The jingoistic state-promoted anti-American propaganda blasting US ‘bullying’ on trade, the popularity of Trump toilet paper and Trump toilet brushes in China, and the virulent resurgence in Chinese nationalism stoked by Xi Jinping augur poorly for successful trade negotiations with China.
The ‘Chinese dream’ that Xi Jinping has promoted is for China to be the world’s only superpower, economically, militarily, and culturally, thus reclaiming China’s leading world role.
And, on the US side, Trump has little to lose and much to gain politically by being a trade hawk with China. Any deal he makes is likely to be attacked by Democrats as too weak, so Trump at this point has little incentive to make a deal with China before the 2020 presidential election.
My prediction is that China will not drop its equity caps and intellectual property theft, and will not stop subsidising all of its state-owned enterprises. If it indeed fails to take those actions, we will see acceleration of the decoupling of China from the United States, in other words, a reversal of the economic integration and interpenetration that has taken place between these two economies over the past 20 years. If Chimerica is not dead, it is at least on life support.
So let us examine the implications of the decoupling of China from the United States, and ask whether China is replaceable.
The first area to consider is trade. The IMF has estimated that if the United States were to impose 25% tariffs on all Chinese imports, and China were to retaliate, the trade volume between China and the United States would drop by 70%. So there would clearly be an initial ‘trade shock’.
The question here is whether the US can find other low-cost suppliers. The answer is yes. We have seen that suppliers such as Vietnam have stepped up their exports to the United States, and other Asian countries and Mexico will also try to fill the role of low-cost supplier to the US market. Vietnam has gained an estimated 7.9% of its gross domestic product from new business created by the US-China trade war. The next largest gainer is Taiwan, with 2.1% of its GDP added as a result of the US-China trade war.
China’s retaliation against US exports opens up opportunities for other exporters to ship into China, as well. For example, India’s exports to China have increased by 32% and have increased by 12% to the United States. Brazil, the world’s second largest soybean producer, has more than doubled its shipments to China, the world’s largest soybean importer, while China has virtually cut off its imports of soybeans from the United States.
What about rare earth metals, which China has threatened to embargo to the United States?
Rare earth minerals are essential for guidance systems and for sensors in missiles and advance fighter planes. An F-35 Fighter, for example, requires 920 pounds of rare earth elements for its iron boron and cobalt magnets.
China is the world’s largest producer of rare earth minerals: elements such as neodymium, europium, terbium, and dysprosium that are crucial to the production of some advanced materials and electronics. Anything less than a total global embargo by China, however, would not work. China found that out in 2010, when it placed a ban on rare earth exports to Japan. That export ban had virtually no impact on Japan, as it simply purchased the rare earth minerals it needed from other countries supplied by China.
In summary, if the Trump tariffs were to remain in place, there would undoubtedly be an initial ‘trade shock’, and some dislocations. Over time, however, the United States would gradually shift its import sources to lower cost suppliers, and would substitute rare earth minerals from other countries. So, with regard to trade, China is replaceable.
The second area is investment. Chinese direct investment in the United States dropped 84% in 2018 compared to 2017, from $29.4 billion to $4.8 billion. Through the Committee on Foreign Investments in the United States (CFIUS), a federal inter-agency committee chaired by the Secretary of the Treasury, the United States will further limit Chinese investors through national security reviews.
The net effect of the US Investment Risk Review Modernization Act (FIRRMA) signed by President Trump on 13 Aug. 2018, is that investors from China will have a difficult time investing in what is deemed a “critical US technology or infrastructure”.
Meanwhile, US direct investment in China has stagnated at $26.9 billion, with the annual growth rate dropping from 11% to 1.5% in 2018. US investment will increasingly take place in other low-wage Asian countries, such as Vietnam and Taiwan, and Mexico.
China will cease to be as large a magnet for US investors, as supply chains have now become mangled by the Trump tariffs, which will greatly burden inter-affiliate imports. Since 30% of the exports from China to the United States are from affiliates of US companies in China to US parent companies it is likely these duty-bearing imports will be sharply reduced.
Moreover, the lowering of US corporate tax rates on 1 Jan. 2018, from 35% to 21% will discourage direct foreign investment by US enterprises, and make the United States a more promising place to invest than China. Therefore, if the Trump tariffs remain in place, China can be largely replaced over time by other countries as an investment target.
On 16 May, the Trump Administration restricted sales by US companies to Huawei, the Chinese telecommunications champion. It is likely that this measure will force Huawei to develop its own versions of chips and operating systems to replace those that it now obtains from the West. And on 21 June, the Commerce Department imposed new export controls that will effectively bar five major Chinese supercomputer developers of next-generation, high-performance computing from obtaining US technology. The commerce ban on exports to the major Chinese supercomputer companies, along with the Huawei ban, will promote the decoupling of the two countries’ tech supply chains. Therefore, it is likely that separate operating systems will be set up for telecommunications, supercomputers, and the internet.
China holds an estimated $1.1 trillion of US government bonds. Some have warned that if China decided to dump US dollars, US interest rates would soar and the US economy would implode. However, in comparison to the size of its economy and levels of international trade, China’s reserves are roughly in line with those of other developing countries. It’s also not a particularly large proportion of the roughly $22 trillion total US government debt to the world outstanding.
China has already sold $221 billion in long-term treasuries since early 2015, including $21.5 billion in April 2019, with no harm done to the US capital market. Therefore, from the standpoint of the US capital market, it seems clear that China is eminently replaceable.
In an ideal world, the United States and China would seek to expand flows of trade, investment, and technology between the two economies. Unfortunately, that is not the world we live in. As Michael Pillsbury has pointed out, “The hard truth is that China’s leaders see America as a rival in a global struggle – one that they plan on winning.” The United States has had to push back to try to level the playing field.
We are entering a new phase of increased Chinese assertiveness. China, as a rising power, is now challenging the United States for global supremacy.
There is a lack of trust by the US government in Chinese intentions, as it now sees China as a predatory competitor and an adversary.
It seems that the global consensus based on liberalisation is likely to be replaced by rival trading blocs. This may not be a desirable development from the standpoint of the United States and the global economy, but it is the most important geopolitical event of our era.
Decoupling from China, while painful for the United States and China, would be preferable to a real war with China, the likely alternative.