While Canadians are understandably focused on what the election of President Donald Trump means for our bilateral trading relationship and the future of NAFTA, a much bigger issue for the global economy is the pending clash between the United States and China.
Focusing on China's huge trade surplus with the United States, Mr. Trump and his economic team are talking about a wide range of trade and currency measures aimed at curbing Chinese exports and increasing the domestic share of the huge U.S. market. It is hard to believe that this would not result in a trade war between the world's two largest economies, which would put a serious dent in growth and job creation for countries such as Canada that export to both.
In an important recent book Unbalanced: The Codependency of America and China, Stephen Roach, former Chair of Morgan Stanley Asia, unravels the U.S.-China economic relationship.
In a nutshell, the United States has been the ultimate consumer and China (with supply chains extending through Asia) the ultimate producer. The Chinese share of the U.S. and global market for manufactured goods massively increased after 1980, especially after China joined the World Trade Organization in 2001. Exports and business investment drove double-digit annual growth in China for about 30 years.
In the United States, by contrast, the driver for growth since the 1980s has been a continuing increase in household consumption fuelled by asset bubbles and debt rather than by rising wages. As Mr. Roach puts it, codependency means that "Americans have been squeezed as workers but have benefited as consumers. The opposite is true of the Chinese."
Perhaps the most striking statistic is that, by the time the global crisis hit in 2008, household consumption accounted for about two-thirds of GDP in the United States, twice as much as in China. While Chinese living standards have certainly improved, export-led development means that China has contributed much more to global supply than to global demand.
The large merchandise trade surpluses China has run with the U.S. have in large part been invested in U.S.-dollar denominated financial assets, above all in Treasury bills. The accumulation of about $3-trillion (U.S.) of foreign-exchange reserves kept the Chinese currency competitive and also helped keep U.S. interest rates at very low levels. China supplied cheap credit and cheap goods to the United States, keeping inflation and interest rates low.
Effectively, China lent massively to the United States at very low interest rates in order to finance U.S. imports of Chinese products. Codependency allowed each partner to grow, but in a way that is clearly unsustainable in the long term. There is a limit to the willingness of China and others to subsidize U.S. consumption by financing the chronic U.S. trade deficit. The codependency of the two major economies is underlined by the fact that Chinese exports are often produced by U.S.-based transnationals and are a key source of U.S. corporate profitability.
As is widely recognized, China needs to rebalance its economy from manufacturing exports and capital investment-led growth to higher domestic consumption. To a significant degree, China is already trying to do this. The currency has been allowed to appreciate gradually; higher wages are being encouraged to a degree; and it is recognized that China must build a welfare state to discourage excessive saving.
While China faces many difficulties in rebalancing its economy, it at least has a plan and the political means to see it through. Meanwhile, the United States has no viable strategy.
Promises of tax cuts and fiscal stimulus by Mr. Trump have already buoyed the U.S. dollar, which is totally counterproductive in terms of reducing the trade deficit. And any move to seriously limit Chinese exports to the United States through protective measures would be inflationary and would disrupt U.S. employment reliant on Asian supply chains.
What the United States should be doing, according to Mr. Roach, is rebalance its economy to investment and to exports of goods and services that meet growing Chinese demand for sophisticated goods and services. This is easier said than done for a country that lacks an effective industrial strategy.
To add to Mr. Roach's argument, the United States could and should work with other countries to gradually depreciate the U.S. dollar, and should curb excess consumption by selectively raising taxes on the relatively affluent. A shift of fiscal resources to public investment and to support industrial restructuring would lower the trade deficit while maintaining growth.
The unbalanced China-U.S. relationship is a major threat to global economic stability. The Trump administration needs to pursue a much more sophisticated strategy if we are to avoid disaster.
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