflation. The US trade balance is hovering around the -$50 billion deficit range, which measures the amount of money relative to the rest of the world that leaves the US in exchange for goods and services. As China retaliates, it too will begin to suffer the same fate. However, from a game theory perspective, Trump and his protectionist economic advisers are hinging on that this could hurt China more, due to US markets being so dominant to their exports. China has started to retaliate, by imposing its own tariffs on major US exports to China. Ultimately however, tariffs are a temporary bandaid solution to low US productivity, and not the deep, structural changes needed to bring back manufacturing industries back to the US. While tariffs could theoretically ‘equalize’ prices, China and America have fundamentally different cost structures and standards of living. This in turn drives the US and China to pursue different economic goals, with China being a developing export growth-based nation, while the US is a developed consumer-based nation. China will eventually have a large middle class that will be able to sustain its growth with domestic consumption, and when the Politburo is ready to switch from export-based growth, the peg with the USD will be ditched. This is the inevitable path China is on and it will happen. It will also elevate the Yuan into greater reserve currency status. The US will view this with mixed feelings. On one hand, the US has always complained of China’s undervalued Yuan, and will welcome the de-peg, which will appreciate the Yuan. On the other hand, a rising Yuan will mean more competition against the Dollar hegemony. The US has to work out which one it favours more. China will at some point overtake the US economy in the next 10 years. It already consumes more oil than the US, which is why Yuan denominated oil futures markets make so much sense. It already has a bigger GDP by purchasing power parity, i.e. when normalising for local costs.
What’s interesting is how this could lead to China ultimately abandoning the US dollar peg, and ditching its Treasury purchases, something the US would both welcome (the removal of the peg) and fear (Treasury dumps). As Trump has mainly singled out China (and Japan) for the time being, putting other tariff measures on hold against the European Union and other nations, the latest bout of trade wars could blow back by crashing the stock market, which has given Trump much confidence up until now. The markets are not reacting well, understanding how this could slash corporate profits and hamper global financial flows. Lets also not forget that all this is happening on the back of the Fed unwinding QE and interest rate hikes, affirmed by the Fed as a policy continuing in to 2019. Which doesn’t bode well for the US stock market. The peak could very well have already passed, or sometime this year, before a big correction falls due. Trade wars will undoubtedly add to more uncertainty and volatility in financial markets. Bond markets and gold could be looking to rally amidst such an atmosphere.
The Geopolitics
In geopolitical terms, what this all means is none other than a manifestation of the famed old Thucydides Trap. During the height of Spartan dominance in the Hellenic empire, a rising Athenian city-state threatened an established power, Sparta, both militarily and economically. So what the Spartans decided to do was pre-empt this threat by going to war. And while Sparta was the dominant power, the colossal toll of the war on Sparta proved to be a pyrrhic victory, resulting in the weakening and ultimate demise of Sparta itself, hence the ‘trap’. The US is a naval power, while China is a land power. The new theatres of war between these two rivals span cyber and finance, with the US going on the offensive (as usual) to escalate financial war with China. Another favourite tool of the US empire in financial warfare is sanctions. It tends to apply these tools on military threats such as Russia, Iran and other states challenging US hegemony. Sanctions are not preferred against China, because China is the biggest economic threat to the US, and sanctions will backfire tremendously on US markets. Nobody knows how this will play out, but given the general decline of the US empire across the board, it probably won’t end well with its intended aim of reducing the deficit or containing China. On the contrary, there will be plenty of blowback. Trump could also very well be using this as a negotiating strategy, given his business background. China could opt to negotiate, and in that regard Trump would have scored a victory. However, if China holds firm and retaliates in asymmetric means that the US won’t foresee, it could implore the US to negotiate as well, thus levelling the field with some sort of grand bargain. In any case, a financial war is preferable to a hot war, however, history shows that the former often leads to the latter.
While the US empire looks to put down an increasing number of geopolitical ‘rebellions’ around the world by rising powers, it would be better for the US itself to loosen its grip on reserve currency status. If you wish to understand why, here are some concepts to look into. A country with global reserve currency status is somewhat of a curse, as it has to run consistent deficits, and this comes with all sorts of consequences. Tariffs in no way address this fundamental fact. But the main reason as to why an empire would want reserve currency status, is that by invoicing global trade in its own currency, it can essentially print the money and buy what it wants without exchange rate risk, and ensure a strong demand for its debt. This is the underlying financial strength of the US empire, backed up of course, by military force. Agreements such as the Petrodollar help to prop this system up. One of the more peaceful ways US leaders can try to escape this trap should it drag the US into deeper debt, is to try and ‘pass the baton’ of reserve currency status to China. However, China will be extremely careful to weigh up its options. I doubt China would want to assume this unenviable role any time soon. What we could see instead is greater competition between ‘reserve currencies’ (starting with the Yuan oil futures), the rise of cryptocurrencies as new, alternative reserve currency assets or some other multilateral frameworks based on the SDR. What this trajectory does suggest is that the world is slowly but surely moving towards a new financial order, one that could be defined by a growing multi-polar world, with greater roles for developing nations. Lets hope that the developed Western world won’t fall into the Thucydides Trap in the meanwhile, as war still remains a real possibility.
Posted in Finance and Economics, Geo-politicsTagged china, finance, Tariffs, Trade War, US Post navigation Putin slam dunks US unipolar power with new deterrent capabilities Leave a Reply
5 Comments on "US-China Financial War Escalates" avatar Subscribe newest oldest most voted Canthama Guest Canthama Hi AJ, this is a top subject and definitively deserves lots of discussions.In my view the actions undertaken by Trump are self-defeating. They’ll directly blow back on U.S. consumers (as you pointed out with inflation), companies, and financial markets (Dow Jones is very nervous). China is a powerful country and a force to be reckoned with, in other words, the US should not fool itself into thinking that China can be pressured to fold under such tactics. Another key aspect to keep in mind is that China’s consumer market has surpassed that of the US and it is still expanding… Read more » 6 Reply 8 hours ago admin Author admin Canthama good points about the rare earth metals. China knows which sectors/exports to really hurt the US if it wanted to. I think that this too will backfire, unless Trump is seeking a bargain, the Chinese are known to be hard bargainers. At this stage its difficult to determine whether the drivers of this policy have more of an economic or geopolitical goal in mind. Tariffs will NOT solve US productivity problems. They will also expedite other countries to diversify and divest from the US, a power than increasingly weaponizes its financial system and currency. The US cannot stop the… Read more » 3 Reply 7 hours ago Muslim Dude Guest Muslim Dude
1. This is a sign of weakness from the US and is clearly a pre-emptive strike for the PetroYuan. This shows that the US is indeed scared of the PetroYuan so is taking some sort of action.
2. China is too big and strong for any of this to damage the country in the long run.
The US is also reliant on China for the production of certain goods without which its materialistic populace will be extremely angry. It is not physically possible for example to create an Iphone factory over night and start supplying US stores with Iphones. It would take a minimum of a few months, and this is at break-neck speed of construction.
If Iphone prices were to go up by x% then the greater the percentage increase the greater the anger and discontent, and this does not signify “Making America Great Again”, but signifies economic suffering. Iphones are a relatively minor example. According to one 2011 chart, 16% of US imports from China were machineries. If there is a US company which has to pay extra costs for machinery from China and it bankrupts or at least financially damages their company it can lead to varying degrees of financial loss, unemployment with the worst case scenario being total closure. Then there is the knock on effect of the closure of that company and the unemployment of all of its workers e.g. the local restaurants near the factory providing the workers with food will take a hit etc. According to another 2011 figure, China accounted for 19% of all US imports.
3. The US cannot impose huge tariffs on possibly almost 1/5th of its tariffs without damaging itself. The difference however is the US populace are much more demanding and accustomed to a higher standard of living and consumer goods.
China can take this as it has been planning for this sort of scenario and it will just unify the Chinese nation even more against aggressive economic warfare.
The US public just does not have the stomach for some sort of protracted economic war, just read this link already:
www.cnbc.com/2018/03/22/u...ar-you-just-cant-win.html
China has already struck back:
fortune.com/2018/03/23/china-us-trade-tariffs/
4. The US is behaving in a very childish manner and throwing ineffective tantrums.
It’s lost in Syria. It’s losing influence and respect all over the world including the Philippines, Qatar, Turkey, Pakistan, Thailand, South America etc.
It cannot threaten China with nuclear war as the US itself would cease to exist in a retaliatory nuclear strike. It has even had to agree to some sort of talks with little North Korea.
This imposition of tariffs just highlights US impotency and will accelerate the rate of rapidly decreasing respect it is earning among many states.
The Russians will only be happy that some of the heat is off them and that the Chinese will be ‘sharing’ some of the burden of ending ‘Pax Americana’ in this Sino-Russian joint tag team effort against the US hegemon.