The Trade War is On, Maybe

Posted by Ray on September 12, 2009 under Main | Be the First to Comment

America fired the second shot in the trade war with China and contrary to popular belief it is a major problem. As you may have heard, there have been two shots fired in this potential trade war between the US and China. It is only fair to state that China did fire the first shot by allowing its banks to bailout of derivative contracts issued by foreign banks, i.e. US investment banking firms like a Goldman Sachs or Citi Group. The Chinese bailing out of those contracts is a major problem, but a livable one as it would basically only hurt the investment banks, which I think they really deserve at the moment.

However, Mr. Obama just escalated this dispute by shooting back a trade tariff on tires from China, which smells of protectionism to me. This was perhaps the dumbest move that a government official could have done that it should make everyone question his judgment or total lack of experience. The 35% tariff was enacted because a union had begged for it, Bush was asked for the same tariff, but declined to enact it, and since Obama is in up to his neck with the unions he jumped at the chance. Even though the other US tire companies, Goodyear and Cooper Tires, did not support this tariff as they knew or know it will only hurt American product sales in China. However, that fact was ignored by Obama.

The tariff is on top of a 4% existing tariff on Chinese goods which means that once cheap tires that struggling Americans would probably buy are no more as the price will increase by the new 35% tariff. While I agree that America needs the work, I also realize that cheaper prices are far more important as we are broke. If the American product was better than it would have been selling anyhow, regardless if the cost was more, but clearly the American consumer wanted value for their money and that is what the Chinese gave us, until now.

The free market had decided that the Chinese product was acceptable and in demand while the American product was not. However, we have an interventionist government who loves to payback political favors to the detriment of our long-term financial health. Enacting a tariff to appease a union is criminal and a sign of corrupt politics. This will not help the US in the long-term and it appears that this tariff was just not a political favor, but also a way to fire back against the Chinese legalizing the right to void derivative contracts. What we are seeing here is a text book example of how a trade war begins and given our weakened state we will lose.

We need to realize something, America is still the #1 consuming nation on the planet, but India has over 1 billion people and China has 1.3 billion people. Based on those quick demographic facts do you really think that China needs to be our biggest trade partner? No, they don’t. In fact, Europe is now the Chinese largest trade partner and Japans largest trade partner is China. At this rate it looks as though decoupling may not be just a theory after all and may materialize in the very near future. A trade war will not help us right now and may lead to a steeper economic decline.

I do not expect our elected officials to understand any of this because they are lawyers and lack the knowledge of understanding economics or money, besides what they can pocket. However, China holds enough of our dollars and is buying assets all over the world that could adversely impact the US if China decides to play hardball. I do not think it is a coincidence that the dollar tanked over the last 6 days and gold broke to new 12 month highs as the President and China play these games with each other. Also, contrary to popular belief, China does not need to buy our debt and nor do they need to hold our debt.

What I mean is this, China holds $1 trillion dollars and has another $1 trillion to spend. Do you think the Chinese are more worried about losing $1 trillion today or do you think they want to risk losing $2 trillion at a future date? I believe the latter is more likely than the former. As they watch the dollar decline the Chinese will want either collateral or much higher interest rates in order to keep buying our debt. To think otherwise is simply absurd. If the Chinese want to escalate this potential trade war then they will start by selling $100 billion in treasuries, which would raise some eyebrows.

We cannot back down from them, but we have to smart in how we approach the Chinese as they can reap economic damage upon us that will further cripple us, economically. We clearly have bad leadership in Washington, in all branches of government, and their inexperience and general knowledge only means more pain for us over the long-term. They simply do not understand what they are doing and the very last thing we need is a trade war and that war is coming very fast at this point.