The US and China can’t afford this trade war

In spite of their constant bickering, the US and China have enough incentives to smoke the peace pipe later this month.

It still makes me chuckle whenever I think about it.

The Leader of the Free World complains bitterly about how the free market is treating his nation unfairly…

Which has awkwardly cast the leader of Communist China in the role of free market cheerleader.

The boot is on the other foot. The US and China have both recently been given a taste of their own medicine.

Americans have learned that a free market without bounds can have negative consequences for domestic economic activity. They have placed their trust in a protectionist president who’s promising to put their country first.

It’s left it up to the Chinese to remind the US of those same economic values US governments exported all over the world in the not so distant past.

China in turn is learning the hard way that it’s actually quite annoying when you find yourself on the other side of protectionist policies.

This year the clashes of the two superpowers have escalated into a full-blown trade war.

Though neither side is backing down, the US and China could bury the hatchet sooner than we think.

Empty war chests

Given the choice between the carrot and the stick, Donald Trump almost always opts for the latter.

Last week, the US President said he’s expecting a “great deal” with China on trade. If the Chinese would give him any trouble, he’d just impose billions worth of new tariffs.

It didn’t take long before Chinese leader Xi Jinping hit back at the US (without mentioning the US or Trump).

In a speech in which he railed against protectionism and isolationism, Xi said countries should get their own house in order first before focusing on others.

And yet, despite their constant bickering, the US and China both seem open to a trade deal. Over the weekend Trump even struck a positive chord.

He said the US and China could be striking a trade agreement over a fine Argentinian steak at the G20 summit in Buenos Aires at the end of the month.

Both the US and China have plenty of reasons to want a trade truce. You might even wonder if either side can afford a protracted trade dispute.

The war chests of the superpowers may not be what they once were. Both countries are neck deep in debt.

At 106% of GDP, US debt is at the highest level in history apart from immediately after World War Two. And debt is only going up. Trillion dollar deficits are the new normal.

Such lavish spending used to occur only in times of war, with debts paid down in times of peace. That’s no longer the case. We now live in an age of perpetual debt.

Ironically, China plays an important part in keeping Trump’s money tap open.

China is the biggest buyer of US debt. It holds $1.18 trillion, or about 5.6% of total outstanding US public debt.

If it stops buying and starts offloading US Treasuries, it could throw a spanner into Trump’s big-ticket spending plans.

Meantime, China’s debt is expected to be a whopping 260% of GDP at the end of 2018.

Chinese authorities have spent an extraordinary amount on investments that won’t return anything to the state’s coffers.

Says Strategic Intelligence editor Jim Rickards:

“Much of China’s ‘growth’ (about 25% of the total) has consisted of wasted infrastructure investment in ghost cities and white elephant transportation infrastructure.”

Just like the US needs China, China needs the US to prop up its economy.

Who else is going to buy all those “made in China” goods if billion dollar tariffs put Americans off imports?

“Chimerica”

The US and China may be pointing a gun towards each other, but they could soon find themselves out of bullets…

That’s not the only incentive the countries have for smoking the peace pipe.

Over the past decades the US and China have created an economic interdependence. “Chimerica” as economic wags refer to this symbiotic relationship.

Here’s how the Economist explains it:

“As China opened up, American consumers hoovered up cheap Chinese goods. American firms built China into their supply chains, enjoying low labour costs and gaining a presence in a domestic market that would one day be the world’s largest.

“Export-oriented development created vast numbers of Chinese jobs, and American investment allowed Chinese firms to gain technological expertise.

“As China grew richer, it purchased American bonds to keep its currency low and its exports competitive. That allowed America to consume beyond its means year after year. This circular flow of money saw America’s current-account deficit grow in pace with China’s surplus.”

When you build up a relationship like that, it’s no longer possible to hurt the other without hurting yourself in the process.

Fortunately there’s still time before the US government’s most punitive tariffs go into effect on 1 January 2019. There are a couple of straws for us to clutch.

Trade negotiations are rarely transparent (negotiators like it that way), which means we may not hear about any progress in the talks until – abracadabra – an agreement is on the table.

Trump and Xi exchanging unpleasantries doesn’t really mean much, either. Brexit negotiating parties continuously blast each other in public. It doesn’t mean negotiations come to a stop.

And if Trump lifts the tariffs on Chinese imports in exchange for, say, China changing its stance on intellectual property rights, then both could claim that as a win.

Given how much the US and China rely on each other, punishing China doesn’t make sense as it would hurt the US too. An economic slowdown in China will be felt all over the world.

“When the downturn arrives, the world is likely to discover that China’s economy matters even more than most people thought,” warns Harvard professor Kenneth Rogoff.

Hurting the Chinese economy and plunging that country into crisis could act as a boomerang that will inevitably make its way back and strike the US economy.

All the more reason to hope Trump and Xi will find each other later this month over a glass of excellent Malbec wine.

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