(What’s Left of) Our Economy: Trump’s Real China Currency Blunder

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airstrikes, alliances, America First, chemical weapons, China, currency, currency manipulation, dollar, exchange rates, North Korea, nuclear weapons, predatory trade, Syria, Trade, trade barriers, Trump, Xi JInPing, yuan, {What's Left of) Our Economy

What was worst about President Trump’s decision yesterday to let China off the currency manipulator hook (for now) was not the scrapping of a long-time campaign promise it represented. What was worst about the decision was its geopolitical rationale – that is, Mr. Trump’s judgment that major Chinese cooperation in reining in North Korea’s nuclear program could be secured if his administration moderates or delays various efforts to counter Beijing’s trade predation.

Nonetheless, some recent developments also presage reasons for modest optimism that a sounder approach to currency manipulation by China (and other countries), at least, will eventually emerge if it becomes clear Beijing is welshing on this deal.

The president’s new China policy makes least sense from a pure negotiating tactics standpoint. After all, what course of action could now be more tempting than for China to keep stringing America along with promises to get tough on North Korea, and even with token actions suggesting that meat is being put on these bones? Think “Charlie Brown,” “Lucy,” and “football.” And how will the president decide that his gamble has failed?

Moreover, Mr. Trump’s own views of China’s clout with North Korea seem confused, at best. On the one hand, the president must (logically) believe that China can make much more of a difference in resolving the North Korea situation than it’s so far chosen to. Why else would he offer China the valuable benefit of better terms of trade than it would otherwise receive? On the other hand, Mr. Trump said in an interview with The Wall Street Journal “After listening for 10 minutes [to Chinese leader Xi Jinping at their summit a week ago], I realized it’s not so easy. I felt pretty strongly that they had a tremendous power [over] North Korea. … But it’s not what you would think.” So here he’s indicating that Beijing can’t help decisively at all.

Related Trump statements point to another major negotiating No-No: Rewarding interlocutors for steps they would take anyway. The president is now on record as stating that Xi “means well and wants to help” on North Korea. But this confidence raises the question, “Why?” It’s of course possible that Chinese policy has entered a new, more charitable phase. It’s more likely, however, that Beijing is becoming increasingly worried about the situation in its next-door neighbor spinning out of control and triggering a conflict that could go nuclear right on its borders.

Indeed, a recent editorial from its own government-controlled press clearly signals that those dire concerns are China’s main motivator: “China…can no longer stand the continuous escalation of the North Korean nuclear issue at its doorstep. Instead of accepting a situation that continues to worsen, putting an end to this is more in line with the wish of the Chinese public.”

Even more revealing, the same editorial made plain as day that official Chinese nerves have been frayed further by Mr. Trump’s willingness to go-it-alone militarily in Syria (when he ordered airstrikes in the middle of his meetings with Xi), by his threat to take a similar course of action against North Korea, and by his dispatch of a powerful American naval force to Korean coastal waters. In other words, the president’s apparent comfort with using force already has caught China’s attention.

Better yet, some concrete evidence of this success has appeared. China seems to be reducing its imports of coal from North Korea – one of Pyongyang’s few major sources of foreign exchange – and it abstained yesterday from voting on a UN resolution condemning Syria’s government for the chemical weapons use that prompted the U.S. cruise missile attack. Until then, China had vetoed similar UN resolutions. Why, therefore, would Mr. Trump sweeten the supposed deal further with trade breaks?

At the same time, these latest Trump decisions are sending signs about the president’s national security strategy and overall priorities that are equally disturbing. Principally, during his campaign for the White House, Mr. Trump displayed a keen awareness of the burgeoning nuclear risks being run by the United States by maintaining its defense commitments in East Asia. In numerous remarks that were pilloried by an ossified bipartisan American foreign policy establishment, candidate Trump quite sensibly suggested that the United States should transfer much of this risk to the local countries (like China) most directly threatened by the North Korean nuclear program. Yesterday, Mr. Trump endorsed America’s longstanding Asia strategy even though the North can increasingly call the U.S. nuclear bluff on which regional deterrence has been based with forces of its own that can strike American targets.

Even more striking, Mr. Trump’s new quid pro quo has demoted policy options that can deliver major economic benefits to his core voters and the entire U.S. economy (more trade pressure on China) back to their longstanding position subordinate to national security strategies that primarily help other countries (the Asian allies covered by the American nuclear umbrella). Far from the type of America First strategy he touted during his campaign and especially in his Inaugural Address, these new Trump moves add up to an America Last strategy.

All the same, Trump’s new approach could set the stage for improved U.S. anti-currency manipulation strategies should circumstances require them. Although unmistakably disheartening to many trade policy critics, this latest American China currency decision was defensible on its own terms. It’s true that substantial evidence continues indicating that China’s yuan is significantly undervalued versus the U.S. dollar – and still enables producers in China (including those owned by or linked with U.S. and other foreign-headquartered companies) to offer their goods for artificially low prices in markets around the world. Nonetheless, it’s also true that China has permitted its (surely dollar-dominated) foreign currency reserves to drop by about 25 percent since 2011 – largely because it’s been selling those reserves and buying yuan in order to curb worrisome capital flight. In other words, Beijing has been trying to support the yuan versus the dollar, and keep its value higher than it would be were it freely traded.

Yet there’s absolutely no reason for trade policy critics – or the U.S. government – simply to conclude that ambiguous circumstances simply force America to accept the status quo. In fact, such shoulder-shrugging would amount to rewarding China currency cheating that the conventional wisdom now admits lasted for years, and whose cumulative effects continue to undercut the price competitiveness of domestic U.S. manufacturers and other producers.

So what to do? According to at least one press report, the Trump administration is considering revamping currency manipulation policy in ways that would appear to abandon the current, blinkered approach in favor of one that takes these cumulative effects into account. Specifically, a Reuters article last week suggested that one option that’s attracted the administration’s attention would involve lengthening “the time period for reviewing currency market interventions from 12 months to several years, capturing more past interventions by China….” At least logically, this shift would signal recognition that the impacts of these interventions (to suppress the yuan’s value) are dynamic, and long-lasting.

Even better, however, would be to recognize that, important as it’s been because of its effects on prices across the Chinese economy, currency manipulation is only one form of trade predation practiced by China, and that such individual policies can easily frustrate current legalistic countermeasures by virtue of the powerful and secretive Chinese bureaucracy’s ability to turn them on and off at will – often with little more than a phone call. More important, China has successfully used these ploys in the past. And P.S.: Other Asian economies are just as skilled as China’s at pulling off these scams.

In other words, the various mercantile measures used by China and others to distort markets are completely fungible. Dealing with them effectively therefore requires Washington to become much more agile and flexible in response. And the critics need to stop focusing so tightly on currency manipulation and keep the much bigger, more important China and global trade picture in mind.

For the entire U.S. economy has a big stake in the Trump administration putting these changes into effect before Chinese and other countries’ trade predation sucker punches even more of its most productive sectors – whether they interfere with the president’s new North Korea strategy or not. So, in all likelihood, does Mr. Trump’s political future.

(What’s Left of) Our Economy: Why ‘Less Can be More’ in Trade with Germany – & Others

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Angela Merkel, currency manipulation, euro, Eurozone, Germany, mercantilism, non-tariff barriers, public investment, Trade, trade barriers, Trump, wages, {What's Left of) Our Economy

This week’s first meeting – in Washington, D.C. – between German Chancellor Angela Merkel and President Trump is being billed as a confrontation between polar opposites due to apparently clashing positions on immigration, trade, alliances and international organizations, and contrasting personalities. Actually, notwithstanding the penchant of the mainstream media and bipartisan policy establishment for Trump hysteria-mongering, one of the divides between Mr. Trump and Ms. Merkel may actually be more fundamental than recognized. Growing trade tensions might be signaling that the two economies simply aren’t structured to trade with each other in mutually beneficial ways – at least not at current levels.

So far, the mounting trade row – which could already be the most serious since American ire at an allegedly undervalued deutschemark during the Nixon era – has produced a now-predictable policy debate. The Trump administration is accusing Germany’s powerful economy of unfairly benefiting from a euro that’s kept weak because of the economic problems of its partners in the eurozone. As a result, goes the American complaint, its goods enjoy major price advantages over their U.S. competition all over the world for reasons that have little to do with market forces.

Germany and its sympathizers counter that the country simply makes terrific products, especially advanced manufactures, and that its trade barriers are actually on the low side. Another argument raised in Germany’s defense – in part because of a strong inflation-phobia created by the disastrous experience of the 1920s and by the population’s natural frugality, Germans tend to be low spenders and high savers.

All of the pro-German positions have merit. And the Trump administration case is further complicated by Germany’s consistent calls for eurozone economic policies that would tend to strengthen the common currency.

Yet Germany’s free trade record is at the least open to dispute. Although its tariff levels are generally low, like most other U.S. trade partners, it uses a value-added tax that effectively raises the prices of foreign goods headed for its market and reduces the prices of its exports via the rebates they receive. Moreover, even before President Trump took office, the U.S. government repeatedly reported that non-tariff barriers maintained by Berlin “can be a difficult hurdle for companies wishing to enter the market and require close attention by U.S. exporters.” The country’s government procurement market appears to pose special problems. According to the American Commerce Department under former President Obama:

“Selling to German government entities is not an easy process. German government procurement is formally non-discriminatory and compliant with the GATT Agreement on Government Procurement and the European Community’s procurement directives. That said, it is a major challenge to compete head-to-head with major German or other EU suppliers who have established long-term ties with purchasing entities.”

Nonetheless, the more closely the German economy is examined, the less amenable to standard trade policy remedies it looks. For Germany has long decided to create a national economic and business model that seeks both to maximize net exports and depress consumption at home. Two examples should suffice to make the case.

First, although Germany’s is, as frequently noted, a high-cost, high-regulation country, upon adopting the euro, its government put into effect a series of policies that put its labor costs on a much slower growth path than those of the rest of the eurozone and the high income world as a whole (including the United States). As many critics of Germany have charged, the resulting wage repression has overpowered the euro-dollar exchange rate and in fact amounted to an “internal devaluation” that produced the same effects as currency manipulation.

Second, Germany has also limited its consumption levels in part through very low expenses on infrastructure and other public investments. Moreover, according to one former European Central Bank official, the country’s external orientation has been so pronounced that “private investment in Germany’s aging capital stock has been weakened by many German companies’ desire to invest abroad.”

Revealingly, some of the harshest attacks on these and similar German policies have come from the eurozone itself. In particular, members like Greece and other southerly countries have accused Berlin of conducting a mercantilist campaign to grow at their expense by flooding them with exports and denying them comparable opportunities to supply the German market.

Without taking sides in this dispute, it’s clear that because the eurozone is a currency union, its success arguably depends on members conducting both their domestic and foreign economic policies in mutually compatible ways. So in principle, Germany’s eurozone fellows have grounds for complaining about the totality of the German national model. (The reverse holds as well in principle.)

The United States also should be perfectly free to ask Germany to change its priorities. Unlike eurozone members, however, it has no legitimate claims to influence over this vital aspect of German sovereignty. Germans apparently have decided that their choices work for them, and are absolutely correct to insist that aside from the rules of the World Trade Organization or other international legal arrangements, they have no obligations to accede to foreign demands for reform. Berlin, moreover, has a point when it notes that the United States should look to domestic practices of its own that might be hampering its global competitiveness, rather than placing the burden of change on others.

This German argument, however, is not dispositive. After all, if America’s national business and economic model emphasizes consumption and domestic-led growth rather than promoting net exports, that’s a choice that its own political system has been entitled to make. Moreover, it’s a choice that makes considerable sense for a big, continent-sized economy with great potential for more national self-sufficiency in a wide variety of goods and services. Germany has no more right to dictate U.S. preferences than vice versa.

The decisive difference between the two countries is that Germany has been happy with the pre-Trump status quo, and the United States has not. Washington of course has the right to press complaints about possible German violations of world trade law and other trade agreements. But it also needs to recognize that such conventional approaches are dwarfed by the breadth and depth of Germany’s approach to economics. Promoting German reform isn’t likely to work, either – given the above sovereignty concerns, and given the sheer difficulty facing even so powerful a country as the United States in urging domestic reform on another powerful country – especially one that views itself as a success.

So what to do?

First, in general terms, understand that, however legitimate Germany’s sovereign decisions, they create problems to which the United States is equally entitled to respond

Second, without continuing to hector or nag Germany, figure out the most effective response and act accordingly.

Third, depending on Germany’s counter-moves, decide what combination of unilateral carrots, sticks, and negotiations, might achieve progress (including some acceptable compromise), while preserving approximately current levels of trade.

But fourth, recognize along the way that Germany’s legitimate sovereign economic decisions simply may not permit bilateral trade to continue at those levels with acceptable results for the United States. If need be, then, revert to whatever unilateral strategy can preserve or enhance interests America has identified as its own priorities.

The new status quo would put the ball in Germany’s court, and grant it full scope to accommodate the United States if it’s dissatisfied, or make whatever other changes are needed to achieve whatever new objectives it chooses.

In other words, Washington should deal with Germany through an ongoing process of give and take, employing a variety of tactics and tools in flexible, agile ways. The aim would be to capitalize on its considerable leverage but also understand where it can and can’t hope to succeed at acceptable cost and risk. This approach clearly has a less impressive upside than efforts to produce grand bargains, or than more extensive international economic integration schemes — both of which can in theory maximize bilateral commerce. But its very modesty means that it’s less likely to risk angry misunderstandings and consequent major blow-ups, and more likely to result in trade and investment that’s sustainable not only economically, but politically, socially, and culturally.

President Trump can think of this new policy framework as the Less is More Strategy. And he should realize that its usefulness extends far beyond Germany.

(What’s Left of) Our Economy: Even in a Globalized World, National Trade Deficits Still Matter

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Canada, China, globalization, Japan, manufacturing, Mexico, NAFTA, North American Free Trade Agreement, OECD, Organization for Economic Cooperation and Development, Paul Hannon, supply chains, The Wall Street Journal, Trade, trade barriers, Trade Deficits, World Trade Organization, WTO, {What's Left of) Our Economy

Wall Street Journal correspondent Paul Hannon deserves a lot of credit for reporting on new worldwide figures that shed light on how economic activity around the world has been globalized. These numbers may seem academic, but should be of intense interest to everyone curious about why U.S. economic growth, hiring, and wages have been so weak for so long, and how likely they are to improve. 

As I’ve documented, the research in question – from the World Trade Organization (WTO) and the Organization for Economic Cooperation and Development (OECD – a grouping of the world’s wealthiest economies) – is anything but an objective exercise in truth-seeking. It explicitly aims to show that production, and therefore employment opportunities, have become so internationalized lately that there’s no longer any point in trying to protect factories and jobs with trade barriers.

Which makes it all the more interesting that what many of the data – which show how much of a country’s exports and imports are actually made in that same country and abroad – actually make clear that the commerce fostered by American trade agreements and related policies have stripped the United States of invaluable capacity and the knowhow it generates. Nowhere is this more apparent than in the manufacturing sector, which deserves special attention due to its economy-beating innovation levels and productivity growth as well as due to its central contribution to U.S. national security. Of course, manufacturing jobs pay better than the national average, too, though this margin has been shrinking steadily.

No one can doubt the rapid growth of global supply chains in global commerce and especially in manufacturing. And Hannon focuses on figures touted by the WTO and OECD showing that countries’ exports keep consisting of lower and lower levels of their own parts and components and materials all the time – meaning that their growth and job-creating powers can be easily exaggerated. But I looked at some other statistics just released by the two organizations, and they produce a very different picture.

In particular, they indicate that despite the attention they’ve drawn for the last three decades from American presidents, their top advisors, and Congress, the same countries keep posing the nation with its biggest trade-related problems.

Take China. The WTO-OECD database on which Hannon based his piece tells us that between 1995 and 2011, imports as a share of the People’s Republic’s booming manufacturing markets rose from 15.02 percent to 19.54 percent. But the import penetration rate for U.S.-made manufactures in China increased from only 1.95 percent to 2.36 percent. What about the flip side of this relationship? Total imports boosted their share of American manufacturing consumption from 10.54 percent to 14.21 percent – so they’ve made smaller inroads in the United States than in China.

At the same time, it’s important to remember that the United States is a technologically advanced, capital-rich country that’s richly endowed with the kinds of raw materials that are major manufacturing inputs. China’s still the opposite in all three respects. If market forces that are widely supposed to be determining most trade flows were really in charge, American manufacturing’s import heaviness would be nowhere near China’s.

Yet look at what happened to China’s share of the U.S. manufacturing market during these years. It skyrocketed from a measly 0.88 percent to 6.81 percent. No wonder America’s manufacturing-dominated trade deficit with China hit $364 billion last year.

The data also show that, although imports keep growing their share of China’s manufacturing market, this isn’t true across the board. For example, in the critical machinery sector, imports’ share of China’s manufacturing consumption actually fell between 1995 and 2011 – from 23.96 percent to 16.99 percent. And some of the growth figures look pretty unimpressive given the media hype they’ve received. Thus for all the talk (and reality) of a China automotive boom, imported vehicles and parts still comprised only 15.77 percent of the total China market in 2011.

Moreover, the area of strongest foreign progress – information technology hardware – looks increasingly troubled for non-Chinese businesses. Beijing’s strengthening determination to reduce its dependence on tech imports (currently at 59.23 percent according to the OECD and WTO), and nourish its own national champions seem likely to result in much weaker foreign sales going forward.

Japan is another major trade trouble spot for the United States with big-time staying power. Between 1997 and 2015, foreign manufacturers overall have nearly doubled their shares of the country’s industrial markets – from 7.11 percent to 13.35 percent. That’s lower than America’s, even though Japan is an island nation woefully short of natural resources. And in key representative manufacturing sectors, Japan also remains much less import-friendly to the United States. Foreign-made machinery had captured only 11.23 percent of the Japanese market as of 2011, versus 41.25 percent in the United States. For information technology hardware, the numbers are 16.29 percent and 42.66 percent. For automotive products, its 5.09 percent versus 49.97 percent. In chemicals, by contrast, the import penetration rates for Japan and the United States are both around 25 percent.

But as resistant to manufactures imports as Japan remainse, it’s even more resistant to them when they come from the United States. America’s Japan market share in manufacturing rose only from 2.66 percent to 3.11 percent between 1995. That’s a much smaller proportionate gain than that for overall industrial imports.

These OECD-WTO databases contain any number of findings about American trade policy, but for now, let’s close with one about the North American Free Trade Agreement. In the process of building integrated North American markets, NAFTA was supposed to create major trade preferences for U.S. exports in Canadian and Mexican markets. But judging from the OECD-WTO statistics, these measures have been major flops. Between 1995 and 2011, the American share of Canada’s manufacturing consumption fell, from 35.61 percent to 28.52 percent, and U.S. manufactures exports dropped from 23.68 percent to 20.99 percent of Mexico’s industrial markets.

Nonetheless, although Canada’s share of the U.S. manufacturing market declined between 1995 and 2011 as well, from 3.47 percent to 3.16 percent, Mexico’s more than doubled – from 1.39 percent to 2.83 percent.

The WTO-OECD researchers say that their findings about all the products that are now “Made in the World” can help prevent national governments from making “misguided, and hence counter-productive, decisions” on correcting trade imbalances. But their findings also demonstrate that if U.S. leaders keep passively accepting the results of recent trade flows, “Made in America” could become an endangered species.

Our So-Called Foreign Policy: How to Stop China’s Maritime Expansionism

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12-mile limit, allies, Asia, asymmetric warfare, China, cyber-security, cyber-war, export-led growth, forced technology transfer, free-riding, freedom of navigation, hacking, international law, multinational companies, Our So-Called Foreign Policy, South China Sea, territorial waters, Trade, trade barriers, U.S. Navy

It’s too early to say that President Obama’s decision to use the U.S. Navy to challenge China’s expansionism in the South China Sea shows he’s grown a backbone. But maybe a vertebra or two? At the same time, it’s clear that this story is far from ended, that there may be less than meets the eye to Beijing’s apparent acquiescence in the administration’s clear dissing of Chinese unilateral claims to East Asian waters, and that the United States needs to explore new types of responses if it wants to maintain its leading position in the Asia Pacific region.

To recap, in recent years, China has put muscle behind its long-stated insistence that many of the seas to its east and south, along with various tiny islands and island chains, are Chinese territory. As with similar longstanding claims made by other Asian countries ranging from Japan and South Korea to the Philippines and Vietnam, these positions aren’t recognized by international law.

For literally decades, all of these countries generally agreed to disagree (despite testing each others’ resolve from time to time).  Yet nearly two years ago, China began upping the ante by creating large physical presences on some of the (mainly uninhabited) islands in the South China Sea, and then by literally enlarging some of the smallest ones (which are so tiny that they literally sink below the waves on a regular basis), and creating new ones through various land reclamation techniques. (Other countries have made similar efforts, but they’ve been much smaller and far more sporadic.) China has also claimed exclusive air rights over many of the disputed regions.

In addition, China has unilaterally declared sovereignty over the waters surrounding all these locations out to 12 miles – the normal allowed by international law, but a standard that doesn’t always apply to the kinds of artificial creations produced by China. Moreover, Beijing went even further, stating that foreign naval vessels needed to notify Chinese authorities whenever they wanted to enter such waters.

This decision apparently convinced Washington that China’s actions unacceptably threatened freedom of navigation in the South China Sea. That’s a huge deal, since trillions of dollars worth of U.S. and other international commerce sail through these waters annually, and since they’re rich in natural resources as well. And incidentally, all other regional powers seem to agree.

So the president finally authorized an American guided missile destroyer to sail close enough to one of the disputed islets to violate Chinese claims – and without asking permission. The administration has also made clear that the kind of mission carried out by the U.S.S. Lassen would be repeated frequently. Even better would be participation by regional allies, whose historic specialty so far has been free-riding on American defense guarantees.  But except for Japan, they don’t seem to be even actively considering such assistance, and the United States bizarrely hasn’t even officially sought it.

China has protested strongly, but don’t dismiss it as a paper tiger just yet. Despite America’s continuing military edge in East Asia, Beijing is hardly devoid of options. For instance, China could create significant military presences on some of the islands. In addition, and more worrisome, according to a tweet from China-watcher Patrick Chovanec, Beijing could escalate its cyber-attacks on American businesses and government agencies.

The United States would be hard-pressed to respond in kind, as I’ve noted, because it lacks clear-cut (and perhaps any) cyber-war superiority, and because such hacking could be much more damaging to America’s more advanced economy and society than to China’s.  And in fact, capitalizing on such disparities would be fully consistent with the notion of waging “asymmetric war” developed by Chinese strategists. 

A much better means of retaliation would be economic. China’s economy, which depends heavily on exporting, and especially to the United States, is slowing. And that growth threatens Communist Party rule because it’s hold on power has for decades depended heavily on its success in boosting living standards throughout Chinese society.

Of course, erecting major barriers to Chinese imports would be condemned, especially by offshoring interests, as shortsighted and even dangerous protectionism that could plunge the two countries, and the larger world, into a “trade war.” But as always, such warnings ignore the long-term net damage inflicted on the U.S. economy – and especially its invaluable productive sectors – by the huge expansion of bilateral commerce since the early 1990s.

They also ignore the clear message being sent by the persistence of the American recovery (however inadequate) in the face of a weakening global economy, and by the reemergence once that recovery began of overall U.S. trade deficits (including of course with China) as major drags on American growth: The United States needs the rest of the world economy even less than ever, and certainly much less than trade-dependent countries like China need the United States.

Would wielding this kind of economic stick against China be cost-free for Americans? Of course not, especially in the short- and even medium-term, before supply chains got restructured. Yet tariffs and other curbs could always be phased in. Nor need they cover all Chinese products (although the more, the merrier). And other means of economic retaliation could be employed as well. How about cutting off all or at least some of the defense-related technology and capital that U.S. multinational companies are still recklessly transferring to China, either voluntarily or under threat of being shut out of the Chinese market?

More important, whatever the resulting costs, they look a lot less intimidating than those that could result from even a brief military conflict (which logically would trigger even greater and costlier economic adjustments), or from massive Chinese cyber-attacks. And don’t forget the flip side of passivity: An America that failed to use its biggest advantage over China for fear of experiencing any pain at all inevitably would be an America that flashed a big, fat green light to Beijing’s expansionists.