Announcing the Winners of the U.S.-China Trade War*

Announcing the Winners of the U.S.-China Trade War

Be patient. Wait for it…

If you’re familiar with the children’s card game “War,” you also would have an excellent understanding of which President country is likely to win the U.S.-China game of Trade Warrior. You’d know the importance of having better cards, what having better cards means and recognize which country is likely to have the better cards … and why that nevertheless may not be determinative of the outcome.

As the rules of War – the card game – require, a deck of playing cards is divided in half with each Player receiving 26 cards and holding them face-down without looking at any of them. Each player then turns over the top card in his deck and the player with the higher card takes both of the cards and moves them to the bottom of his deck. They become that player’s to use in future flips. The flipping of top cards continues with the goal being to capture all of the other player’s cards. The player who does so is the winner. As might be imagined, the game of War can last for quite a long time. Aces are high, then Kings, etc., down to the deuce. For example, if one player turns over an Ace and the other a King, the Ace captures the King and the Ace and King become part of the winning player’s future weapons. Similarly, if one player has an Ace and the other a deuce, the Ace captures the deuce and, although the Ace has won the battle, it has not progressed itself in the Game of War since the deuce is useless as a future weapon. The random pairings therefore matter. They add a significant element of unpredictability to the outcome. If the two cards played are of equal value, there is a “battle” that is resolved by both players ducking one card – meaning that they place the next card in their decks face down on the table – and then turning over the next succeeding card. The player with the higher turned-over card wins that “battle” and captures the face-up and face-down cards of the other player, adding those cards to the bottom of his deck. If the face-up cards are once again equal, then the “battle” continues with one face-down card and a succeeding face-up card until one player has the higher face-up card.

The U.S. and China have been turning over their cards in the high-stakes, real-world Game-of-U.S.-China-Trade-War. Trade War is a highly complex game among nations that can be played narrowly – like the card-Game-of-War – and be limited only to trade. Unlike in the card game, however, that rarely is how nations behave (see, for example, “America at War” in the May 3rd TLR and “Red Storm Rising” in the April 12th TLR).

In the card-Game-of-War, the cards are dealt at random. In the U.S.-China Trade War, the U.S. has been dealt the far-better cards. It has more Aces, Kings, Queens and Jacks than China. It has the stronger, more mature, more balanced economy, the stronger military, and the greater global support. Consequently, if the cards dealt to the two countries all were to be turned over at the same time today, the U.S. would be the winner … hands’ down, so to speak. However, that’s not how the card-Game-of-War, or the Game-of-Trade-War, is played. Although the odds currently favor the U.S., the Game-of-Trade-War can last for a very long time and likely will include multiple, unpredictable skirmishes – the “battles” of the card-Game-of-War – with the outcome of each such skirmish, and therefore of the Trade War itself, incorporating a randomness factor. Put another way, the current Trade War is not about the known unknowns. It will be decided by the unknown unknowns (as Donald Rumsfeld might put it).

On August 1st, President Trump escalated the Trade War by announcing new tariffs of 10{29ea29b64b10057f61377b2c087cd5b7537a0cd24da4295a308b0bf589469f35} on $300 billion of imports from China to take effect on September 1st. These are in addition to tariffs he previously imposed on $250 billion of Chinese imports, which together with the additions will equal 100{29ea29b64b10057f61377b2c087cd5b7537a0cd24da4295a308b0bf589469f35} of all imports from China to the U.S. Although China countered Trump’s initial $250 billion of tariffs primarily by targeting American agriculturals, it can’t match the new total since it imports only $178 billion of U.S. goods. It nevertheless retains several potentially potent weapons – including being the global supplier of rare earths to American companies for American technology and weaponry, having an ability to impact America’s crude oil exports, and being able to manipulate its currency by reducing the cost of Chinese imports and discouraging the purchase of foreign goods and services by increasing their prices –, although these are merely Queens and Jacks and not Aces or Kings in this Game-of-Trade-War. But then, of course, because the Game-of-Trade-War can continue for quite a while, randomness can have significant interim effects as well as outcome-determinative ones.

As one of several responses to Trump’s August 1st tariff tweet, China decided to allow its currency to truly float, and the Yuan promptly weakened to fall below 7 to the Dollar, largely offsetting the economic impact of America’s tariffs. Seven-Yuan-to-the-Dollar is a level China had been defending for several years – that is, China most recently had been manipulating its currency to strengthen, rather than weaken, it. A stronger Yuan is now in China’s best interest and, among other things, has been supportive of its efforts to validate the decision of the IMF to include the Yuan in its global currency basket. Currency validation is a first step in China’s quest to include the Yuan as a global reserve currency and for the Yuan someday to stand above alongside the US Dollar, the Euro and the Japanese Yen. Although China had been actively manipulating the Yuan to lower levels earlier this decade, it has been supporting it against deflationary pressures over the past several years. Immediately after the Yuan fell below 7 to the Dollar, the Trump Administration U.S. Treasury Department declared China to be a “currency manipulator,” a clear case of the pot calling the kettle….

The reality is not that China has weakened its own currency. Rather, America’s fiscal policies have caused the Dollar to strengthen and, consequently by comparison, the Yuan to weaken.

The American economy has been humming in large part because of the tax cuts enacted by the Trump Administration in 2017 … as well as because of the Federal Reserve’s successful fiscal manipulations over the past 10 years – that is, through its printing almost unlimited amounts of Fiat Currency Dollars (via Quantitative Easing), reducing interest rates to historically unprecedented levels, and implicitly promising to “do whatever it takes” to keep the economy moving ever upwards (see, for example, “Managing The Economic Cycle (Part 2)” in the May 10th TLR). As President Trump has tweeted – accurately –, this has led to “massive amounts of money from China and other parts of the world … pouring into the United States.” Those massive Dollar flows are the reason why China and Japan are the largest holders of U.S. Treasury securities, and why foreign sovereigns and private investors alike are potent participants in U.S. equity markets. When massive amounts of money pour into a country, that country’s currency and its stock market appreciate and the currencies of competing countries depreciate … and that’s precisely what has happened to the US Dollar versus the Yuan (and other currencies). The effects of the money flows are supplemented by the Administration’s America First trade and defense policies which further strengthen the US Dollar and weigh on other currencies … notably the Yuan.

China therefore has no need to manipulate its currency downward. The U.S. is doing precisely that – that is, the U.S. is the “currency manipulator” –, and the Yuan will naturally continue to depreciate unless China supports it … as China had been doing and has now stopped doing … leading the Treasury Department to label China a “currency manipulator.” Even were the Fed to now lower interest rates as Trump has been berating it to do – and, in light of the escalating Trade War and its impact on the economy, that now has become a likelihood –, that will not change the Dollar flows. The Yuan will continue to weaken and the Dollar to strengthen.

The Game-of-Trade-War therefore has reached a “battle” stage similar to that in the card-Game-of-War. Both sides have played their cards and upped the stakes …, but the Game will continue no matter which player wins this single “battle.”

On August 13th, the President prudently attempted a de-escalation of the Trade War by unilaterally delaying until December the effective date of a large portion of his proposed additional tariffs. At the same time, Trump invited President Xi to sit down with him to work out possible solutions. His hope was that this would be a first step to a bilateral settlement of the underlying problems that led to the Trade War. However, it’s unclear what each side views as the underlying problems and, consequently, what basis there might be for a mutually acceptable settlement. Is the U.S. seeking a level playing field for American companies and products in China – the underlying cause of the Trade War (see “The Trade War with China: What’s America’s Beef?” in the May 22nd TLR) – or the elimination of America’s trade deficit with China – which has been President Trump’s public rationale for waging the War? If the former, any settlement would require Xi to re-organize China’s economy, something he will not do, especially at this time. And if the latter, although President Trump could declare victory and move on, of what benefit would that be to the U.S.? Importantly, at this point in the War, analysts question whether China cares one way or the other since for Xi this is this now about proving that he and China will not be pushed around by American arrogance demands, even if those demands were to have no substantive impact on China’s economy. Moreover, it appears that Xi has been preparing China for economic pain intransigence. The State-controlled media have been making the point that no country, and especially not America, will bring China to its economic knees. The fact is that the issues, as well as the economics, have become more-and-more complex by the day, and the stakes are now quite high for both countries … and their leaders … and for the global economy. Whatever the merits or demerits of Trump’s latest attempt at de-escalation, the odds of settlement appear long. Xi has not taken up Trump’s invitation or responded in kind to Trump’s de-escalation … and the consensus among analysts is that China has dug in to fight the War over the long term.

China has been in a similar position in the recent past. In 2015, the Obama Administration denied Intel a license to sell microprocessor chips to Chinese super-computer companies because those companies provided technology to the Chinese military. As a consequence, in 2016 China created its own super-computers powered by Chinese-manufactured microprocessors, and by 2018 China led the global super-computing race with 206 of the world’s 500 fastest super-computers. The U.S. was second with 124. The same outcome is likely with respect to the effect of America’s sanctions on Huawei. Because of those sanctions, Huawei is now creating its own operating system to replace Google’s Android. China apparently has gotten the message that it cannot depend on America … or American-made products. It will go it alone and seek to compete with America … on all levels. That is not a good sign for settlement of the current U.S.-China Trade War.

If the Trade War is to continue, which country will be the winner? Will President Trump blink first because he sees an election looming? Or will President-for-Life Xi blink because the economic pain China is enduring becomes intolerable? Either way, both the U.S. and China will have been damaged. Both countries already have suffered significant economic injury. The longer the Trade War continues, the more they will lose. Because both the U.S. and China necessarily must continue to play their economic, military and political cards despite the damage doing so causes their economies and their internal politics, other countries and companies will fill in the gaps in global trade and production. They already are doing so. They will be the winners from the Trade War. They will emerge stronger with an enhanced economic ability to compete with U.S. and Chinese firms. Vietnam and Taiwan currently lead the pack in this regard. Unfortunately, when the dust settles on the Trade War, the likelihood is that this global Game-of-War will have created economic havoc and, macroeconomically, more losers than winners. As TLR previously has cautioned, 2019 finds disturbing parallels in the 1930s (see “1937” in the March 11th TLR).

Finally (from a good friend)

*┬® Copyright 2019 by William Natbony. All rights reserved.

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