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Tariff Tough Talk

April 10, 2018

International trade policy shouldn’t be headline news. We just need stability, so everyone can conduct business—but that’s not where we are.

Trade and tariffs are all over the news because President Trump is going after China. This vexes financial markets, which want minimal trade barriers.

Regular readers know I’m not a Trump fan… but on this, he’s partly right. China hasn’t reciprocated US trade policies, and some changes are necessary.

However, which policies the president attacks and how he tries to change them is important. Flawed methods usually produce flawed results.

In this case, the problem is more than a flawed method. It’s flawed economics.

Photo: Getty Images

Little Pieces of Deficit

The president’s tweets and public statements tell us he doesn’t like trade deficits, particularly the one with China. He seems to view it as a win-or-lose proposition.

That’s not exactly right.

For one, a trade deficit between two nations isn’t unusual. Precise balance would be strange. Countries have different needs, so some import more than others.

Furthermore, it’s not like the side with the deficit loses anything.

In this case, China gets our dollars and we get Chinese-made goods. Your house is probably stuffed with little pieces of the US-China trade deficit.

Is that bad? As an economic matter, it’s just reality.

  • Americans want Chinese goods more than we want the dollars spent on them.
  • Chinese want those dollars more than they want the goods.

It’s not about winning or losing. Everybody gets what they want.

Photo: Getty Images

Not Winning

There is a wrinkle to this, though. I said, “The Chinese want those dollars,” but they’d prefer to use their own currency. Eventually they will, too, but for now we still settle our trade in dollars.

Just as our homes hold Chinese goods, Chinese bank accounts hold trillions of greenbacks. That’s the other side of the trade deficit President Trump hates so much. It’s the same money.

What do the Chinese do with those excess dollars?

Well, they invest many of them in US Treasury securities—to the point that China is our government’s largest foreign lender.

Some people see this as ominous, fearing China will dump this paper and cause a crisis. But doing so would probably require Beijing to take a big loss, and that’s not its style.

The bigger danger is that China may simply buy fewer Treasury bonds. This is simple math. Chinese investors can’t buy our T-bonds unless they have excess dollars—and they won’t if the president succeeds in reducing the trade deficit.

See the problem?

  • The US government spends way more than it collects in taxes.
  • Treasury must finance the difference by selling bonds.
  • Someone with dollars must buy those bonds.
  • China’s dollar surplus makes it a natural buyer.

If China doesn’t buy our bonds, somebody else will… but probably at higher interest rates. Prices rise when an external force constrains supply. This will raise Washington’s interest costs and further enlarge the debt.

And when Treasury rates rise, other long-term interest rates (like mortgage rates) rise too. That could make home purchases more expensive, reducing other consumer spending and maybe hurting the housing industry.

So attacking this trade deficit problem—which isn’t really a problem—risks making some actual problems even worse. That’s not “winning.”

Photo: Getty Images

Burning Bridges

Now, some say all of this is a negotiating tactic, that the president’s unpredictable tough talk leaves opponents off guard and sets up a “win.”

Such tactics worked for Trump in private business. In fact, the president’s business skill is why many folks voted for him. He promised to negotiate great deals and had a track record for doing it.

The problem: governing isn’t a business.

In a transactional business like real estate, you probably won’t deal with the same counterparty again. Burning bridges behind you can make sense if you have thousands more unburned bridges in front of you.

In politics, both domestic and international, you must negotiate with the same people repeatedly on different topics. If you’re unreasonable on Item A, it also affects Item B.

Trade negotiations are particularly hard because so many groups have a stake in the outcome. Overt threats rarely help. They might even hurt, by sparking opposition that prevents the other leader from offering concessions.

Photo: Getty Images

Risk for Everyone

Trump is right that China hasn’t always played fair. Many other nations feel the same way. That’s a negotiating tool the US could use to our advantage.

As China’s biggest export market, the US has plenty of leverage. We could have even more leverage by working with China’s other top customers, primarily Western Europe.

But Trump isn’t doing that. He is doing the opposite by openly threatening Canada, the EU, Japan, and other developed countries with tariffs as well. This makes it hard to ask their help against China—and even gives China an opening to seek EU support against the US.

Consequently, the chance of getting significant reforms from China is lower, and the risk of a negative outcome like trade war is higher.

Maybe President Trump sees that as a risk worth taking. But it highlights another key difference between business and government negotiations.

In his real estate deals, the people at risk were Trump himself and the business partners who willingly joined him. As president, he’s generating risk for everyone. No one gets to opt out.

Financial markets see this and don’t like it at all—nor should they. Events could easily spiral out of control, with harsh economic consequences.

China’s response so far is to threaten its own tariffs on US agriculture and other Trump-friendly sectors. They think penalizing the president’s supporters will make him back down.

I’m not so sure, for two reasons:

  • First, those same business groups failed to stop the president’s earlier trade actions. Their influence on the White House appears to have waned.
  • Second, being punished by China might make the president’s supporters more loyal, not less. Outside attacks often unify people who might otherwise split.

If so, the trade fight is likely to get worse before it gets better. So get ready for a long siege.

See you at the top,

Patrick Watson

P.S. If you’re reading this because someone shared it with you, click here to get your own free Connecting the Dots subscription. You can also follow me on Twitter: @PatrickW.

Discuss This


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April 10, 11:58 a.m.

Pat:  I assume you are like me, above average income and net worth and we live a comfortable life.  I spent most of my career in Ohio and many people there are hurting just like in many Midwestern states.  Trump certainly has his faults but people in “flyover country” deeply appreciate that someone is trying to help them Many proud Midwestern families have had to take welfare, etc. but they want jobs.  Maybe Trump’s actions will not work but to these Midwestern families at least someone is doing something other than the standard economic lecture.

April 10, 9:58 a.m.

Interesting take, but a few dots are missing.

For one, if Trump actually does put sizable tariffs on Chinese goods in place and we buy the goods at a higher price, part of that price hike is tax revenue that doesn’t require China to recirculate the money into Treasure debt.  Basically it cuts out the middleman.

Wouldn’t that lower our Treasury funding costs since Chinese businesses are now paying “new” taxes and seeing their profit margins shrink?

Forgetting that for a moment, say that China decides to retaliate by using the surplus dollars to buy European government debt instead of US Treasury debt.  Fine, now the Europeans have to find a place to park the dollars China just spent (and European debt is now trading at even lower yields relative to the US).  So wouldn’t the Europeans choose to buy undervalued US debt or something similar?  Investors risk weight their purchases, and when other people do stupid things like buying too high (like the Chinese government is in this example) investors move to the cheaper risk-weighted asset class or classes.

Oddly, the markets will see all of these alternatives and front run the effects.  Actually, not so oddly as that is the way markets are supposed to work.

So let me be entirely blunt, the proposed tariffs are looking more like the VAT tax our Congressman so strenuously avoid than a punishment for bad behavior (of the off-shoring American businessmen and the Chinese elites who profit from it).

April 10, 9:53 a.m.


I have some questions regarding connecting dots. What if Trump’s
advisors are just using trade wars/sanctions to up the ante for a real war?

The Chinese culture has the second highest intelligence quotient on
the planet and the US quotient is falling off a cliff as the first
Eastern European and European generations die out. What if Xi was
made leader for life in preparation for the West’s obvious Bully War?
What if Xi is so strategically ahead of the US that they realize that this
is nothing more than population extermination as the cowards hide in their
What if all this is not about trade wars? 

What if those that are being bullied and capable of fighting-fight back?
Although the US takes credit for winning “the WWII”, British history shows
that Churchill had to keep their feet to the fire as they wanted out before
the going got tough. The Russians know they won the war and not the US. The
Chinese know the US didn’t win the war as well. Sadly, the US has been at war
93% of its history and has been no more than a covert bully with a 100% loss

Don Braswell

April 10, 9:21 a.m.

Patrick, Yes and no.  Trade barriers increase the marginal cost of a product.  But “Free Trade” only exists between the individual states in the USA.  (and even there the playing field is not truly level - note the competition between the states for Amazon’s HQ2). 
Remember NAFTA?  “Free Trade Agreement”?  It’s 1700 pages long.  A Free Trade Agreement would be one paragraph - no limits, no tariffs no barriers to trade between countries.  It is a carefully managed “North American Mercantile Trade Agreement” (that title, while more accurate, would not have sold very well.) 
Free Trade benefited the USA immediately after WWII because we were one of the few industrial countries not destroyed by war.  Now “Free Trade” benefits the guys who erect barriers - a small cost to some of their citizens - to create the desired production capacity in their home country.  As in China’s barriers to Visa, MasterCard to build their own banking infrastructure that they can control.  China has a well known demand for technology from participating companies, as well as their systemic corporate espionage.  When they are finally able, they erect barriers to these companies, and squeeze them out.  Reference KFC in China.  So, trade ain’t free.  Ask the steel mill and coal miners if it was free for them, as they play with their toys made in China. 
The sooner educated folks like yourself start calling the system by its real name (Mercantile) the better for all of us.  We recognize our own system better and we recognize the WTO for its real mercantile purposes.

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