US President Donald Trump showing no signs of backing down against China, calling it out on several occasions for unfair currency manipulation. Economic analysts can’t help but speculate that this could fuel an all-out trade war between the two nations. Most analysts feel that China has the upper hand given its large holdings of US Treasuries but fund manager at Tressis Gestion and Professor of Global Economy Daniel Lacalle has a different take.
First off, Lacalle notes that China currently holds the largest trade surplus with the United States. In other words, this means that the Asian superpower exports more goods to the U.S. than it imports. In fact, exports amount to approximately $480 billion while imports are only at $116 billion. However, it’s worth noting that a huge chunk of these Chinese exports to the U.S. actually comes from American companies that are producing in China and sending their products abroad.
With Trump’s “America First” goals, the administration plans on repatriating companies and production back to the homeland, which should generate more jobs and be positive for overall growth. This should also get rid of the problem of currency manipulation, as China has been accused of artificially keeping its currency weak in order to make its exports cheaper and more in demand.
This also explains why China holds a large trade surplus with the rest of the world at close to $600 billion. Cheap labor and a weak currency have allowed goods to be relatively more affordable than other counterparts so businesses generally prefer to import goods from China. However, as Lacalle points out, this has created an overcapacity in the past few years.
In part, this overcapacity was created to adapt to growing demand from China as it keeps production going by purchasing raw materials from other nations. But if China winds up reducing its exports to the rest of the global economy, this imbalance could worsen as an excess of raw materials and commodities could spur even larger overcapacity.
Besides, a potential trade war could start a gradual slowdown in global growth. Lacalle estimates that a 10% reduction in trade activity could shave off 0.03% to 0.05% from global GDP, as other major economies are also reliant on products and demand from China. For one, the European Union could lose a large market of its exports, along with Japan.
To top it all off, a drop in trade activity could undo all the progress made in terms of inflation so far. Recall that price levels have taken a huge hit after the crude oil slump in late 2014 and that most economies are just starting to recover from weak inflation. Lower productivity on account of weaker demand from trade partners could mean another challenge for inflation, which also puts global growth in jeopardy.
However, as Derin Cag of Richtopia points out, China has been busy making sizable investments in the United Kingdom which is likely to find itself in the middle of a trade conundrum sooner or later. Keep in mind that Brexit negotiations are set to happen soon and that Prime Minister May has conceded that they might give up access to the single market in exchange for immigration control. She has also cited that they are open to exploring trade arrangements with other nations, something that China has picked up on.
Even so, China is still on weak footing even as its economic numbers don’t seem to suggest so. As Lacalle wrote, China has an overcapacity of nearly 60% and total debt already exceeds 250% of its GDP. This financial problem can only be dealt with devaluations while exporting weak inflation to the rest of the world, which suggests that it might be on the back foot in a potential trade war.