Trump’s Trade War with China Explained

The trade war between the U.S. and China is escalating, and there’s very little chance of it abating any time soon. The real test is which country will feel enough pain to cry uncle first and how much damage will be inflicted in both economies in the meantime.

In September, Mr. Trump imposed $200 billion in tariffs on Chinese imports on top of the $50 billion he imposed in May. He also threatened to levy another $267 billion if Beijing retaliated. China responded be levying $60 billion in tariffs of their on US products. If Mr. Trump follows through on his threat, more tariffs may be on the way.

The Trump Administration’s tariffs are meant to address very real problems. China’s habit of strong-arming American companies into turning over technology in exchange for access to the Chinese market is the explicit basis for the two rounds of tariffs introduced this year. There are also broader concerns about the vast and opaque government subsidies China provides to state-owned businesses, which give them an unfair advantage over foreign competition.

For Mr. Trump though, America’s trade deficit with China is the central issue. “Last year, we lost $500 billion on trade with China,” Trump said earlier this year. “We can’t let that happen.” Mr. Trump’s figures are off — the trade deficit with China was actually $375 billion, not $500 billion — as his preoccupation with it.

The Trump Administration is pushing China to trim $200 billion from its trade deficit with the U.S. by 2020, a demand that will be impossible for China to meet. Even if China rectifies the legitimate complaints Mr. Trump’s Administration has raised about China’s unfair trade practices, it is unlikely to make a major dent in the trade deficit, and even if it were possible, it might not necessarily desirable. This is because the primary driver of the trade deficit with China lies in deeper, underlying issues such as the variation in savings rates in the two countries. Closing the trade deficit would require American consumers to consume dramatically less and save more, likely plunging the American economy into recession in the process.

Mr. Trump sees America’s goods trade deficit as a zero-sum game with the country possessing a trade surplus the winner and that with a trade deficit the loser. But, that misunderstands how trade between nations works.

At its most basic level, the trade deficit means China sends more stuff to Americans than they require Americans send them in return. This is great for consumers, who get cheaper goods. The excess dollars China receives in the process flow back into the U.S. in the form of investment, principally in the form of U.S. Treasury securities that finance government spending and facilitate low interest rates.

Of course, for U.S. workers that might otherwise be employed to produce goods, at higher cost, that can be more cheaply imported from China this is cold comfort. But, reducing the trade deficit with China does not necessarily mean those jobs return to the U.S. More likely, those same goods will simply be sourced from other low-cost producers or from highly automated U.S. factories that employ relatively few workers.

Will the U.S. or China Win?

In an economy as large and dynamic as America’s, the impact of the tariffs will probably not be felt immediately by most consumers. The current round of tariffs focuses on intermediate goods, such as auto parts and computer chips. This means that U.S. manufacturers, especially those that depend on Chinese component parts, will likely absorb the brunt of the increase in costs. The Trump Administration has attempted to soften the blow as well by phasing the tariffs in over time — rising from 10% to 25% by January of next year. This, it hopes will give firms time to adjust.  Still, some of the very manufacturers that it hopes to help will feel bear the heaviest burden in the meantime.

The more immediate effects are being felt by U.S. exporters facing retaliatory tariffs from China. The pain is especially acute among farmers that export soybeans and other commodities to China. The Trump Administration has attempted to blunt the impact with subsidies to agricultural producers through deficit spending that is financed, ironically, by Chinese purchases of U.S. Treasury securities.

The Trump Administration maintains that the tariffs give it leverage to force China to the table. Mr. Trump credited his hard-edged strategy with the new NAFTA Agreement announced earlier this month. “Without tariffs, we wouldn’t be talking about a deal,” Mr. Trump said of the revised North American trade pact.

Mr. Trump’s team calculates that its trade war will inflict more pain on China than China inflicts on the U.S. in return. China has been experiencing an economic slowdown as it faces a reckoning over excessive debt held by Chinese businesses. Trade frictions with the U.S. certainly do nothing to help its troubles, but resolving them doesn’t fix China’s underlying problems either.

Beijing has introduced measures to blunt the impact of the tariffs. Most recently, the People’s Bank of China slashed the amount of cash it requires banks to maintain in reserve in a bid to pump more money into its sagging economy. That won’t completely stop the bleeding, but it shows that China is digging in for a long-term fight.

The U.S. shows no sign of backing down either. “We changed the paradigm, we have tariffs in place, and the president is not going let this go long, where you take intellectual property, where you have a forced transfer of intellectual property, where you treat American companies and farmers and ranchers poorly,” U.S. Trade Representative Robert Lighthizer said in September.

President Trump once tweeted that “Trade wars are good, and easy to win.” Reality is proving that trade wars are neither.

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