I have written numerous times about the brewing trade war between the U.S. and China with many people thinking I was crazy. Well, it appears that this thing is escalating with the esteemed Paul Krugman weighing in on the issue, in a very unusual way. I am sure everyone is aware of Krugman’s political leanings, he is a bit left of center, and is a full blown Keynesian. While I am far from a Noble Laureate, actually I am nowhere close to ever receiving such a prize, but I am capable of doing nothing so you never know, but I do know what a street fight looks like and there is one brewing.
It all started many months ago over allegations from the U.S. of China dumping tires on our market, which is probably true, but during a recession I am not going to complain about cheaper products. It then escalated as China began to look into chicken products being imported from the U.S. From there it has just gone downhill with seamless pipes to automobile complaints. However, the one thing that has never stopped is the current administration, from its very beginning, has called the Chinese currency manipulators. Of course, Chuck Schumer, who would kill to get air time, literally, was weighed in on the issue as well.
Far be it from me to pick on a man who has never held a private sector job and knows as much about economics as my 10 year old, but Chuck is out of line. Krugman is not helping by saying that the RMB or Yuan is undervalued by 25% and the U.S. should place a tariff of 25% on all Chinese imports. Schumer points to this as validation of his mythical point, but I see it as one nut job helping out another. Regardless, Schumer and a few other Senators have sent a letter to Treasury demanding that the Chinese revalue their currency. This is all to save U.S. jobs and boost our exports, but it is protectionism at its worst.
Schumer and Krugman believe that we have the Chinese right where we want them, they own a ton of my debt and are very angry with us. Oh, I forgot to mention that we are heavily dependent on the Chinese to buy our debt to fund out current and future deficits, but that seems to slip Krugman and Schumer’s mind. I always hate pointing out the obvious, but if we need money and our largest creditor starts to cut you off that is a recipe for disaster. It is not the selling of the Chinese current treasuries that we should really worry about, well, we should worry about it, but not really, it is the future purchases of our debt that we need them for.
There is no doubt that the Yuan is undervalued, but who knows by how much and they need to raise its value anyhow to fight inflation. However, I have seen that the Chinese do not like being told what to do by the U.S. and payback could be a problem for all the ridiculous political posturing. Essentially, we want the Chinese to increase the value of their currency, which is pegged to the dollar I might add, making their products more expensive in the U.S., see the protectionism yet (?), so the Chinese will buy more of our products. In Schumer/Krugman land this will lead to massive U.S. corporate job growth and a return to prosperity, but reality is very different from fantasyland.
What will happen is the U.S. will begin to import more products from other countries where the dollar goes further, like Brazil, India, Indonesia, Pakistan, and a million other places. That means the job situation here will not get much better and other economies will flourish. Of course, Krugman/Schumer will then demand that all other countries increase the value of their currencies as well, it just will not work. John Mauldin brought up a great point, we tried this in 1971 with Japan, as Krugman points out, and what happened was the Yen dropped from 350:1 to, now, 90:1 and what happened to Japan’s trade surplus? It went higher because the Japanese save their money, which if we saved our money it would be the solution to our trade deficit issue I might add. It did not work in 1971, really, and it is not going to work now because people will continue to buy from China because they like the products or they will find comparably cheap products made elsewhere.
Mauldin brings up another point, Canada’s Loonie is almost at parity with the USD so why shouldn’t Canada hit us with a tariff as well if this is the game we are going to play? Of course, this wouldn’t happen because we love Canada and they love us, I think. The point is that this is protectionism, pure and simple. It is a very dangerous path and if we follow it we may find ourselves in a Smoot-Hawley situation. I am not sure why Krugman doesn’t see it that way and maybe I am wrong, after all I am not a Nobel Prize winner, but like I said I know a street fight when I see one. This is turning into a street fight and we do not have China right where we want them.
It is possible that China would, this is highly unlikely, sell their treasuries to burn us if they get angry enough. The military already suggested using our debt as a weapon against us and it would work. Sure, it would hurt them, but you know what? Mao killed 70M of his own people, I am pretty sure they could like with losing a few billion. Plus, if they take down more gold they are hedged, kind of. It is not that I am taking China’s side on this, I think they are in the wrong, and I do not think they would blow up their treasury portfolio, I am just pointing out what they could do.
We can make the argument that they need us and they do, but if they do not increase the value of the Yuan and we impose a 25% tariff on all their products I am pretty sure all bets are off and they would have to learn to live without our business anyhow. Keep in mind, China’s trade with Europe and Japan is climbing rapidly. While we are the biggest market in the world they can survive by moving deeper into those markets along with other frontier markets and Africa. The other thing you have to remember is that China has been buying resource companies over the past few years, so they have been moving away from treasuries anyhow. Finally, perhaps we should look at our own dollar situation before we pick on china. If we had taken care of our currency to begin with the Yuan would be stronger anyhow.
There have been several actions taken by both China and the US this year against each other both claiming dumping charges. The irony is that all the accusations are probably true given the fact that China does subsidize its industries rather substantially which allows them to bury overpriced US products. However, China’s accusations about US dumping of auto parts and cars is also true given that GM and Chrysler is also heavily subsidized by the US government as well, that is now undeniable and an embarrassment to all US citizens.
I realize that the US won the ITC, International Trade Commission, ruling today, but do you really believe that ruling was impartial? Considering the US provides a large portion of the funding for such organizations it would be doubtful that we would lose any case brought before them. I would compare this to the arbitration clause in your credit card application which was so blatantly slanted to the creditor that Congress basically was going to strip it of its powers before the industry ‘voluntarily’ got rid of that clause from its agreements. It stands to reason that when one party basically funds an organization to arbitrate disagreements between that party and third parties there is no objectivity, at all.
Regardless, how many actions is this now between the US and China? It started with tires, moved on to chicken, cars, seamless pipes and now steel grates. All of this while the US is trying to force China to strengthen its currency, which China would be nuts to do I might add. All of these actions smell of protectionism which will not be good for the average American in 2010. While the Fed wants to create inflation I think Obama misunderstood what type of inflation they were talking about, wage inflation not just price inflation. At this rate, and for the first time ever, the US consumer could be facing the same or lower wages with rising prices because this administration is picking fights with our largest supplier of goods.
The irony is that the media actually says that foreign nations actually love us now because of Obama. That may be true in Europe, but I could care less about Europe because the last time I checked we did not get the vast majority of our cheap everyday goods from Europe, we get them from China. Frankly, we are ticking China off by demanding that they do things they do not want to do and we are in no position to demand anything at this stage of the game. Especially since China is almost, if not already, the number 2 economy in the world with the largest population in the world. Did I mention they also hold a lot of US dollars as well?
Telling China, not asking them, to strengthen their currency is also protectionism whether you want to believe it or not. By asking them to make their currency stronger you are telling them to raise their prices on their goods which, in turn, makes products at Walmart more expensive. The goal, of course, is fruitless, but Obama figures that if Chinese goods are more expensive then you and I will opt to by a US made good instead. This is not a new idea and has been tried many times before, it never works, and it may trigger some pretty bad things to happen, but hey who cares about history and facts when we have perpetual bailouts going.
I have no idea how China will react to this politically, I am not a politician, here is what I do know. If we buy less Chinese goods that means our trade deficit legitimately gets smaller, a good thing right? Wrong. With some $5T in treasury debt to roll and issue this year we need countries like China to run trade surpluses so they are forced to buy our paper. If they are not running those trade surpluses then they will not have to buy our paper, they could if they wanted to, but they would not have to. That is the biggest reason in the world to not play games with them right now since our ‘recovery’ is shaky at best. If they do not buy our debt that means QE will continue and then we are in really big trouble because technically monetization of a countries debt is the final straw before it defaults, that is a historical fact not an opinion.
I am not sure if the current administration understands that or not, but somehow I doubt it. I believe they think that this forced ‘buy American products’ policy will work, but protectionism was what really kicked started the Depression, combined with bank failures, which we already have a ton of I might add. Maybe this is some type of payback to organized labor or something, who knows, but I see other troubling signs of protectionism as well. Japan is doing a cash for clunkers program that American car makers do not qualify for.
Now, US lawmakers made the rules and most c4c sales went to Japanese car makers and why not they make one heck of a car and the companies are solvent. The Japanese program is slanted towards only Japanese automakers, again, why not they make great cars and the companies are solvent, but now some representatives are upset about this. What are they going to do about it, I do not know, but they could do something dumb like put a tariff on Japanese cars or something, which I hear is being discussed, that is protectionism.
Protectionism and trade wars are bad, bad, news for everyone, but especially for the US consumer. Our government knows not what they do and they continue to do ridiculous things which make life increasingly more difficult for the everyday American, but let the people who messed up the economy off the hook, completely. If they do more to increase this blossoming trade war or initiate more protectionism legislation you have to act and tell them to stop. I want America to succeed, but on its own merits, not through legislation that punishes free trade.
As I talked about yesterday there is a trade war that is quickly heating up. Contrary to what the experts in the Whitehouse think, we desperately need China to help us fund our ever increasing deficits. The Whitehouse said that they do not believe a trade war will erupt, but what do you call the actions of the Chinese over the past 2 days? It is a trade war that has consequences we cannot comprehend.
As stated yesterday, Obama, in order to appease his labor union friends, instituted a 35% tariff on tires from China. China immediately filed a complaint with the WTO, which I am sure we will win since we usually never lose those fights, but today the Chinese are claiming ‘dumping’ of auto products and chicken products. Those are serious accusations and also an indication that China is not going to back down and why should they?
Frankly, we need them more than they need us as they fund our deficit spending and provide us with cheap products, that we really don’t need, but hey we like to buy stuff. Yes, we provide China with a market, but we are no longer their largest market, Europe is. Not to mention that their population could, theoretically, support itself or they could just sell more products to India or other large populated countries. I believe in the decoupling theory and we might just be at this point as China gets fed up with the amateurs in the Whitehouse, who insist on fiscal irresponsibility and embrace crony capitalism to benefit the unions instead of America as a whole.
If you do not think this is a big deal, think again. They have two ways to really engage us on this issue and rattle our cage.
Net sell dollars they hold, in a bigger fashion than they are already doing; or
Not buy at the treasury auctions in the near future
I know that we Americans think we can do anything, and we put that to the test daily, but right now we desperately need the Chinese to fund our deficit. If they do not fund us we are going to feel a world of pain because Helicopter Ben will simply print the money to quantitatively ease our way into hyperinflation. Not to mention that the Chinese could hurt us one other way that most people do not realize exists, they could stop buying our financial products which account for a large portion of our exports.
China has already said their banks do not have to honor derivative contracts they own and are, as far as I know, forbidden from entering new derivative contracts, which presumably started this incident. Whether they started it or not is irrelevant because we did not need to escalate it. I firmly believe that the Obama administration has shown its arrogance and inexperience with this situation. From what I see it is clear that they do not understand how money works and that they think printing money is just fine, it is not. This trade war, if it escalates, has the potential of crushing our currency which is already struggling.
Looking at this from the Chinese perspective, I can see why they would be upset. Their dollar holdings are worth less than 12 months ago and they were probably sold some MBS, CMBS, CLO’s and whatever else Wall Street could pawn off to them which they surely lost money on. Now the Chinese are funding our deficits and we go and throw a tariff on one of their products, which makes no sense. I think they have played our game for too long and lost, to a certain extent. Now, they want to play by their rules and we are in a predicament because we need them more than they need us.
I fear this will grow out of control and make a tenuous situation into a dangerous one for the US. We need to get our budget under control so we will not be subject to, for lack of a better term, blackmailed. What I mean is that if the Chinese called up Geithner and said remove the tariff or we will sell $200 billion US dollars tomorrow, what do you think would happen? Exactly. The other issue is the only one who truly pays for higher tariffs are the US citizens because they are now denied a lower cost product and forced to buy a more expensive product, no matter who they buy it from, the US or the Chinese.
Once again the average American loses because of Washington’s idiotic behavior.
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.
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