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July 20, 2018

Trump Negates the Chinese Growth Model

(The original was published in Japanese version of "Newsweek" on July 18th and the English translation was first published in the site of the English-Speaking Union of Japan)

The trade conflict between China and the United States is now in full swing. The two nations are flinging major tariff hikes at one another, neither willing to give an inch in the standoff. Thinking back to the defensive posture taken by Japan during its own trade frictions with

America, I must admit to feeling somewhat jealous of China for its ability to stand its ground. Japan, as a nation under the US security umbrella, was unable to implement effective countermeasures for fear of the backlash they might trigger among domestic industries worried about the impact on their business. As a result, Japan's decisions tended to fall along the line of how far to accept US demands in the trade disputes of the time.

The ongoing Sino-American dispute, meanwhile, seems to a certain extent to be just an act, with both sides firing their guns noisily, but harmlessly, toward the sky. These opponents may shake hands and call an end to the hostilities at some appropriate juncture. Global financial markets, perhaps perceiving the same thing, have been rebounding immediately after each trade-friction-triggered plunge.

How serious is the United States about this trade conflict? President Donald Trump is clearly seeking to create momentum and lay down a track record of results as he heads toward the midterm elections to be held this autumn and, looking farther ahead, toward the presidential election to take place in 2020. It will be particularly important for him to be able to claim that he created jobs once again for the "Midwest working class" that played such a key role in putting him in the White House.

However, it is unlikely that higher US tariffs on Chinese steel, aluminum, and other exports will do anything to bring jobs back to the factories of the American Midwest. China exported just 1.2 million tons of steel to the United States in 2017, placing it eleventh on the list of steel exporters serving the American market. Fully half of China's exports are smartphones and similar products that are merely assembled in the country for Western companies. Slapping restrictions on imports like these will only cause trouble for US firms like Apple and GM while raising prices for American consumers (therefore, such items are carefully omitted from the final list for tariff hike).

Rather than bring their assembly operations back to the United States, these US companies are likely to move them from China to other low-wage regions like Vietnam or India. For this reason, Washington is not likely to seek to crush China as a competitor; it will rather press China to greatly increase imports of American aircraft, automobiles, medical equipment, and pharmaceuticals, while ensuring that unfair fines are not levied on US companies active in China and creating an improved investment environment.

Beijing, for its part, insists that it will not give an inch in this struggle. It is likely uncertain about how best to proceed, though. If China does follow through with its threats by slapping hefty tariffs on American soybeans and aircraft parts, it will only be harming its own interests, as there are no other trading partners capable of providing such plentiful flows of this item. If the Chinese government sells off a considerable portion of the US treasury bonds it holds, it will again be the party to suffer, not the United States: Japan and other purchasers will snap up the bonds flooding onto the market, and China, meanwhile, will have trouble finding ways to put its massive new influx of greenbacks to use.

Many are calling China an economic giant, and the country itself has come to see itself as a superpower in this sense. In truth, however, it has been pushing its luck within the framework and systems of the postwar global economy that the United States first put together. The yuan is far from a readily convertible currency, leading China to conduct much of its trade on a dollar-denominated basis. It has established a yuan-denominated crude oil futures market in Shanghai to chip away at the global rule of the dollar, but this is unlikely to attract foreign participation so long as the yuan remains relatively unconvertible.

Therefore, the tariff war will not cause an Armageddon in US-China economic relations. Both countries will continue negotiating on trade. What is far more important, however, is the possibility that Trump's fixation about trade deficit may have triggered a profound change. Namely, if the current event prompts the Western companies to reduce their investments in China, the Chinese sacrosanct export-driven growth model will become unsustainable.

Since the first decade of this century, China has made use of this surplus, which, along with foreign direct investment, has climbed to as much as a combined $400 billion in some years, converting it to yuan and spending it domestically on real estate and infrastructure investment, multiplying the capital by several hundred percent in returns. This has been the core of China's stellar economic performance in recent years, but now the country stands to lose this momentum if a trade war escalates. The country is now running a considerable trade surplus vis-à-vis the United States, accounting for 49.0% of its total 2016 surplus of $510.7 billion. When the US surplus with Hong Kong is included as well, this ratio goes above the 50% mark.

If foreign companies, which are responsible for about 50% of Chinese exports, will curtail their production in China and exports therefrom, it will depress the Chinese economy and lower incomes of the Chinese. In 1985 Japan was made to face a similar situation, when the US forcibly devalued the dollar against yen almost twice. Japan, deprived of its export-driven growth model, eventually fell into stagnation. Since then the long-time ruling party LDP (Liberal Democratic Party) was voted out of power as many as two times.

China, where the Chinese Communist Party (CCP) is entitled as the only and permanent ruler, will step into a turbulent time, as there is no alternative for the CCP, which may lose people's support, while the ever increasing tempo of the aging of the population will exacerbate financial and economic woes.

The US may have knocked down China, a threat to its prominence, as it did to Japan in the past.


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