Newton’s law of physics helps explain the tariff war
Newton’s third law of physics states that: “For every action, there is an equal and opposite reaction”. Likewise in a trade war, Newton’s third law also tends to apply. This is why China imposes reciprocal tariffs on US imports every time Donald Trump and his Treasury Department impose tariffs on Chinese imports into the United States. Yet this simple phenomenon of reciprocity appears to dumbfound certain American Sinophobes who were hoping that China, the country with the highest Purchasing Power Parity (PPP) in the world and soon to be highest overall GDP in the world would somehow lay down and capitulate in the face of Washington’s tariffs.
Far from surrendering, China is rapidly engaged in a win-win formula with the wider world in which the Beijing is opening up its vast domestic market to more imports while working with new partners on major free trade agreements. Among the biggest will be a China-Eurasian Economic Union (EAEU) free trade agreement which comes into effect next year, thus allowing the free flow of goods between China and Russia, Armenia, Belarus, Kazakhstan and Kyrgyzstan. Yet for Trump, these offers of more rather than less bilateral free trade were not good enough and as a result not only are American companies losing out on new opportunities to trade in China, but America’s farmers who once exported substantial amounts of foodstuffs to China are now being subsidised so that they can let their food rot as the trade war has drastically restricted US agricultural access to the Chinese market.
While the US remains China’s biggest single export destination, China has no real compulsion to capitulate to the US in the trade war, not least because the current trade war when coupled with the Federal Reserve’s anti-inflationary policy of shrinking the global dollar supply actually benefits China by naturally inflating the Renminbi, thus making its exports cheaper for American consumers with a more powerful Dollar in their pocket. What’s more is that China will never surrender its monetary independence the way Japan did in 1985 in order to attempt and avoid a trade war with the United States.
Japan’s giant mistake
In the latter half of the 20th century, Japan was exporting ever more goods to the United States. The oil price hike of the 1970s led small, fuel efficient Japanese cars to sell well in the US market vis-a-vis the larger American cars that were becoming difficult to afford during a fuel crisis. While oil prices dropped in the 1980s, Japanese car and electronics makers were still outselling American ones in the US market. Rather than consider the fact that Japan prioritised research and development in its industrial base while US industry was stagnating in this respect by the 1980s, policy makers in Washington blamed Japan’s allegedly undervalued Yen for making Japanese goods “too affordable”.
Against this background some American politicians clamoured for tariffs on Japanese goods. Unlike Donald Trump, President Ronald Reagan tended to sympathise with free trading factions so instead of launching a trade war, the US, its European allies and Japan reached an agreement in 1985 whereby Japan would allow the Yen to appreciate vis-a-vis a Dollar that some claimed was over-valued due to the anti-inflationary measures taken by Federal Reserve Chair Paul Volker.
As a result, Japan lost revenue in its trade with the US and by the late 1980s ended up selling some goods at a loss in an attempt to re-capture market share by overwhelming competitors on the basis of volume. Crucially though, Japan’s trade surplus with the US never ended but what did end was Japan’s strong economy.
Most crucially, the lost revenue from trade with the US combined with a rising Yen caused Japan’s assets market to become highly overvalued as low borrowing rates designed to prevent a deflation crisis led to an unsustainable buying spree. By the end of the 1980s, Japan’s overvalued asset bubble burst. The result was a 1990s era known as Japan’s “lost decade” while in technical terms Japan has still not fully recovered from the burst bubble of the late 1980s, even though the country remains the world’s third largest economy with famously high domestic living standards.
China is no one’s fool
While Japan committed economic suicide by agreeing to the Plaza Accords, China has remained firm on not over-valuing its currency in spite of severe US pressure to do so. Japan avoided a trade war with the US by doing so in 1985 but the result was that the US still lost the trade “war” while Japan lost out on economic growth.
China instead is willing to wait out the trade war knowing that it has major advantages over the US in 2018 and multiple advantages over the position Japan was in during the mid-1980s. In many respects the elephant in the room when talking about a US trade war with China is China’s own vast domestic consumer base. Not only is this base the largest in the world in terms of head-for-head consumer count (aka the world’s highest national population) but in terms of Purchasing Power Parity (PPP) China is already ahead of the United States. Thus, while Japan’s biggest customer base in the 1980s was in a country with a far bigger population than Japan, China’s biggest potential customer base is its own domestic market.
Secondly, rather than doing with the Renminbi what Japan did with the Yen in the 1980s, China has no plans to overvalue the Renminbi by allowing a free float which would likely lead to a higher value in the national currency. Likewise, China has no plans to artificially de-value the Renminbi either. Instead, China aims for a stable national currency in order to avoid boom and bust cycles at home while also doing with the Renminbi what Japan could have never realistically done with the Yen – position itself to become the world’s future reserve currency. Furthermore, China’s managed float (which could easily be called a managed peg) of the Renminbi to other major currencies including the US Dollar, Korean Won, Japanese Yen, Euro and other less globally traded currencies will help the Renminbi to ease itself into its inevitable future position as the world’s major reserve currency.
As soon as China’s GDP eclipses that of the US, something likely to happen by 2040, as was the case from the Roman Empire up to the present day, the world’s most powerful economy will tend to dictate that which is the world’s primary reserve currency.
Thirdly, while Japan struggled with a rising Yen in the 1980s and ultimately lost the fight, China’s slow and steady strategy with the Renminbi combined with the fact that the US Dollar however strong is now seen as less secure because of the constant threat of sanctions and tariffs from Washington to both rival and ally alike – this means that more and more nations are being pushed towards a Renminbi (in the short term a Euro/Renminbi) dominated currency basket for international trade than ever before.
In the 1980s, Japan and the US pursued a lose-lose model that did not help American producers in a wider trade war but did dramatically punish a close US ally for ultimately committing no economic crime. Today, with the US and the rest of the world vastly more dependant on Chinese goods than was the case with Japanese goods in the 1980s, China has nothing to fear in terms of an economic collapse just because some of its goods are restricted from the major US market due to Trump’s tariffs.
Rather than panicking as Japan did in 1985, China is instead maintaining a stable yet flexible enough monetary policy to avoid boom and bust while Trump’s trade war is only helping the Renminbi to become more attractive as a major trading and future reserve currency throughout Asia, Africa and in parts of Latin America (oil rich Venezuela in particular).
At the same time, China knows the world needs its goods and this includes a domestic Chinese market that is larger than the second place US market. Finally, unless China overvalued the Renminbi so much so that its goods became internationally un-affordable, the US simply cannot win a trade war with China. Instead, the US looks set to become more self-sufficient assuming a new industrial mentality arises in the US to accompany Trump’s ironically very Japanese closed mindset to imports. All the while, China will be leading the rest of the world into a more open, flexible and non-ideological free trade based economic future and most important one that will eventually be dominated not by the Dollar but by the Renminbi.