Opinion | How Donald Trump is helping China
China has failed to translate capital inflow into a current-account deficit that would finance increased domestic investment and/or consumption
The Sino-American trade war, initiated early this year by US President Donald Trump’s administration, is escalating rapidly. Already, the Trump administration has imposed an additional 25% tariff on $50 billion worth of Chinese goods, and an additional 10% tariff on goods worth another $200 billion. Unless the leaders of the two countries can strike a deal at next month’s G20 meeting in Buenos Aires, the situation is likely to worsen. That’s better news for China than it is for the US.
So far, China has refused to bow to US pressure. While it has retaliated, it has kept its actions proportionate, to avoid excessive escalation. But there is no reason to think that the Trump administration will reverse course. After all, Trump believes that a country with a bilateral trade deficit is necessarily being taken advantage of by its partner. The reality, of course, is that whatever costs the US incurs from trade with China are vastly outweighed by the benefits. For starters, thanks to low-cost imports from China, US consumers pay less for a wide range of goods.
Moreover, the US runs a massive current-account deficit, meaning that it is borrowing much more from its foreign counterparts than it is lending. Without inflows of Chinese capital, the US Treasury would face higher interest rates, raising the cost of financing government debt and the cost of homeowners’ mortgages.
True, the trade deficit with China has cost the US jobs. But those losses have been in low-wage positions, and have been offset by new employment in other areas. The key question is whether the US is able to upgrade its economic structure and ensure a fairer domestic distribution of the benefits of trade.
This cost-benefit calculation is probably why successive US administrations were happy to run trade deficits with China, even if they pretended otherwise. China’s government, too, was generally comfortable with the arrangement, though some Chinese economists have long warned that running a trade surplus with the US was not in China’s long-term interests, for a few key reasons.
For starters, running surpluses against the US implies accumulating foreign-exchange reserves. As the late MIT economist Rudi Dornbusch pointed out, it makes more sense for residents of poor countries to invest their resources at home in ways that raise productivity and living standards, rather than buying US Treasury bills.
Though China is among the world’s leading recipients of foreign direct investment (FDI), it has failed to translate all that capital into a current-account deficit that would finance increased domestic investment and/or consumption. Instead, by continuing to run a current-account surplus, China has established an irrational international investment position. Not only do US Treasuries produce meagre returns; they are also less safe than they appear. After all, the US Federal Reserve could always decide that its debt burden has grown too heavy, and attempt to inflate it away by printing more dollars.
In short, China has outgrown the world market, and its economy is desperately in need of rebalancing. Though the country has made significant progress on this front since 2008, its total trade-to-GDP (gross domestic product) ratio (37%) and export-to-GDP ratio (18%) remain significantly higher than those of the US, Japan, and other large economies.
It is worth mentioning, however, that a rapid deterioration of China’s current account will pose a serious challenge to the country. If China must reduce its trade surplus with the US, it must also reduce its trade deficits with the East Asian economies. The impact of such a rebalancing on the global economy could be very grave indeed.
China needs to stop accumulating foreign-exchange reserves. If it is to amass foreign assets, they should be more profitable than US Treasury bills. In any case, China should also reduce costly foreign liabilities. To that end, it must balance its imports and exports, while levelling the playing field for foreign corporations operating within its market by eliminating the incentives for local governments to compete for FDI regardless of cost.
These objectives are not new. But, thanks to Trump’s trade war, policymakers are now pursuing them with a new sense of urgency. In that sense, the trade war may end up being a blessing in disguise for China. In 2005, when the US government was pressing China to allow the renminbi to appreciate, Phillip Swagel, a former member of President George W. Bush’s Council of Economic Advisers, wrote: “If China’s currency is undervalued by 27%, as some have claimed, US consumers have been getting a 27% discount on everything made in China, while the Chinese have been paying 27% too much for Treasury bonds.”
But, as Swagel acknowledged, maybe that was the point. The US push for China to let the renminbi appreciate was “a devious attempt” to sustain the “enormous benefits” the US derived, at China’s expense, from the fixed exchange rate. Even if this was an accident, the end result was “a brilliant strategy to keep the good times rolling.”
With Trump, those good times may be about to come to an end. Trump claims that the “trade war” with China “was lost many years ago by the foolish, or incompetent, people who represented the US.” But it is he who most likely will be remembered as the fool—a bungling, capricious leader whose attacks on China only made that economy stronger, at least partly at America’s expense. ©2018/Project Syndicate
Yu Yongding is a former president of the China Society of World Economics and served on the monetary policy committee of the People’s Bank of China from 2004-06.
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