November 14, 2016    7 minute read

US Versus China: What’s Next For The Two Powerhouses

Trouble On The Horizon?    November 14, 2016    7 minute read

US Versus China: What’s Next For The Two Powerhouses

After an exhausting campaign period, Donald Trump has won the election and is now going to take over as the 45th US president from Barack Obama in January 2017. Much has been written about it.

So much that it has become a cycle in which most authors are just repeating arguments against Trump while others keep trying to defend him. This article will not focus on what kind of candidate Donald Trump has been. Rather it will try to analyse, evaluate and project the impact of a new President Trump on the relations between the current global superpower and its probable successor.

The US Vs China

Besides questionable statements against Mexicans, women and refugees, Donald Trump’s sworn enemy during his campaign has been the People’s Republic of China. China has been the main subject of his tweets and has been mentioned in pretty much every public discussion Trump participated in.

The relationship between China and the US governed by Donald Trump is certainly one of the most interesting topics, even more so since there has been basically no reaction from the Chinese government to Trump’s statements up to now. However, it has always been Beijing’s doctrine not to be engaged in other countries domestic affairs.

There are three core aspects Trump repetitively illustrated throughout his campaign, which are directly or indirectly referring to the relationship between China and the US.

First, according to Trump, China currently fosters a currency war by undervaluing the renminbi. Consequently, by doing so, China’s export-oriented economy are stealing jobs from US citizens. Furthermore, Trump questioned whether it is in the interest of American citizens to keep military bases in the Pacific region.

In an interview with the New York Times at the end of March this year, Trump argued:

“If we’re attacked, they do not have to come to our defence,” while “If they’re attacked, we have to come totally to their defence. And that is a — that’s a real problem.”

Let’s start with China manipulating its currency value in order to foster its exports. This is certainly not a very new argument. Obviously, this argument is based on the late 1990s and early 2000s as can be seen below. As Chart 1 shows, China’s exchange rate system changed over time. Until 1994, China had a fixed exchange system.

The New Exchange Mechanism

Between 1995 and 2004, the Chinese currency was pegged to the dollar at 8.27 renminbi/dollar. Starting from 2005, China adopted a managed floating exchange rate system which is based on a currency basket.

However, to gain a better picture about countries’ competitiveness in terms of the exchange rates, it is crucial to not take the nominal exchange rate against one particular country, but the real effective exchange rate (REER), that is adjusted for inflation and measured against a bas­ket of currencies, into account.

The Basel-based Bank for International Settlement (BIS) calcu­lates and publishes the data. Results are displayed in Chart 1 as well. Manipulations of the REER remain a more difficult task and are not that easily achievable. The REER increased almost steadily over the last ten years and made Chinese products more expensive around the world.

Fig 1 Exchange Rates and Current Accounts

(Chart One – Exchange Rates and Current Accounts)

Accusing China of having a manipulated nominal exchange rate, therefore, does not catch the logical foundations and transmis­sion channels of international macroeconomics.

Furthermore, comparing changes in the nominal dollar/renminbi exchange rate further does not find the ex­pected reaction in the current account of both countries, which is shown in Chart 1.

The Impact Of Currency Manipulation

The nominal renminbi appreciation in 2005 caused both the Chinese current account surplus as well as the US current account defi­cit to increase.

The reverse logic applies for nominal renminbi devaluation in 2008 when the Chinese current account surplus and the US current account deficit decreased. Economic research implies that the renminbi exchange rate does only play a minor role in global trade imbalances and is not the underlying culprit for them.

Instead, the domestic measures of savings and investments are at least equally important. As for the bilateral trade imbalance between China and the US, the Chinese saving rate is by far the most important factor influencing the current account surplus of China.

On the other side, the US would have almost no possibility to increase its current account on its own as its saving rate is very low. As a steady trade surplus of China means that they are actually financing the US and China’s trade is thereby more and more depending on the stability of the US, China’s government has to change its economic growth system.

To solve this problem, China needs to raise its domestic consumption so that the saving rate declines. Accordingly, China is actually in the middle of a transition process turning its back to the manufacturing sector it used to depend on, in order to achieve high trade surpluses. Instead, it has started to focus on the service sector which is a strong indicator for the transition towards a consumption based economy.

Chart 2 shows that the PMI for manufacturing has been mostly below 50 points, which indicates that the manufacturing sector is shrinking. Contrarily, the PMI for services shows that the service sector has consequently been above the break even point of 50.

Fig 2 China PMI Indices

(Chart 2 – China’s PMI Indices)

To sum up, Trump’s statements about China’s economic strategy are obsolete at best, and from an economist’s point of view, they are simply wrong.

Analysing Trump’s Plans

In order to relocate jobs to the US which have been lost to the Chinese competition, soon-to-be President Trump plans to introduce a 45% tariff on Chinese products. Protectionist policies meant to shield domestic industries are common political instruments. There is nothing new about such proposals.

However, when the US has become a member of the WTO it agreed on the Most Favoured Nation Article (Article 1 GATT), the reciprocity principle and the National Treatment Obligation (Article 2 GATT). These three core agreements alone indicate that the plan to introduce a general 45% tariff on every Chinese product is not possible as long as the US is a member of the WTO.

Knowing this, Trump already threatened that he would make the US leave the WTO and plans to impose penalties on companies which relocate American production plants to other countries.

The Effects Of Trump’s Protectionism

If Trump actually realises his plans, this will certainly lead to a large scale trade war which will ultimately lead to an economic downturn as the highly needed foreign capital would be withdrawn from the US. Investments would shrink and, therefore, the whole economy.

Companies that relocate their production to East Asia due to cheaper labour would not have the chance to do so, which eventually makes them less competitive compared to their international peers which, in turn, would just result in highly automatic production processes. So, instead of bringing old jobs back to the US, Trump’s protectionist plans would, in fact, result in an even more drastic increase in the unemployment rate.

Trump’s Foreign Policy

Contrarily, Trump’s statements regarding his foreign policy plans are much less aggressive. In fact, they would lead to a slowdown of the current powder-keg in the Southern Chinese Sea. Compared to former presidents and certainly to Hillary Clinton, Trump’s views on human rights – an always returning topic in the relations between China and Wester countries – seem to be less idealistic, if not to say he simply does not care about them.

The Global Times, a Chinese Newspaper, stated that:

“Unlike traditional idealistic politicians who tend to place ideological values, such as democracy and human rights, as the priority in their diplomacy, Trump has more realistic interests in mind.”

Trump’s suggestions that Japan and South Korea should just build up their own nuclear arsenals did certainly distress Chinese officials. In a recent interview with the WSJ, China’s finance minister, Lou Jiwei, called Trump an “irrational type.” However, a very common view in Chinese media is to declare Trump’s rise as a sign of the American citizen losing confidence in their political system.

Ironically, if Donald Trump is actually going to realise his plans, he will become the stirrup for China’s rise to the single global powerhouse.

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