Why Donald Trump's China policy is a trade war in the making
Donald Trump's telephone call with the president of Taiwan shortly after he won the vote to become the next president of the US caused a diplomatic stir. Some attributed it to Trump's ignorance of diplomatic protocol - which is to officially ignore the existence of a Taiwanese government that's independent of the mainland. Others speculated that it signalled a radical shift in US government policy in Asia as a whole.
The president-elect has a long history of impetuous and ill-considered behaviour, but this exchange with President Tsai Ing-wen was over 20 years in the making. Tension between the US and Chinese governments has emerged and intensified as China's economic might has grown. Trump's recent appointment of Peter Navarro, a polemical critic of China, as his adviser on industrial policy demonstrates that the call to Taiwan was no gaff of a novice.
So Trump's insult is not out of the blue. He was the messenger, but the source of the message lies in the reality of liberalised trade. As the US and China shall demonstrate, four decades of reducing regulations on commerce between countries results in the opposite - trade liberalisation leads to trade wars.
The free trade scam
Advocates of liberalising global trade argue that the "free" movement of goods yields benefits to all trading countries, promoting peace, harmony and cooperation. This argument has long been made. British politician Norman Angell made the same case that trade among countries fosters peace among them in the early 20th century in his book The Great Illusion. Just four years after it was published, the bloodiest war in human history began, fought among countries closely integrated through trade.
The benign story of free trade was wrong in the 20th century and it is still wrong in the 21st. Its fallacy is basic and simple - all countries do not gain from trade. On the contrary, among countries as within countries there are winners and losers, because market competition is a malign force.
The overwhelming majority of international trade occurs among corporate giants. Because of their size and political influence, economics and politics go together in the competitive struggle. Far from a benign process that brings cheap products to the consumer, global competition generates cross-country tension as giant corporations enlist their political allies in the fight for market access.
A country cannot maintain economic stability and continuous trade deficits. An excess of imports over exports implies a rising external debt by the public or private sector or both. A government can service this in its own currency by borrowing from its central bank (in effect, borrowing from itself). But this type of self-financing is not possible for the debt held in foreign currency.
As external debts increase, the cost of servicing them rises. Because the debtor must pay the creditor in international currency, foreign debt accumulation at some point requires that exports grow to close the trade deficit.
Since the end of World War II, the US has enjoyed a unique advantage because the dollar has functioned as the most accepted currency for international exchange. Governments of other countries hold US dollars "in reserve" to clear their outstanding international obligations. Plus, the US dollar is typically viewed by businesses and governments as the safest depository for idle funds.
These motivations for foreigners to hold dollars mean that the US government can accumulate an external debt far larger than any other government. But even for the US, debt accumulation has a limit.
Trade with China is shifting that limit from possibility to reality. Since China opened up its economy in the 1980s, Chinese exports to the US have grown from a modest US$14 billion in 1989 to almost US$500 billion in 2015. US exports to China, meanwhile, grew by considerably less, reaching a peak of US$164 billion in 2014 (for details see US Department of Commerce).
As a result, the US trade deficit with China has risen to an annual average of well over US$300 billion during 2011-2015. For the last decade, the negative balance with China accounted for more than half of the US trade deficit when we exclude petroleum (as shown in the upper part of the chart below).
With a surplus so large, it comes as no surprise that China holds 15% of US public debt not held by US government agencies.
Since the early 2000s, the ratio of the US trade deficit to GDP has exceeded the rate of growth of the economy. As long as this is the case, foreign debt will grow faster than the economy as a whole. Unprecedentedly low yields on public bonds - close to 0% - have kept the cost of servicing foreign debt manageable.
However, the head of the US Federal Reserve, Janet Yellen, has warned of several interest rate increases for 2017. Should US bond rates return to more typical levels in the range of 2-4% and the trade deficit persist where it has been for the last five years (3-4% of GDP), the combination would threaten the stability of the dollar and the US economy itself.
Trade imbalances generate trade wars, which are initiated by governments when those imbalances threaten domestic economic and political stability. The US trade deficit results from the combination of many factors. One of the more important ones is the domestic law that has facilitated the relocation of manufacturing abroad.
The non-sustainability of the US trade deficit helps us understand the foreign policy of president-elect Trump. First, substantial success in narrowing the US trade deficit requires reducing the imbalance with China. In the short- and medium-term that means import restrictions, with the implied political conflict. Trump's telephone call with the president of Taiwan is a signal to China of an intent to intensify that conflict.
Second, having alienated one great power, Trump needs a counter-balancing ally. Russia is the obvious candidate. The person designated to be US Secretary of State is a professed admirer of the Russian president, as is Trump himself.
The combination of conflict with China and friendship with Russia may lay the ground for a return to a world order in which states seek to establish exclusive control over specific areas or "spheres of influence". Whether or not that happens, it is clear that the neoliberal economic dream of a harmonious world of free-flowing trade was a fleeting fantasy, inconsistent with the reality of global economic and political competition.