Talk of a bruising trade war between China and America reached a high pitch this past Thursday and Friday. The stock market went down more than 1,000 points in these two days. China said they were evaluating all options including reducing their vast holdings of US Treasury securities. A sane & colorful as always description of US media hysteria came from CNBC’s Rick Santelli who said “we are putting fire ahead of the alarm“.
So we thought it useful to turn to a sane & knowledgeable source that studies US – China relations from a geopolitical view. Our first question was about the scale of what has been launched. The answer:
- “The tariffs and penalties the U.S. is proposing apply to only about 10 percent of Chinese exports to the United States and just 2 percent of Chinese exports to the world. That is not exactly a scorched earth policy; in fact, it’s more like a slap on the wrist.“
What about a war-like analogy for the measures announced?
- “They are a shot across the bow designed to demonstrate U.S. resolve to the Chinese when it comes to trade.”
This knowledgeable source is Geopolitical Futures, specifically their article on Thursday, March 22, titled A US-China Trade War? Not So Fast. According to their analysis, Rick Santelli was correct to use the term “alarm”. Because an alarm is itself a trigger, a trigger that says what has been building underneath has now risen to a visible stage. As Geopolitical Futures reminds us,
- “The U.S. has been working up to this moment since Donald Trump’s first day in office.”
What has the U.S. been working towards? And what can China do about it?
- “… [U.S.] wants to reset the conversation with China on its own terms. And China does not have much choice but to go along.”
Why doesn’t have China have much of a choice? According to Bianco Research that was quoted by CNBC’s Rick Santelli on Friday, 50 million Chinese jobs are involved in China’s exports to America while only 500,000 jobs are involved in US exports to China. As Geopolitical Futures points out,
- “ … one-fifth of Chinese gross domestic product still comes from exports; … in 2016, 23 percent of Chinese exports, worth roughly $481 billion, ended up in the United States. China’s other top export destinations were key U.S. allies in the Pacific – Japan and South Korea. Meanwhile, just 8 percent of U.S. exports, worth about $116 billion, went to China.”
Not just that, but a real trade war with China could pose a serious structural crisis for China.
- “After all, Chinese President Xi Jinping is launching massive structural economic reforms that will necessarily lead to lower GDP growth rates, and that means China can ill afford a trade war that will lower those growth rates even further. If the U.S. were to raise tariffs on all Chinese exports, it could send the Chinese economy into crisis or, at the very least, force China to abandon its attempt to rein in stimulus spending and irresponsible credit growth, which would just delay the inevitable reckoning by a few years.”
So what is likely to be a near term resolution? Geopolitical Futures opines:
- “The Trump administration will proudly tout these more recent measures as a major victory against China. China will beat its chest with equal vigor and make harsh statements about defending its rights and interests against irresponsible U.S. overreactions. … As always, Beijing will be looking for a win-win scenario, where the Trump administration can claim victory at home but no real damage is done to the Chinese economy at this critical juncture. “
China Now & Japan of 1930s; Trump & FDR
The current situation reminds of U.S. and Japan in the late 1930s. President FDR was determined to reset what he saw as Japanese expansion into South East Asia by using severe trade measures. Eventually he put an embargo on commodity exports to Japan, a step that prompted Japan to lash out militarily.
Since January 23, 2016, a week before the Iowa caucus, we have been writing about a potential pivot by President Trump to FDR from Reagan. We think President Trump is as determined to “reset” U.S.-China trade and Chinese mercantile practices as FDR was determined to change Japanese expansionism. This is a defining mission for the Trump Presidency and, while he may weave & feint tactically, he intends to achieve his strategic & structural objectives.
Chinese Holdings of U.S. Treasuries
That brings us to the often repeated fear of China selling their 1.6 trillion of Treasury securities to explode US interest rates & send the American economy into recession. How realistic is that and what could President Trump to prevent it?
One big misconception is that somehow China is doing America a favor by investing so much in US Treasury securities. The reality is China gets over 400 billion of U.S. Dollars from its exports to America. If China were to take back this massive amount to China, the Chinese currency would shoot up against the U.S. Dollar and makes Chinese exports uncompetitive. This leverage allows America to regularly threaten to designate China as a “currency manipulator”.
Regarding Chinese threat to stop buying U.S. Treasuries, the reality is that China has been reducing its holdings of US Treasuries since 2015. China is constrained by a lack of options, especially since the Euro lost its “safe haven” reserve currency status due to EU problems. So China really doesn’t have any other choice except the U.S. Dollar and that means owning U.S. Treasuries.
But things can unravel and get out of hand in an angry dispute between two proud & powerful nations. Outbreak of nationalistic fervor can force countries to strike out in irrational and dangerous ways. So it is sensible to consider the possibility of China suddenly deciding to sell say even 25% of its 1.6 Trillion position in US Treasuries. What could happen then?
First, China can’t sell even $100 billion in U.S. Treasuries in any market without the entire Treasury market being aware of it. The result would be an immediate big move up in U.S. interest rates. Does any one think President Trump would allow China to hurt the U.S. economy by dumping their Treasury holdings in bulk? Remember how President Nixon unilaterally cancelled the direct international convertibility of the U.S. Dollar into gold in 1971? With that one declaration, President Nixon unilaterally made Bretton Woods, the then international financial exchange, inoperative.
So President Trump has prior precedent to take action to protect the United States from Chinese dumping of their US Treasury holdings. But what could he actually do? One simple but devastating step would be an Executive Order from President Trump that went something like this:
- “All transfers of Chinese or Chinese related holdings of U.S. Treasury obligations held in electronic book entry in the system maintained by the Federal Reserve will be suspended immediately. Holders will receive interest and principal as agreed but no sale or transfers will be allowed.”
Recall that FDR had used the 1917 Trading with the Enemy Act to confiscate gold in 1933. Recall that President Carter had updated this 1917 Act into the International Emergency Economic Powers Act of 1977 (IEEPA). Recall the two preconditions for the use of IEEPA:
- There must be a threat to the national security or the economy of the United States, and
- the threat must originate from abroad.
Now ask yourselves whether a believable or even expected threat of China selling a large portion of its $1.6 trillion of US securities would fit the above two preconditions for the use of IEEPA?
Ask yourselves whether you believe President Trump would allow China to dump its Treasury holdings to cause financial damage to America when he has such devastating options to stop it?
We think China would be find it safer to create a military engagement in the South China Sea than attempt to attack America with its 1.6 Trillion holdings of Treasuries. But that is a topic for another time and another article.
For now, it suffices to quote Geopolitical Futures to point out why the U.S. fired a shot across China’s bow this week:
- “In a negotiation, it is not always enough to simply point out your adversary’s vulnerabilities; sometimes, it is necessary to demonstrate how badly those vulnerabilities could hurt when they are exploited.”
Or, as Rick Santelli said, to raise an alarm!
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