The Trump administration has finally put some teeth into its America First rhetoric, imposing tariffs on big washing machines from South Korea and solar panels from China. A hefty tariff on Chinese steel is being floated while Chinese aluminium is rumoured to be on the chopping block. At Davos, the US Treasury secretary was talking down an already weak dollar. Are we seeing the start of a long-feared trade war between the US and East Asia, especially China?
I suspect this is not a real trade war. The Trump administration doesn’t have a strategy to go all the way. The US economy depends on a vast stock market bubble and foreign financing of its fiscal deficit. Its tax cut is adding US$1.5 trillionto its deficit over the next decade, making it more dependent on foreign capital. If the US goes deep into a trade war or debasing the dollar, the stock market will crash, foreign money will flee, its bond yield will surge and its economy will crash.
A credible trade war requires two elements: the US being prepared for a prolonged recession, and a coherent industrial policy. The US economy is driven by maximising short-term profitability for big listed companies. They have been driving the outsourcing model in global trade because cutting costs through outsourcing is the quickest way to boost profit. The high stock prices from the boosted earnings reward the top managers at these companies. The US CEOs have seen incredible increases in their incomes, far ahead of their counterparts in Germany and Japan, while its industrial workers face declining wages. Unless the US changes the incentive structure for its top corporate managers, this dynamic won’t change.
Germany and Japan, while they don’t publicly admit it, have industrial policies. They concentrate resources in industries where they could achieve long-term competitiveness. Their CEOs put the country’s interest ahead of short-term profitability. And, they don’t pay themselves tens of millions of dollars, because their societies have implicit social contracts against it. They are still high-cost countries and can’t achieve high economic growth. But, a deep industrial base leads to a more stable and equitable economy.
The ongoing trade dispute with China continues the decades-long pattern in how the US handles its trade with the East. Four decades ago, the anti-Japan rhetoric was more heated than that against China today. Far more serious restrictions were imposed on Japanese steel, automobiles and electronic products. They have had no impact on how industrial development has evolved on both sides. What has changed is that industries have moved from one Asian country to another.
East Asia’s advantage in manufacturing is not just labour cost. Its labour quality is superior to that of the US. Even more important is cheap capital. East Asia has a high savings rate and accounts for most of the net savings in the world. Any capital-intensive industry is likely to be rooted there. An industry such as semiconductors may start in the US, but eventually becomes a typical East Asian industry, because it is capital intensive. This advantage in capital may be exaggerated by financial repression that boosts savings. Countries like China should eliminate financial repression. Still, even when government policy doesn’t tilt the savings rate one way or another, East Asia will have higher savings rates.
Anglo-Saxon economies like the US, Britain and Australia practise the opposite of financial repression. Their financial markets tend to exaggerate paper wealth and encourage borrowing. Hence, they have an unusually low savings rate and high cost of capital. This is a key reason that Germany and Japan have stronger industries. If the US wants to reindustrialise, it must first stop excessive monetary stimulus that encourages debt.
US President Donald Trump’s protectionist policy will at best prolong the life of sunset industries like steel and aluminium. As the capital market sees their high cost, it will hold back and they will just wither away. For a new industry like solar panels, it will merely encourage tariff arbitrage. Some companies will start local assembly operations with imported components, mostly from China, similar to what developing countries used to do.
A real trade war could occur only if the US’ asset bubble bursts and the Federal Reserve cannot start a new one. That would mean a prolonged recession. The nascent populist movement that got Trump elected could become a dominant force and completely change the country’s ruling elite. That is a possibility but not likely, at least in the next decade. The financial bubbles over the past three decades have created a powerful and extremely wealthy class. It is difficult to see that they will give up easily and see their wealth deflate under a new regime.
The US will stick to the whack-a-mole approach in its protectionist policy. It may scare the other parties into doing a few things to boost US exports, but the big picture won’t change. The US will continue to run large trade deficit until East Asian countries don’t want dollars any more. When that day comes, the dollar will collapse, and the US will slide into stagflation, while East Asian economies will be stuck with deflation.
Andy Xie is an independent economist
This article appeared in the South China Morning Post print edition as: US isn’t ready for a full-blown trade war with Asia