What a time to be alive. Donald Trump is POTUS, and although policy specifics aren’t set in stone, the world is abuzz considering his first 100 days in office. Commentary regarding his initial policy push centers around Mr. Trump’s “Contract with the American Voter.” This contract has rightfully drawn much attention, however some simple foreign policy objectives have been overlooked. Here is the contract (emphasis mine):
To “protect American workers,” Trump would renegotiate or withdraw from NAFTA, pull out of the Trans-Pacific Partnership, label China as a “currency manipulator,” direct the executive branch to “identify all foreign trading abuses,” lift restrictions on fossil fuels, allow the Keystone Pipeline, and remove the U.S. from climate change agreements.
There is real possibility for Chinese and American conflict over trade and currency values in the near future.
The history of the conflict
The situation that we currently find ourselves is not new. Due to financial repression and hidden taxes on savers and consumers in the Chinese economy, China has an extremely low consumption share of GDP. To offset this historic low share of consumption, Chinese households must save an ever increasing share of their inadequate income. Consumption and demand in China is weak, so China is forced to export it’s goods. So although China had extremely high investment rates, they have an even higher savings rate.
The following graph shows the growth of the Asian savings glut. Note the trend grew in 2002 following a peg to the United States dollar. Note how it increased year on year as the Chinese economy became more and more imbalanced. Note that it briefly declined during 2008 financial crisis. Note that is now rising again to previous highs.
How does this effect the United States?
There are two ways. First, China would use United States Government bonds to help sterilize Chinese banks. Second, the increased capital flows from China inflated American banks. It is no coincidence that the American real estate bubble coincided with increased capital movement from China to America. Chinese money fueled speculative asset inflation.
The following graph shows a rise in the Asian current account surplus matching an american deficit.
What benefit does America receive?
China uses the open American system in order to transfer money from savers to producers. The Chinese economic system needs someone to absorb their surplus. The Chinese economic system needs someone to sterilize their banks. So what does America receive? American corporations are allowed to operate in China. That’s it. Market access.
If something can’t go on forever, it must end.
There are two constraints to the Chinese growth model: debt growth from high investment rates and unwillingness to absorb trade surpluses.
Both of these things are happening now.
Even if we ignore Trump’s calls, an increasing number of influential economist are calling for an end to this model. It is a mathematic fact that it is bad for America. Here is Brad Setser (emphasis mine):
The combined savings of China, Japan, Korea, Taiwan, and the two city-states of Hong Kong and Singapore is about 40 percent of their collective GDP, a thirty-five-year high. No other region of the world currently contributes more to the global glut in savings that has brought interest rates around the world down to record lows…Without a policy push to bring down savings, East Asia’s excess savings will continue to give rise to new economic and financial risks, both inside the region and globally…The traditional U.S. economic agenda in East Asia—aimed at liberalizing trade, investment, and exchange rates—needs to be complemented with a push for the policies needed to bring East Asia’s savings down to a level that the region can more easily absorb internally. The adjustment should be centered on China, where exceptionally high levels of savings no longer serve the same purpose as during the country’s catch-up phase of economic development.
I told you so. On July 28th I wrote in opposition to George Magnus. I wrote the following:
George Magnus gave a prediction of the RMB devaluing to 7:1 by the end of the year. My prediction is a little different. I believe that Chinese investment levels will drop by the end of the year, and Chinese savings rates will not change. Thusly, China’s current account surplus will rise.
I believe that this time next year, China will run an increasingly large trade surplus with the world. I believe this trade surplus will grab international attention and be received poorly. The current account surplus will put upward pressure on the RMB.
Step one of my prediction is a rise in China’s current account surplus. Look for it to rise over 3%. Step two involves international backlash. The main party would be the United States. Look for the United States to start mentioning key phrases such as “currency manipulator” during and after the election.
The RMB has been devaluing since 2014 ,and this devaluation is due to capital flight. Because there is more supply of RMB than demand, the markets are pressuring the RMB to a lower value. This pressure is huge. Although a bit outdated, this article from Zero Hedge accurately shows Beijing’s dilemma. On one hand, Beijing is facing the impossible trinity. On the other hand, the United States is showing an unwillingness, as they should, to absorb China’s domestic imbalances. This cannot happen forever. In fact, it could, at best, only last another year before China runs the risk of losing all foreign exchange reserves. The value of the RMB is going to be a political struggle, and I am keeping with my initial bet.
The Chinese growth model is ending. Domestic imbalances are causing an unstable increase in debt, and foreign nations are increasingly unwilling to absorb these imbalances. What are the odds that the United States refusal to accept Chinese domestic imbalances are used to explain to the domestic Chinese population why the growth model has failed. With the current administration completely failing to reform by any serious metric, what are the odds that “foreign black hands” are used as a tool redirect domestic discontent?
The value of the RMB and geopolitics of an East Asian economic rebalancing looks to be the defining foreign policy test of the Trump administration.