US President Donald Trump’s recent switch from engaging to confronting China has put the world on edge. China’s quick response in vowing a “tit-for-tat” on US tariffs imposed on its goods prompted a free fall in the US stock market, with a combined loss totaling nearly 6% in the week ending March 23, the worst in more than two years, though it has rebounded since.
This market volatility coupled with outcries from US businesses against Trump’s “tough” policy stances seem to have an impact on the US president or his senior officials. Treasury Secretary Steven Mnuchin called his Chinese counterpart, Vice-Premier Liu He, on Saturday to discuss the issue. In that telephone call, Liu was reported to have told Mnuchin that China would retaliate against the US if Trump followed through with his tariff proposal.
The fact that Mnuchin is opening the door for negotiations to address issues with China’s “economic czar” is a good sign of a pragmatic approach to addressing differences between the world’s two largest economies. That will avert a trade war, at least for now.
What’s more, Mnuchin’s gesture seems to indicate recognition that the kind of trade threats leveled against Japan, the UK, France and Germany in the 1980s will not work agains 21st-century China.
Today’s China is not 1980s Japan
The United States’ huge trade deficit with Japan in the 1980s led to the signing of the Plaza Accord in 1985 among the so-called Group of Five: the US, the UK, Japan, Germany and France. The main purpose of the accord was to weaken the US dollar against the other four countries’ currencies.
Between 1980 and 1985, the greenback appreciated as much as 50% against the yen, pound, franc and mark, prompting US companies such as General Motors, Caterpillar, Motorola and others to ask for protection against foreign imports (notably from Japan). What’s more, the US had incurred a merchandise trade deficit of almost 3.5% of gross domestic product with the four powers and had just emerged from a recession.
The US Congress was considering protectionist policies in an attempt to reduce the trade deficits and spur economic recovery. But president Ronald Reagan was not a protectionist, preferring to address the issues through negotiations, which led to the signing of the Plaza Accord in 1985.
Robert Lighthizer, the current US Trade Representative, joined the Reagan administration as deputy trade representative in 1983. What role he played in the run-up to the Plaza Accord is unclear now, but he seems to be taking a page out of that 1980s playbook.
One important aspect of the accord was allowing central banks to intervene in the exchange-rate market, culminating in the US dollar depreciating by as much as 50% against the other four signatories’ currencies. Japan got hit the hardest.
The accord resulted in the yen appreciating from 285 per US dollar to 80 by 1992. Being an export-dependent economy, this significant appreciation coupled with Japan’s voluntary reduction of exports (mostly to the US) had a devastating and lasting effect on the Japanese economy, blamed in part for the country’s prolonged period of deflation.
The other reason for Japan’s deflationary spiral or “lost decade” was an asset bubble attributed to the country’s “cheap money” policy. That policy reduced consumption and raised property prices at home.
Fast-forward to today, and the US has been incurring a huge merchandise trade deficit with China. As in the 1980s, the US is struggling to recover from a serious recession, this one caused by the 2008 financial crisis.
However, that’s where the similarity ends. The US dollar cannot depreciate against the Chinese yuan to the extent it did with the yen, nor can imposing a heavy tariff on Chinese goods bring manufacturing back to the US.
First, most of America’s “imports” from China may be “made in China,” but “by America.” In this regard, whatever tariff is imposed will likely be passed on to American consumers. And second, China has a formidable retaliatory arsenal, ranging from not buying agricultural products to selling its more than $1.2 trillion in US Treasury holdings.
In short, attempting to use the 1980s trade playbook against China would incur not only economic risk, but political risk as well.
Trump’s “tough on China” policies and replacing relatively reasonable senior officials such as Gary Cohn with China hawks like Peter Navarro were meant to pander to his support base, following through with his 2016 presidential campaign rhetoric. But he may be going the wrong way, because it will not be easy to bring back the manufacturing sector and jobs he promised. It will take time to train a full complement of skilled workers required by the manufacturing sector.
What’s more, investment decisions are based on expected rates of return, the very reason US companies outsourced manufacturing to China and other lower-wage nations. Indeed, many US enterprises (such as Seagate and others) now are leaving China for poorer countries where wages are lower and regulations less stringent. But very few have returned to the US, where production costs remain much higher and labor and environmental laws more stringent.
Therefore, US manufacturing activities and jobs are not likely to increase by the 2018 midterm congressional election or even by the 2020 presidential election. If so, many Republican members of the House or Senate may lose their seats, and they will most likely blame Trump. As well, Trump’s supporters could turn against him.
Protecting US dominance
The other major reason Trump is tough on China might be to protect America’s military and innovation dominance. The presence of the chief executive officer of McDonnell Douglas, America’s biggest defense-systems producer, at his side when Trump made the tariff proposal seemed bolster that argument. His successful demand for a huge increase in the defense budget to more than $700 billion is another indication that military dominance is his goal.
Barring Chinese smartphones and blocking Chinese investment in the US is meant to protect America’s high-technology hegemony. China’s “Made in China 2025” initiative is designed to compete with the developed world’s products that still enjoy a comparative advantage. It is therefore no surprise that Trump targets tariffs at or bars Chinese investment in artificial intelligence, robotics and other advanced technology goods.
The problem, however, is that it might be too late to stop China from being an innovation or military powerhouse.
Trump should negotiate with China
China’s response to Trump’s tariff proposals was firm but flexible, threatening “tit-for-tat” but leaving the door open for negotiations. This is a good gesture in that not only could a trade war be averted, but it could “Make America Great Again.” Indeed, the stock market rebounded in light of the news that a US-China war might be averted.
In summary, Trump may well make a U-turn, negotiating with China rather than confronting it. He is a businessmen, after all. It is in his and the nation’s interest to do so.