Asia

Why the US-China trade war is not about jobs – Part II

Buenos Aires, Argentina

We’re meant to believe that Donald Trump and Xi Jinping are good friends…at least, according to the former. But, at this rate, it’s going to need a hell of a lot more than sharing “beautiful” chocolate cake to calm things down in the US-China trade dispute.

Far from cooling down, things keep heating up in the US-China trade squabble. It should be obvious to all that trade relations between the World’s two largest economies are a big deal. So I’ve been taking a look at what’s going on.

Part I looked at how China’s economy took off, how it resulted in a huge trade surplus with the US, and how the excess dollars were largely sent back to fund US government budget deficits…at least, until 2010.

Today, I’ll look at why China’s foreign exchange reserves may have flatlined for years, despite ongoing trade surpluses. But first, let’s look at what could be driving the US to upset the trade applecart at this particular time.

President Donald Trump and his government would have us believe that it’s all about American jobs. But US unemployment is very low right now.

In fact, the only time US unemployment has been abnormally high since China’s economy took off, in the early 2000s, was once the global financial crisis hit. And that was entirely self-inflicted by the US (see Part I).

US unemployment rate since the 1950s

Put another way, if the trade dispute with China is really about creating more jobs in America, then the US is going to need a hell of a lot of new immigrants to fill those positions. Somehow, I don’t think that’s what the US government has in mind…

But does this low unemployment figure mask some other problem? Perhaps there are too many of the “wrong jobs” these days – namely, the low paying kind. Has China hollowed out the “right jobs”, taking away the kind that pays well?

That may be the case in some instances…in specific, isolated industries. But there’s good evidence that it’s not the case across the US as a whole. We can see that by looking at real (inflation-adjusted) median household income trends, as shown in the following chart.

Real median US household income since 1984

Source: Federal Reserve Bank of St. Louis

Clearly, there was a big dip during the (self-inflicted) global financial crisis. But the overall trend has remained upwards. Median household incomes are higher today than in the late 1990s, after adjusting for inflation.

This is significant since, in the late 1990s, China’s economy still hadn’t really taken off. Meaning its impact on global production and trade was still modest.

Importantly, that last chart specifically uses the median figure, and not the mean. The median income measures the amount of the middle household in the distribution. That means half of all households are above and half below.

The median isn’t skewed much by income disparities between rich and poor, which we hear so much about. It literally shows the trajectory of middle America, defined in income terms.

So yes, some people in the US may have suffered from the China effect. But the evidence is for little damage to American employment levels or incomes overall. Offshoring to China has had some effect on manufacturing jobs, but that effect is almost certainly overstated by vote-hungry politicians.

(The real thing that’s been gutting manufacturing jobs – and that continues to do so – is automation. But that’s another story.)

So, if it’s not about jobs, let’s get back to asking what’s really going on…

  • If China still has trade surpluses, but isn’t growing its foreign exchange reserves or holdings of US treasuries, where’s all the money been going since reserves peaked in 2014?
  • I suspect that a lot of the money has been funneled overseas, but mostly outside the US. More research is needed to confirm this, but I’ve seen some evidence already.
  • For example, a lot of it could have been spent or lent to fund China’s massive global infrastructure projects, collectively known as “One Belt, One Road” (see here for more). Current estimates put the cost of that at around $1 trillion over time, a huge figure. But it’s relatively difficult to get good data.
  • Other dollars could simply be lent to China’s global friends…or desired friends. From South America…to Africa…to Asia. Perhaps China is now a conduit between dollars spent on Chinese goods in American Walmarts and dollars invested into essential railways built in Africa? (Hmmm…does that make consumption of Chinese goods something sinister or a charitable act? I’ll leave you to decide.)

Given all of this, what are the likely motivations that the US government has picked this moment in time to challenge China on trade?

  1. If a huge piece of the US trade deficit is no longer being recycled into funding the massive US budget deficit, this puts pressure on the US balance of payments. So there’s an incentive to reign in the trade deficit with China, even if it means penalising US consumers with higher prices or US companies with lower profits. (Recent research by investment bank Goldman Sachs says this is what’s happened so far when the US has imposed tariffs on Chinese goods.)
  2. If successful, rebalancing US-China trade slows the net flow of dollars into China’s coffers, by reducing China’s overall trade surplus. This potentially slows down China’s ability to spend or lend those dollars elsewhere in the world (although China can increasingly use its own currency, renminbi yuan, instead).
  3. Politically, it sounds good to pick a fight with a mysterious and distant adversary. It’s a show of populist strength. Most people don’t understand the financial or economic realities of what’s going on. But protectionism always plays well with certain types of voter.

Why else would anyone keep commenting on such an important process via such a trite medium as Twitter?

Incidentally, it would be wrong to think that China has no leverage in this game, just because it sells more to the US than it buys.

  • Obviously, there’s the question of whether it could dump a big chunk of its $1.1 trillion of US treasury bonds. That has the potential to drive up yields, feeding into dollar interest rates of all kinds, and in turn inflicting great damage on the debt-sodden US economy.
  • It’s also a cinch to make life harder for American companies that operate in China. Sudden inspections of facilities, foot dragging with customs clearances or licence approvals, exclusion from government contracts (including from any state-owned enterprises), and so on.
  • One suggestion is that China could ban all exports of rare earth elements to the US, which are essential components of most electrical products. Since the US currently gets 80% of its rare earth needs from China, this could seriously disrupt parts of the US tech industry.

On top of this there’s a big side issue, which isn’t really about trade at all. That’s about a struggle for technological supremacy, often using the spurious justification of national security. (Remember, the US government also thinks that German cars are a “security threat”, which is obviously laughable.)

But, if the US thinks it can hold back China’s technological advance, I suspect it’s fighting a lost cause. China has already achieved massive success in internet commerce, electronic hardware, and electric vehicles. With its already huge internal market, China will most likely continue to make great strides, whatever the US does.

That doesn’t mean that US governments won’t try, even if just for domestic political purposes. Most recently, the Commerce Department has blacklisted Huawei, the world leader in 5G mobile data infrastructure and second largest manufacturer of cell phones (after Korean Samsung).

This moves bans US companies from supplying Huawei. Alphabet/Google has already announced that Huawei phones will be cut off from updates to its Android operating system. Intel, Qualcomm, and Broadcom – all designers and suppliers of microchips – have also said they will cease supplies to the company.

Of course, this will be inconvenient to Huawei in the short term. But, in the long term, it will damage the US companies. I expect all the Chinese cell phone companies – also including Xiaomi, Oppo and Vivo – must have serious doubts about the reliability of Android by now. I’d expect them to each develop their own systems, as Apple does, or to create a shared Chinese system along with Huawei. We’ll see.

The US-China trade dispute creates a lot of uncertainty in the markets, not least due to the way that developments are broadcast via Twitter. It will probably calm down eventually, and something will be agreed. That’s assuming that both sides can find a face-saving compromise.

But there will be future flare-ups from time to time. In the meantime, tariffs are a tax on consumers and producers…in both countries.

Let me know what you think.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com


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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.