Sit back and enjoy the Kabuki trade show
Financial markets have plenty to be worried about but their latest concern — a trade war between the United States and China — should not be on the list.
Aligned self interest and a knowledge on both sides of the causes of the Great Depression should limit matters to a kind of trade war Kabuki, a highly stylized piece of theatre in which the United States shakes its fist and China responds in kind but no blows land.
The Obama administration on Friday slapped tariffs of 35 percent on the import of auto tires from China, reacting to a surge in imports and complaints from the United Steelworkers union. It also acted on the recommendation of the independent U.S. International Trade Commission.
China duly responded, announcing investigations into subsidies made to U.S. chicken producers and auto products, as well as vowing to take its case to the World Trade Organization.
Shares around the world sold off on Monday at least partly in response to the dispute, which awakened memories of the 1930 Smoot-Hawley tariffs and the trade war that ensued, a key cause of the Great Depression.
What’s worse, the United States is not just spitting into the wind of history but also into the face of its largest creditor. China holds about $1.8 trillion of Treasuries and any decision on their part to lighten up would send the dollar into a steep decline and torpedo U.S. plans to fund its fiscal deficit.
That’s just it. The United States and China need one another, and both sides are big enough and mature enough to understand this. China cannot dump U.S. investments without walloping its own portfolio, nor can either side accomplish any of their economic goals without the other as a client.
It is best to understand the U.S. move not as the first salvo in a war, but as a relatively small sop thrown to a domestic constituency, organized labor, that President Obama needs for other purposes, notably health care. It is also, in an odd way, a sign not of weakness but of the stabilization of the global economy. It is only now that things have calmed down that the United States would dare to appease a domestic special interest in this way. Had they done this in February, financial markets would have fallen over in a dead swoon.
The dollar, tellingly, actually rose as a first reaction to the fuss, hardly the reaction you would expect if the Chinese were preparing to dump dollars. Treasuries lost ground, but nothing extraordinary.
STUPID BUT PROBABLY HARMLESS
Technically, the United States is probably within its rights to impose the duties. WTO rules allow this if a surge in imports threatens a domestic industry, even if the trade is not unfair.
Rights and laws aside, the duties are indefensible. They protect less efficient makers and simply punish China, not for unfair trade practices, but for success. They also punish U.S. consumers, arguably hurting living standards more than the loss of the jobs the tariffs are presumably meant to protect.
Expect China to make a lot of noise about this. They also have domestic audiences, and theirs are rightly aggrieved. Expect too the rest of the G20 leaders who will assemble this week in Pittsburgh to say all the right things in public and to play peacemakers in private.
What I would not expect is for this to accelerate into something damaging and destabilizing. The stakes are too high and the political rewards domestically for a trade war are tiny in comparison.
There are, however, longer-term issues which are unsettling. China’s interests and those of the United States are diverging and over time there will be serious conflicts to be negotiated. The system of China trading goods for Treasuries which did so much to raise living standards in China and fill garages with stuff in the United States is no longer tenable.
The U.S. will consume less of China’s stuff and must even compete with China more effectively for exports, probably in areas like military technology where sales will be doubly unsettling for the Chinese.
China, over time, will not want to subsidize U.S. borrowing rates and will want to diversify its currency holdings. This will not be easy or pleasant for the United States but, broadly speaking, is probably in its own long-term interests.
All of this could blow up, especially if it undermines confidence in Treasuries and the dollar. It has not yet, and I think the two protagonists will put off the serious business of working out their conflicting interests until either the global economy returns to robust growth or things in the United States stay bad long enough to change the political math of a real trade war.
We are not there yet, and for at least another year probably won’t be.
–At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.–