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Who’ll blink first: Trump or Xi? Both sides are losing in the escalation of the US-China trade war

May 28, 2019   6 mins

Over the past few weeks the most important relationship in the global economy has moved towards a chaotic break-up. The US-China trade talks that began in December 2018 after last year’s preliminary tariff skirmishes have broken down, and President Trump has announced new tariffs on Chinese imports. He has since made moves towards banning US companies dealing with Huawei – China’s most successful technology company and the world’s leading provider of components for 5G networks – and is pushing China to reduce its oil purchases from Iran.

For its part China has escalated its own tariffs, and is threatening to impose an export ban on rare earths used in many hi-tech goods as well as some military equipment. Such a rupture was not one either side appeared to have contemplated over the past five months of high-level trade negotiations. Trump apparently had expected a deal he could portray as resetting the US-China trade relationship to American advantage while the Chinese leader, Xi Jinping, simply cannot want the US to declare economic war when the Chinese economy is as vulnerable as it presently is to financial shocks.

The US-China relationship is in crisis because the United States has under Donald Trump reversed strategic course, and most of the American political class across both the Republican and Democratic parties back him. Although Bill Clinton came to office attacking his predecessor as too accommodative of China, he ended up pursuing a strategy of integrating China into the international trading and financial order through China’s accession to the World Trade Organisation.

Many large American companies responded to this strategic environment by investing in China, selling into Chinese markets, and setting up manufacturing and supply chains that run through China. Apple, for example, has today more suppliers in China and Hong Kong than it does in the United States. Meanwhile China was able to make the United States the centre of its drive for export-led growth and accumulated a massive portfolio of dollar assets that allowed it to manage its currency. This apparent co-dependency was named ‘Chimerica’ by Niall Ferguson, and it drove much of the growth in the world economy between the late 1990s and the 2008 crash.

Some of its problems have been long apparent. By the middle of the last decade, China’s rising trade surplus produced plenty of discontent in the US Congress. The Bush administration eventually responded by pushing China into a moderate revaluation of its currency. When China lost confidence in its holdings of Fannie Mae and Freddie Mac’s debt, it forced the US authorities to make the two mortgage corporations’ massive liabilities the responsibility of the federal government. Under the guise of a ‘‘Pivot to Asia” in 2011 the Obama administration sought to encircle China from the Pacific. It pushed the Trans-Pacific Partnership as a Pacific trade bloc that excluded China. It also declared that freedom of navigation in the South China Sea to be an American national interest, and developed an operational doctrine for a possible military confrontation with China.

But crucially the Obama administration sought to contain China without disrupting the international trade order, including the supply chains that run through China. It grumbled about China’s behaviour on intellectual property rights, forced technology transfer, and cyber spying, but eschewed any fractious face-off. In pursuing the Trans-Pacific Partnership as another trade agreement it also ignored the escalating domestic protectionist pressures. While some in the Democratic party, such as New York Senator Chuck Schumer, had long railed against the outsourcing of US manufacturing jobs to China, the Obama administration appeared sanguine and presented the dislocation as the inevitable consequence of economic success.

The cultivation of Chimerica is now seen in much of Washington as a mistake and Obama’s attempt to shift to containment without disrupting it as a failure. Trump made these issues, and the relationship between Chimerica and the donor class around the Washington establishment, central to his campaign in 2016. But in this regard he has been a catalyst for change with causes that extend far beyond him. Under Xi Jinping’s leadership China responded to Obama’s Pacific containment strategy first with the One Belt, One Road initiative – which seeks to make Eurasia the primary external environment for the next stage of China’s economic development – and then a “Made in China 2025” strategic plan under which China will become a hi-tech manufacturing power with core materials made in China. If China wants direct economic competition with the United States then, most American politicians have concluded, the terms of Chimerica must be changed.

Europe is exposed by the American turn to confrontation. There would appear a strong geopolitical logic for the United States to use the European Union as a balancing force in Eurasia, especially when China itself is picking off EU states, such as Italy, to join One Belt, One Road. The EU also shares certain economic interests with the United States in regard to China. In principle the United States could have worked with the EU. For example, in June 2018 EU filed a legal case at the WTO against China on intellectual property issues and forced technology transfer.

But Trump has opted to act alone. For the Trump administration the WTO is a sideshow. Although the US did start action against China at the WTO in April last year, Trump has since said that the WTO is soft on China and has blocked the appointment of judges in WTO cases, making the WTO’s overall operations more difficult. Moreover, when it comes to the US trade deficit the EU is for Trump more like China than not. Indeed, when President Macron visited the White House last year and suggested that the US and EU should work together on China, Trump insisted that the EU was worse on trade than China. The Trump administration is also taking a tough line with Europe on Huawei, with the Secretary of State, Mike Pompeo, recently chastised Theresa May by pronouncing that Mrs Thatcher would never have tolerated appeasing China on security matters.

Germany faces particular difficulties from the threat to Chimerica since the United States is its biggest single export market and it imports more from China than any other national economy. German firms and politicians have had their own illusions about China and Chimerica shattered. German manufacturing firms have supply chains involving China that are central to German export strength. German car makers are also dependent on China’s large consumer base, not least from their US production sites where exports are now subject to China’s tariffs. Made in China 2025 was as much a blow to Germany as to the United States.

Last autumn the Federation of German Industries described China as a ‘strategic competitor’ looking for technological dominance, and warned firms to reduce their dependency on China from supply chains to markets. The problem for Germany is that what happens in China will hurt its export-based economy more than it does the consumption-oriented US economy, as the Germany’s economy woes in the second half of last year demonstrated. Germany has also made the Eurozone much more dependent on external trade than it was. Prior to the Eurozone crisis the Eurozone for most of its existence had a current account deficit with the rest of the world. Now it has a significant surplus, making it more vulnerable to a downturn in international trade.

Germany may in part want EU solutions. For example, the Federation of German Industries last year recommended creating European industrial champions. But any conflict about external trade also exposes disagreements within the EU, not least between Germany and France. While Germany pushed last July to offer EU-US trade talks as a way of holding off Trump moving to tariffs on European car imports, France was never keen on them and last month voted against the Commission’s negotiating mandate for the talks, with Macron declaring that the EU should not negotiate with states that aren’t party to the Paris climate agreement. Germany also has simultaneously to fight another battle with the United States over Nord Stream 2 – the second gas pipeline under construction from Russia to Germany – with Trump edging towards sanctions.

What has changed since the boom years of Chimerica is not just the strategic judgement in Washington about China but the United States’ geopolitical power. The United States is quite simply in a significantly stronger position in relation to Europe than it was before the 2008 crash when that same year the Bush administration had to accept Germany and France’s veto of Georgia and Ukraine joining Nato. Shale energy production, the dependency of still struggling European banks on dollar funding, the ascendancy of the US digital and high-technology sector, and the Eurozone’s ongoing structural weaknesses have given the US the leverage to demand more from Europe and to ignore it as a strategic constraint.

Whether the United States has, however, sufficiently recast its geopolitical position to prevail over China is another matter. Trump appeared to believe that the battle could be won without too much risk to inflation, share markets and oil prices and by offering some financial compensation to American farmers who have seen their Chinese soybean market collapse under Chinese tariffs. But share markets reacted badly to the breakdown of the trade talks, Saudi Arabia and its allies may well not be able to supply more oil at the prices Iran has been doing, and farmers in the mid-West, already stung by flooding this year, are becoming very vocal about the sacrifices expected of them. There may well be an incentive for Trump to try to patch the talks back together. The risk is, though, that there is now no way back, and that under a temporary pretence that there is, Trump will sharpen his fire on Europe.

Helen Thompson is Professor of Political Economy at the University of Cambridge and co-presenter of UnHerd’s These Times.


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