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While investors keep their eyes glued to headlines about Trump’s threat that he will impose US$60 billion in tariffs on China, followed by reports that he is ready to strike a deal, the real trade war bomb may actually be lying somewhere out of view, albeit with a longer fuse.

Former official at the Asian Development Bank, the International Monetary Fund and the World Bank, Shang-Jin Wei, says that it is US tax cuts, set to go into effect this year, that pose the real threat to the US-China trade relationship.

Writing in The Asset on Tuesday, Wei, who is now a professor at Columbia University, says that America’s current-account deficit will balloon after the aggressive tax relief goes into effect, which will have significant impact on domestic politics:

“The new tax legislation will widen the US government deficit by US$1-2 trillion over the next decade, a shortfall in national saving that will not be offset by an increase in private-sector saving or reductions in private-sector investment.

“What this means for trade, and particularly trade between the US and China, is key. Because the US current-account deficit is the sum of investment minus private sector and government saving, the US current-account deficit is likely to increase – again, by as much as US$2 trillion over the next decade. The US trade deficit will surge accordingly, and the annual bilateral deficit with China could grow by US$50-100 billion.

“When this happens, US politicians will need to cast blame, and China will be the likely scapegoat. In that case, the new US tax law – hailed by Trump as a victory for the American people – will come home to roost in the form of even more serious trade tensions. While the connection between the tax law and an increase in the US trade deficit is not well understood, its impact will be felt for years to come.”

He adds that while Washington and Beijing may reach some form of grand bargain on intellectual-property rights – the basis for Trump’s potential tariffs – the ballooning trade deficit will be a much tougher nut to crack.

“China’s trade surplus and the US trade deficit ultimately reflect saving and investment imbalances. The non-market ‘trade remedies’ being considered by the US and China might produce a smaller trade imbalance between the two economies,” Shang says, “but at the cost of a larger imbalance with the rest of the world. This could leave consumers and companies in both countries, and around the world, worse off.”

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