China caught off guard as US trade war highlights Beijing’s dilemma

As a politician, Winston Churchill was probably the greatest orator in history. His inspirational speeches have been copied and reworked from generation to generation, a template of the “chain of destiny.”

Yet, perhaps, Churchill’s instinctive and insightful view of the nature of politics illustrates the challenge facing President Xi Jinping, with the trade war between China and the United States escalating, while problems mount on the domestic front.

“A politician needs the ability to foretell what is going to happen tomorrow, next week, next month, and next year,” the iconic British prime minister, said. “And to have the ability afterwards to explain why it didn’t happen.”

Xi and the Communist Party’s propaganda ministry, which has been rebranded into the Publicity Department of the Central Committee of the CCP, are struggling to do just that as they are dragged deeper into the conflict with Washington, while realigning the economy and pushing ahead with the controversial “Made in China 2025” policy and the Belt and Road Initiative.

For more than two decades, China was the poster child of economic development and during the past 10 years a major driver of global growth during the Great Recession in the West after the financial crisis in 2008.

But as Europe and the United States gradually recovered, cracks in Beijing’s progressive image started to appear. The program of reforms, which had turned the country into the world’s second-largest economy, started to slow, and government subsidies for key industries and state-owned enterprises gathered pace, despite a cosmetic headline-grabbing approach to shrink the bloated SOE sector.

‘Forced technology transfer’

Intellectual property violations continued along with the practice of “forced technology transfer” for foreign companies doing business in China. “Promise fatigue” also set in as Xi’s government constantly talked about further opening up the economy to overseas competition without producing a detailed timetable of when the changes would be implemented.

Finally, patience snapped in the US under President Donald Trump’s administration and even inside the European Union, which launched legal proceeding against Beijing at the World Trade Organization in Geneva last month for “unfair technology transfers.”

“[There is] a sense of disappointment that China’s WTO accession didn’t do more to transform the rules of the game inside China’s own market,” Brad W. Setser, a senior fellow for international economics at the Council on Foreign Relations, wrote in a blog post.

“Expectations that China would have to change, politically and economically, to succeed in the global economy haven’t been born out, as Ely Ratner and Kurt Campbell argued in Foreign Affairs,” he added.

“China’s Communist Party hasn’t been tamed by commerce. The Party-State still has firm control over the commanding heights of China’s economy – both directly, and indirectly, through its influence on large “private” companies (who can only remain both successful and private with the support of the Party),” Setser concluded on the website of the nonprofit think tank based in New York.

Grappling with this new reality has forced China to reevaluate its relationship with the US and to a lesser extent the EU. Yet it could not have come at a worse time as concerns increase about a cooling economy, and the effects of Beijing’s two-year battle against corporate and local government debt.

On Tuesday, the latest official data from the National Bureau of Statistics showed that factory activity dipped. The Purchasing Managers’ Index, or PMI, a key economic barometer, came in at 51.2 for the month, down from 51.5 in June.

Although the numbers indicate a downturn, they were above the 50-point mark, which separates expansion from contraction. Still, manufacturing sentiment has been hit by the trade dispute.

“Despite their outward firmness and rhetorical bravado (President Xi Jinping has vowed to ‘punch back’), Chinese leaders must be deeply worried,” Minxin Pei, a professor of government at Claremont McKenna College and a non-resident senior fellow of the German Marshall Fund of the United States, wrote in the Nikkei Asian Review.

“The rupture of Sino-American relations in the last few years is undoubtedly a strategically calamitous development few in Beijing anticipated,” he added.

Behind the scenes, a rare debate has emerged between the People’s Bank of China, or central bank, and the Ministry of Finance on measures to combat the changing economic landscape, while there appears to be a reshuffle at the top with Vice-Premier Liu He taking on the toxic brief of pushing through SOE reform.

So far, it is unclear whether he will still play a role in discussions with Washington if they resume amid reports that Beijing was caught off guard by the depth and scale of Tump’s trade assault, and his condemnation of the broader “Made in China 2025” policy.

What followed has been well documented. Tit-for-tat tariffs were rolled out before the White House announced plans at the end of July to launch proposed duties on the entire list of Chinese imports worth US$500 billion.

China left isolated

To increase the pressure, Trump then thawed out relations between the US and the EU last week, following discussions with European Commission President Jean-Claude Juncker. This, in turn, left China isolated.

“When they announced an alliance against third parties’ ‘unfair trading practices,’ they didn’t even have to mention China by name for listeners to know who their target was,” Donald L. Luskin, the chief investment officer at Trend Macrolytics, a  macroeconomic research firm and consultancy, wrote in the Wall Street Journal.

“Cooperation between the US and EU will squeeze China’s protectionist model, and even before this agreement, there’s been evidence that China is already running up the white flag,” he continued. “Yes, China is acting tough in one sense, quickly imposing tariffs in retaliation for those enacted by the Trump administration. But while US stocks approach all-time highs and the dollar grows stronger, Chinese stocks are in a bear market, down 25% since January.

“The yuan had its worst single month ever in June and is well on its way to a repeat this month. Chinese corporate bonds have defaulted at a record rate in the past six months, yet this week China unveiled a new stimulus program designed to encourage even more corporate borrowing,” Luskin added.

Significantly, this is exactly what the International Monetary Fund warned against on Friday when it predicted 6.6% growth this year compared to 6.9% in 2017.

Indeed, this paradox of squaring the circle would not have been lost on Churchill.