John Mauldin says the Trump administration is right in being tough with China, but regrets how they do it. If you're going to fight a trade war, don't point the gun at yourself, he argues
By John Mauldin *
Good news: The trade war is over. No, it's getting worse. Or is it the end, but it may start again tomorrow.
Confused? All this was true at various points in recent weeks. Markets popped up in reaction. And we are still no closer to knowing how it will all end.
Needless to say (but I will say it anyway) this uncertainty has a cool effect on business investment. If you are considering whether to spend billions on new production capacity, open stores or hire new employees, you need to know the cost and have reliable supply chains. It is anything but impossible with tariffs going up, down or sideways depending on the day.
The saddest thing is that the world trade system actually has serious problems, many of which originate from China. We have to fix them. I fully support that goal. I'm glad we have an administration that takes Chinese behavior seriously. But the tariff strategy makes the situation worse, not better, and the focus on trade deficit is completely misplaced.
This will be a potentially burning letter, but sometimes things just need to be said.
China and intellectual property
I'm going to start with a story that might fit better in the middle of the letter, but I suspect some readers won't get there. They want to read my fairly strong free trade benefits and feel that I do not recognize the problem China represents. Nothing could be further from the truth. Although I'm not happy with the way Trump is waging a "trade war," I'm glad he's doing something about it.
It is a drug manufactured in China that works well against stroke and many other less destructive medical problems. It is derived from swine pancreas or human urine. It is not approved in the US due to sound regulatory issues, but it is used in Europe as well as China. It is quite expensive, both to produce and to buy.
A small biotech company in the United States has the technology to synthesize this substance without using pancreas or urine. This would be safer and lower. The Chinese company agreed to pay the US company $ 4.5 million at the meeting with certain guidelines and then purchase the drug from the company for a fraction of the Chinese production cost. For the American company, it was a good deal to get the main distributor to buy their fabric without having to set up the distribution process.
The US company spent a lot of money and met their policies, giving the Chinese company everything required under the contract. The Chinese company then said, basically, "We need to see the actual process and the cell lines to confirm the process."
That means, in essence, "Give us your spiritual work." With that knowledge the Chinese company would no longer need the US company. When the US company had to tell shareholders that the deal was falling because they (correctly) asked the Chinese company to go pound the sand, the value of the board fell. The Chinese company knew it would happen and had bet that the Americans would fold. In this case, they did not.
This happens many times each year with Chinese companies on a hundred different fronts. Standard practice. That is why the US and other countries are pushing back against theft of intellectual property by Chinese companies.
Let me just go a little further. This is not just a widget or a better way to make a phone. This is a drug that, if introduced in the United States and the developed world, would allow far faster treatment of victims and save thousands if not tens of thousands of lives each year.
This is only a small part of the cost of Chinese intellectual property theft.
Binary thinking
I have long said that protectionism is the greatest threat to global prosperity. As we approached the recession in 2001[ads1], there were calls for trade protectionism. I wrote at the time that the most destructive economic force that could be unleashed on the United States would be serious trade protectionism.
Unfortunately, I have to keep saying it because politicians keep trying it. What Trump is doing right now is not new. I wrote this back in 2007.
It is the growing mood in Congress to have passed trade protection legislation that could launch a series of retaliatory actions around the world that could result in a trade war, a la Smoot-Hawley in the 1930s.
Stephen Roach, chief economist at Morgan Stanley, writes a rather relaxing description of his recent testimony to the Senate Finance Committee. He noted that when he entered the room, he looked up and saw a picture of Senator Reed Smoot on the walls, when Smoot was a former chair of the committee and co-sponsor of the 1930 Smoot-Hawley Tariff Act, largely responsible for the Great Depression .
During the hearing, it was clear that a bi-partisan effort is getting ready to enact legislation that would penalize China for the huge trade deficit we have with that nation.
As I recall, it was Democratic Senator Chuck Schumer and Republican Sen. Lindsey Graham who led the way in worrying about trade deficits, essentially proving that none of them knew anything about trade deficits. As we will see a little, trade deficit is not the problem. Fortunately, that effort was fixed, although I suspect it helped set up the fireworks of 2008.
Politicians of all parties love free trade in theory. The benefits are clear, but they are also unevenly distributed. What I admit is a problem.
As long as we have sovereign national authorities, goods will face obstacles and delays that cross national borders. We cannot have "free trade" unless we eliminate boundaries, which of course creates other problems. (Think of the United States as a free trade zone. Would we be almost as prosperous if we had to negotiate every single small trade transaction between different states?)
Countries that trade with each other need fair and reasonable rules, and both sides need to enforce it rules. Obviously this is complicated in a modern economy. This is one of the reasons why trade agreements take so long to negotiate. And of course there will always be quarrels and disputes. But in general, open trade is possible, as we see in blocks such as the EU and NAFTA. It works because all sides have committed to make it work.
Problems arise when a country exercises the rules or selectively enforces them, as China does. I have often talked about China's rapid entry into the advanced world economy. In less than a few generations, it went from living to modern industry. This happened because the United States and others agreed to allow their domestic businesses to trade with China on favorable terms.
China would retaliate on similar terms. It sounded like, but has not been thorough or consistent. This is most evident in intellectual works. The Chinese government routinely pulls (or steals) trade secrets from foreign companies wishing to operate in China. Software code, drug formulas and other information then find their way to Chinese companies that shamelessly copy it.
This is nothing new. The same thing happened many years ago when Chinese merchants pirated all kinds of Western consumer goods. Recently, they have done the same for intangible technology and sent it to overdrive. And the Chinese government is doing nothing to stop it.
Negotiations to solve these and other problems have been fruitless. Beijing agrees to amendments and fails to implement them, and escapes because the United States and other Western democracies have these inconvenient things called "elections." China's rulers know that they can only wait for the clock until we get a new leader with different priorities.
The trade deficit is not a goal card
Give Trump the credit that he at least acknowledged the problem and tried to do something about it. Unfortunately, he has some weird ideas about what "victory" looks like. Furthermore, he gets bad advice from so-called "economists" like Peter Navarro. I deleted half of this letter which was basically an exposure to Peter Navarro who I think is the most dangerous man in the Trump administration, if not the country. I know he has a Harvard doctorate, but I think William Buckley was pretty much right when he said better to be guided by 2,000 random names from the phone book than by Harvard professors.
We see this in the president's trade deficit. He seems to think it's a kind of scorecard. If the US buys more from China than China buys from the US, the US loses. That's not what it means at all. Both sides get what they want. China (or other exporters) get cash, we get useful goods at reasonable prices (or we would stop buying them).
Better yet, since we own the reserve currency, we have to pay for these goods in dollars, which then came back here when the Chinese or foreign recipients invest in US assets, namely our treasury. It's good for Americans. It's actually important. Our interest rates would be sharply higher, and our currency much lower, if not for the trade deficit, because US savers must cover all government debt. We do not save nearly enough to do so.
And that is a very critical point. If other nations do not want your currency, you cannot run a trade deficit without serious financial problems. Valéry Giscard d & # 39; Estaing was right: The United States has an exorbitant privilege of owning the world's reserve currency.
If you have the reserve currency, it is your obligation to make a deficit so that the world has enough currency to trade. No country south of the Rio Grande has that privilege. Europeans kind of, kind of do. And the Japanese. The Chinese are working diligently to make the yuan a reserve currency, even if they are not yet there.
If the United States fails to achieve a real trade deficit, we will stop having reserve currency. It's that simple.
Bilateral trade balances – whack-a-mole?
Eliminating the trade deficit is not as easy as it may sound. Paul Kasriel sent out a note this week which I thought was compelling. Let me quote:
President Trump has imposed higher tariffs on US imports from China, in part to limit the bilateral trade deficit that the United States carries with China. The president's tariff policy seems to be working. As shown in Figure 1, the twelve-month cumulative US trade deficit for goods with China (the blue bars) has narrowed. For example, after reaching a record deficit of $ 419.5 billion in the 12 months ended December 2018, the US mainland China deficit narrowed to $ 400.7 billion in the 12 months ended June 2019
Source: Econtrarian
So far, so good for President Trump's desire to see the US bilateral trade deficit with China narrow. But I think it is fair to say that the President believes that it is in the United States' best interest not only to reduce our bilateral trade deficit with China, but our trade deficit with the rest of the world as well. And here things are not moving in President Trump's desired direction. Also shown in Figure 1 is the 12-month cumulative US trade deficit for goods with the world (the red line). Although the US bilateral deficit on goods with China has narrowed in recent months, the US deficit on goods with the world expanded to a record $ 886.0 billion in the 12 months ended June 2019. This seems like a game of Whack- A-Mole. President Trump raises tariffs on imports from one country to reduce the bilateral trade deficit with that country, and our trade deficits with other countries expand.
Again, the trade deficit is no problem. But even if you assume there is a problem, the tariffs will not solve it as long as the government continues to have huge and growing deficits. Neither party has any intention of going against a balanced budget. Therefore, the trade deficit will grow – with other countries, though not China.
The United States uses the wrong weapon to solve the wrong problem and damage our own economy in the process. What would work better? I think Trump's choice (which candidate Clinton said she would do too) to cancel US participation in the Trans-Pacific Partnership was a mistake. That deal would have set up a gigantic free trade zone as an opposition to China, and I think at least would have forced Beijing to negotiate more sincerely. TPP had more than a few problems, but they could have been solved. But at best, it would have made it much easier for companies in the United States to skip China for their supply chains.
As it is, the other TPP nations went ahead without the United States and are now trading with each other on more favorable terms. Thanks to TPP, Japan is increasingly importing food from Canada instead of the United States.
Navarro doesn't seem to care, and Trump seems to agree with him. And to be fair, Trump had protectionist inclinations long before he met Navarro. Any of this can happen anyway. But the combination of Trump and Navarro proves financially disastrous.
There have been a series of articles over the past five months that have indicated that Trump's tax cut was, on average, around $ 900 per taxpayer. Tariffs have already eaten around $ 800 of that tax cut, which essentially invalidates the benefits of the tax cut. JPMorgan said it again this week.
We have spent two years digging a hole for China. Will we spend at least as many years refilling it? It's not easy to win a trade war.
Should we deal aggressively with China because of intellectual property theft, the lack of a fair playing field, its mercantilist policies and government subsidies for companies? Absolutely. And you can insert a few explosives that were deleted after it absolutely.
We can start dealing one-on-one with companies that clearly violate intellectual property and other WTO rules. Just ban them from doing business in the US, or take away their banking rights. The WTO should classify China as a developed market in the WTO, not a growing market. Just look at pictures of Beijing and Shanghai and dozens of other cities to recognize China have emerged.
Tariffs hurt American consumers. China does not pay those tariffs, we are, and every economist worth its salt (other than Navarro) knows it.
Is it getting tough with China? Damn skippy. But don't make Americans pay for it. If you're going to fight a trade war, don't point the gun at yourself.
* This is an article from Mauldin Economics & # 39; Tanks from Frontline, John Mauldin's Free Weekly Investments & Economic Newsletter. [19659053] This article was first published here and is used by interest.co.nz with permission.