It was hard to miss that Mr. Market had a bad day on Monday as a result of China setting the level of the renminbi about 1.5% lower, below 6.90, in response to the Trump Administration announcing plans to slap 10% tariffs on $300 billion of goods as of September 1, in addition to the $250 billion of goods subject to 25% tariffs in July. The effect of the September measure, if Trump follows through, is that virtually all of China’s exports to the US would be subject to tariffs.
The selloff continued overnight in Asia as the Administration designated China a currency manipulator after US market hours. The initial declines overseas stabilized after China nudged its currency a wee bit higher.
Business Insider’s recap of the Monday action as the Dow closed 760 points lower, which was merely the biggest fall since last December:
The escalation has spooked global markets, wiping between 2.9% and 3.5% from all major US indices and setting off a global sell-off. Overseas, 2.5% was slashed from the European FTSE, 1.8% from the German DAX and 2.2% from the French CAC.
The price of iron ore plunged 6.6% while the price of gold, seen as a safe haven during stock market volatility, jumping around 1.6% as investors flocked to it.
In Tuesday morning trading in Asia, benchmark stock indexes in Japan, Australia and Hong Kong were among the major decliners with each falling more than 2%. China’s Shanghai Composite fell 1.9%, while South Korea’s Kospi declined 1.6%, all building on retreats the previous day….
Bond prices and gold rallied. The yield on U.S. 10-year Treasury notes fell 0.01 percentage point to 1.72% Tuesday, and government bonds in Australia, South Korea, Japan and China all rallied. Bond yields fall as prices rise. The Japanese yen, considered a haven currency, was little changed at 106.32 a dollar.
China’s central bank set the daily midpoint for onshore yuan trading at 6.9683, 0.7% weaker than the previous day but still stronger than 7. The People’s Bank of China also said it would issue 30 billion yuan ($4.25 billion) of central bank bills in Hong Kong—a move seen as limiting possible short selling of the currency.
The more freely traded offshore yuan strengthened 0.2% in Hong Kong to 7.0828, a day after it hit a record low. The onshore yuan was little changed against the greenback at 7.0476.
Financial analysts noted that the designation of China as a currency manipulator was largely symbolic, a message that the US was not backing down. However, it’s worth noting that despite the fact that the renminbi really was undervalued during the early years of the Obama Administration, Treasury always punted on its April-October reports to Congress on designating China, which ran a hard peg back then (it moved to what is often called a “dirty float”) as a currency manipulator.
It’s not clear that there is any good path to a de-escalation, much the less a resolution. On the one hand, Trump in his one role where he displays a high degree of competence, that of master troll, has played the game with China (and North Korea) of dialing up rhetoric and threats and then backing off. On the other hand, Trump’s trolling has already hurt some American exporters, such as farmers. And stock market investors don’t like being in the crossfire. Stock market performance has been one reason that Trump’s base has stuck doggedly with him. Recall that the median income of Trump voters was higher than the median for US households overall, and above the median for both Clinton and Sanders voters. Anecdotal data, such as focus group findings, suggest that higher income Trump voters have given him good marks above all for the gains in their portfolios during his time in office.
Conventional wisdom among China watchers has been that the Middle Kingdom could simply outlast Trump, that the famously patient Chinese would best the erratic US president who is operating (at best) based on his gut instincts rather than any strategy. But Trump does have one of the best people in his Administration leading the China trade effort, Robert Lighthizer, although with Trump one is never sure until leaks spill out whether Trump has overridden his advisers or not. From a 2018 post by Marshall Auerback:
In spite of the shift in prioritizing services over manufacturing, and the discarding of the old Cold War quid pro quo, there remained throughout successive administrations a broader philosophic agreement about the virtues of free trade as a benign end in and of itself, rather than a means to end. Under Donald Trump, and his trade representative, Robert Lighthizer, that has all changed. Trump has always viewed trade as a zero-sum game in which there is one clear winner and one clear loser. He tends to focus on bilateral trade relationships, as a means of establishing which countries are playing the U.S. for patsies. Trump has even resorted to taking out full-page ads in his favorite media adversaries, the Washington Post and New York Times, to signal his new aggressive, unilateralist approach on trade.
Similarly, Lighthizer, who has immersed himself for decades in the fine details of U.S. trade policy, is not averse to using “executive orders, diplomatic pressure, and legal measures like… Section 232 [of the Trade Expansion Act, which empowers the U.S. president to impose tariffs on national security grounds, as]… legitimate tools for unsettling existing arrangements and pushing partners to the negotiating table. Lighthizerism is no roadmap for retrenchment but a blueprint for recapturing what is seen as a lost edge for U.S. manufacturing on the world stage.” He has also been very dismissive of the prevailing “conventional wisdom ”that implicitly assumes trade liberalization in and of itself would induce countries like China “to become more and more Western in… [their] behavior—almost as if… [they] were merely a more exotic version of Canada.”
When you start from the premise that free trade in and of itself is not an unalloyed good, but part of an “America First” strategy to make American manufacturing great again, or even allow free trade considerations to be superseded by national security considerations, it almost invariably follows that trade negotiations will be less benign and more aggressively unilateral, even with so-called allies (as both Justin Trudeau—“that punk little kid running Canada”—and Angela Merkel are now learning). Moreover, the lowest possible cost considerations (the usual endgame in a trade negotiation) might well not represent the primary objective in the overarching framework of a new agreement with Trump. Trade policy under Trump is designed to revive U.S. manufacturing, so as (in the words of Reihan Salam) “to steer U.S. firms to build resilient supply chains based in the Americas, not in China’s industrial heartland.”
As readers may recognize, even though Lighthizer has a coherent point of view, the flaw is that getting manufacturing back in the US isn’t just a matter of making China a less attractive place to business via tariffs and other means, like changes in Federal contracting. The US has lost skills at the factory floor, direct supervisor, and plant manager level. Even with the US embracing industrial policy and backing it with Federal spending, revived US manufacturing would rely heavily on automation. Yes, it would also create some good jobs, but almost certainly not in the numbers lost to globalization. And that’s before you consider that even with our EPA standards being weakened, US voters would not welcome the sort of pollution that has been part and parcel of a fair bit of China’s manufacturing.
The fact is that if Trump were in a position to be bloody-minded, the US could inflict more pain on China than it would suffer. The early rounds of this spat saw China’s quarterly growth rate fall to its lowest level in a decade while overall US growth remained solid. There have been on the ground reports from China of other signs of weakness, like a serious slowdown in payments to suppliers.
More generally, China an economic glass jaw. Its growth has been more and more dependent on debt, private debt as well as provincial-level government debt. Many analysts have pointed out that those debt increases are becoming less and less productive in terms of how much GDP growth they generate. Steve Keen also identified China as vulnerable to a crash by virtue of its high (by emerging economy standards) debt levels in combination with its rapid growth. His models show that merely stopping the growth of debt would kick off a crisis. Businesses that are too financially stressed to pay their suppliers on time are not good candidates for increased borrowing.
Some have argued that China could depreciate its currency to offset the impact of tariffs. There are limits to that. First, a fall in the currency big enough to offset tariffs would be massively inflationary in China. China imports food and fuel. China has been working hard to reduce inflation (which a decade ago was much higher than now) because it was socially and therefore politically destabilizing. Second, the prospect of further weakening of the renminbi would encourage capital flight, when China recently tightened its capital controls to put a damper on that. And China has cause to be concerned. From a June article in MERICS:
The growth of the financial system has raised the volume of capital flowing in and out of the country to levels that make it difficult for authorities to react to shocks. In a piece for MERICS, Victor Shih (2017) calculated that if 10 percent of China’s money supply were moved abroad, the country’s foreign currency reserves would be used up.
Now the countervailing question is: how much political pain is Trump willing to suffer? Here the China bulls have a point: the same way that the US military has become casualty-averse, so too are US voters not willing to take short term pain for longer-term gain, particularly when the prospect of gain is awfully tenuous. And China views Trump’s goal of having China agree to measures that would reduce its US trade deficit by 50% was draconian and clearly designed to undermine its standing as the up-and-coming superpower.
Now there is an area where the US could score a quick win: intellectual property. Getting China to curb counterfeiting and theft of trade secrets would give Team Trump a success and allow them to back off on other demands. But how do you assure compliance from China? Even though its move towards a total surveillance society gives it unparalleled ability to find and punish cheaters, why should it provide anything more than compliance theater? They could take a page from Japanese bureaucrats: do the least important 40% slowly and make earnest noises as to why the part that counts is hard to do but they are working on it.
There was one perverse upside for China to the trade row and market reaction dominating the news: it displaced coverage of the massive general strike in Hong Kong. From Hong Kong’s Massive General Strike Protest Has Paralyzed the City in Vice:
Hong Kong’s embattled leader Carrie Lam warned that the city was on “the verge of a very dangerous situation” as a general strike and coordinated protests paralyzed the city Monday. As tensions boiled over, two cars drove through crowds of protesters, and an armed mob attacked demonstrators with wooden poles.
The city was plunged further into chaos as workers from across about 20 sectors, including the civil service, went on strike. Coordinated and simultaneous rallies were held in seven locations, shutting down transport links and spreading the protest movement to virtually every corner of the city.
Protesters occupied and barricaded key arterial roads and shut down metro lines. Workers from the aviation sector joined the strike, forcing the cancellation of more than 200 flights at the city’s busy international airport.
South China Morning Post provided live-blog style coverage in As it happened: tear gas, arrests and fights as chaos reigns across Hong Kong. If you do a Google site search on scmp.com for “hong kong general strike” you will also find quite a few video clips.
The Chinese, contrary to expectations in some circles, held off from a military crackdown. By contrast, one is left wondering whether Trump’s China escalation was an impulsive reaction to widespread denunciations of his anti-immigrant talk in the wake of the El Paso mass shooting. But Trump may merely be an extreme creature of the times. Silicon Valley has fetishized moving fast and breaking things, and more specifically, having no regard for rules and regulations. Trump’s efforts to smash institutions, even ones that have served US interests like NATO and the WTO, are similar in spirit, though playing out in different arenas. Whether they recognize it or not, they act as heirs of the libertarian anarchism of Milton Friedman and Ayn Rand.