President Xi is left over an economic barrel

While it took the Pentagon 20 years to call China an ‘adversary,’ there has been a sea change in the economic relationship with the United States. Indeed, President Donald Trump has China’s head of state Xi Jinping over an economic barrel.

And if Trump plays his cards right, Xi and the Communist Party of China will soon face some tough choices.

This is quite a turn of events. Not long ago, we were being told the future was China. American Thomas Friedman and others reckoned Chinese leaders were brilliant and infallible – the wisdom of the Orient, you know – while Americans were idiots. Tinker a bit, play the ‘long game,’ and 6.5% growth, or whatever number desired, was guaranteed.

Now, however, the US economy is thriving while the PRC continues to slump. Chinese manufacturing is stumbling, debt and stock markets are a mess, as is unemployment.  Millions of people are being forced back to their villages to become ‘entrepreneurs.’ More likely, there is no work and the authorities want them out of major cities.

The Chinese population seems spooked, and Xi appears rattled after calling a meeting of senior officials a couple weeks ago before saying they should get ready for a crisis.

There is a reason China’s domestic security budget is bigger than its defense budget.

But Xi doesn’t seem to have any brilliant ideas – beyond cutting taxes, pouring money into the economy and telling banks to lend to private companies. And his doubling down on inefficient SOEs, or state-owned enterprises, is the ‘Road to Perdition,’ but easier to control than China’s private sector.

Meanwhile, Xi reassures the private sector they are loved although they have heard that before.

Make no mistake, the PRC will not collapse but the hubris is gone.

This was bound to happen as the problems in China’s economy were obvious. Trump has simply been a catalyst. His advisors – at least the ones who aren’t Goldman Sachs alumni – understand the PRC’s economic vulnerabilities and are applying effective pressure.

One key weakness is that the yuan is not convertible, so, the PRC must earn foreign currency (FX). The CCP can, of course, print all the yuan it wants but nobody outside China really wants it. Rather, it’s dollars, euros, or yen, please.

Just like the Confederate States of America, when buying Enfield rifles from Britain, Jefferson Davis had to pay in Yankee ‘greenbacks.’ The same goes for Xi.

How does the PRC earn FX? Mainly from exports or foreigners investing in China. Chinese companies buying assets and operating businesses overseas are other ways. And with the Belt and Road Initiative, it is getting foreign governments and organizations to pay for it.

Developing country

China also passes itself off as a developing country to squeeze money out of the World Bank. Things were going well before Trump came along.

As trade tensions increased, Washington imposed tariffs, launched intellectual property theft prosecutions and pressured major companies, such as ZTE and Huawei. It also tightened CFIUS restrictions on Chinese investment in the United States to reduce access to a convertible currency.

Indirectly, many Europeans and even the Japanese have quietly cheered Trump on. Even the developing world has increasingly seen the PRC as rapacious and corrupting.

China’s capital controls reveal plenty about the CCP leadership. Individuals can only take US$50,000 out of China each year while companies must request foreign exchange.

Yet, the country’s business elite, as well as the CCP leadership and its families, have long spirited their wealth out of China. Remove exchange controls for even a month and the yuan would plummet with money gushing out of the world’s second-largest economy.

According to one PRC estimate, Chinese citizens have $21 trillion stashed overseas and the CCP wants it back. Good luck with that one.

In fact, CCP behavior suggests they have got a ‘case of the shorts’. Going after billionaires and tax-evading actresses to grab their money is the equivalent of looking under couch cushions for loose change.

Imagine the US Government kidnapping Bill Gates and taking over Microsoft because it needed his money.

Facing this dilemma, how does China placate Trump?

Beijing hopes he will accept an offer to buy more American products – particularly agricultural commodities – thereby reducing the trade deficit, which stood at a record $323.3 billion last year.

Still, the US is after more than that, such as structural reforms, which would end discrimination and bullying of foreign companies.

The PRC will promise further ‘opening up’ as it always does. Unfortunately for Xi, few people on the US side believe it.

‘Opening up’

One American businessman remarked:

“The US weekend-only edition of China Daily [the state-owned English-language newspaper] is distributed in my hotel. I picked up a copy yesterday. The bold print headline: ‘Xi Pledges Greater Opening-up.’

“I can tell you … this same headline has been blasted out at least once a quarter ever since I started in China. I have been doing business with China for a total of 133 quarters. This means China has made 133 pledges to ‘greater opening-up.’”

Chinese negotiators will also promise to stop stealing technology which they constantly deny. But this is part of Beijing’s economic strategy and a moral imperative.

The US is still skeptical about enforcing any agreement. The required changes might even threaten CCP control – and China will refuse to take orders from foreigners.

In fact, if you take Washington’s demands to their logical extreme, you have ‘regime change.’  The CCP will drive the Chinese economy over a cliff before letting that happen.

So, the US and China will not be solving their problems anytime soon – unless one side surrenders.

But by leveraging trade, or pulling the plug on companies such as ZTE or Huawei, and retaliating for decades of intellectual property piracy, the US can take the steam out of the Chinese economic juggernaut.

And Washington can force CCP leaders to make some hard choices elsewhere as they run low on cash and their economy sputters. They might, for example, ease off on Taiwan, back off in the South China Sea and refrain from bullying the Japanese in exchange for US restraint.

More worrisome, they might also lash out violently against Taiwan or Japan to distract public attention. Dictatorships do that.

While the Chinese brim with chutzpah and are skilled ‘bluffers,’ that only works when the guy across the table has no idea what cards they are holding. And Trump’s team knows the Chinese only have a ‘pair of two’s’ – a very weak hand.

Indeed, bringing formal charges against Huawei just as a PRC trade delegation arrived in Washington last week suggests Trump might not fold like his predecessors. This will get interesting.

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