How America Can Win The Trade War With China

how america can win the trade war with china
How America Can Win The Trade War With China

By former Fed governor Larry Lindsey.

We have been of the view that America can “win” a trade war with China, in the sense that China will take more “casualties” than America. But that kind of war is the proverbial negative-sum game. Who wants to do something in which your side is still “losing” (taking casualties), even if you “win” the war? The purpose of a trade war is to establish a trade peace, in which your side reaps benefits that far exceed the costs of the war. Even though China is now vulnerable, an outcome that benefits America, rather than merely hurts China, will require a policy pivot. Without that policy pivot, the vulnerabilities in the American side of the dispute will start to rise very rapidly.

Until quite recently, markets have responded negatively to trade announcements coming from the Trump administration, but then recovered as market participants came to believe that Trump was merely being tactical. As a result, key market indices are essentially flat for the year. But the recent spate of trade policy announcements have shaken that confidence.

Unless the administration can restore the belief that the goal is to win a trade peace and not just a trade war, then equity values should go down because the future will be bleaker, not more positive.

This does not mean a comprehensive solution to all trade problems on the planet needs to be resolved. But it does mean that the Trump administration must come to a “deal” on something, just to show that it can. Otherwise it is merely a disruptor of the status quo and not a disruptor that leads to a better outcome. China is a natural place to start, in large part because it also needs the promise of a cessation of hostilities at some point in order to keep its economy together and so it can agree to a trade “peace,” or even a trade “cease fire,” that will give Trump and America much of what it is looking for.

A trade cease fire might look something like this.

  1. China agrees to reduce its annual trade surplus with America by some number, say $150 billion. This is about one third of the current deficit and, other things equal, would add about three-quarters of one percent to American GDP.
  2. America agrees not to impose any new tariffs on Chinese goods for one year. At the end of that year it will evaluate China’s success at meeting its promised reduction in the trade deficit.
  3. America will handle other issues, such as intellectual property, outside of the tariff framework and use processes like CFIUS, augmented by FIRRMA, to handle these matters.
  4. Over the next year the two sides will work together to negotiate a more lasting solution.

This is hardly a comprehensive solution to the trade issues between the U.S. and China. However, it does remove an important component of the uncertainty now beginning to creep into both financial markets and industrial planning around the global supply chain.

Can investors be certain that a new round of tariffs will not begin a year from now? Of course not, but that was something that could never be guaranteed. It also separates the narrowly defined “trade” relationship from the intellectual property and investment issues. A basic rule of policy is that the number of policy instruments should be at least as great as the number of policy goals. Using tariffs as a mechanism for dealing with intellectual property concerns violated this fundamental principle. In so doing, it “overreacted” on the trade front thereby inducing others to respond to the overreaction using the same tools.

Most important, it establishes a positive dynamic on the trade front that can lead to a net winning position for the American economy and not just one in which America merely suffers fewer losses.
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Author: HEDGE

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