When U.S. President Barack Obama slapped a 35% import on Chinese-made tires, he did so saying that it was a necessary step to maintain ‘credibility’ in trade deals. China reacted with predictable outrage, with the country’s Commerce Minister Chen Deming calling Obama’s decision an ‘abuse’ of trade.
But it may very well be that this saber rattling will actually promote trade “peace” rather than a trade war. Just as “mutual destruction” kept the East and West from wielding nuclear bombs during the cold war, the same mutual threat of economic collapse will keep major trading partners like China and the U.S. from using tariffs to correct slow growth and rising unemployment.
The cumulative effect of overspending by the Western consumer, especially in the U.S., has resulted in major U.S. dollar holdings by the Chinese. Despite the fact that China exports far more to the U.S. than it imports, few feel that America will attempt to cure this mismatch by instituting tariffs. Instead, both countries recognize that the best approach is for China to redirect its economic growth model toward expanding its domestic consumption. Given America’s consumption of Chinese goods was financed by an unsustainable level of borrowing, its economic model is now shifting toward expanding its exporting industries. The success of this approach may very well be helped by a weakening of the U.S. dollar versus the Chinese currency over the coming years.
Are reserves of one trillion dollars to China’s advantage? The answer is both yes and no. With 95% of their country’s financial reserve in its major trade partner’s currency, the Chinese are at the mercy of a falling U.S. dollar. This could cut the value of those reserves dramatically. Accordingly, any action China would take to threaten the stability of the U.S. is also a threat to their national net worth. Seen from the perspective of a supplier of products to a retail store, who is to blame if that store buys too many products from the supplier on credit and then goes bankrupt? Was it the store’s fault for buying more than it could afford, or was it the supplier’s fault for lending the store too much money? As with China and the U.S., both sides are at fault. And both sides are left equally dependent on each other to solve the problem in the best possible way.
Given this situation has persisted until it has reached a fever pitch, the thought that this pattern of trade would now resume is out of the question. Which brings us to the solution: both countries must now change their growth models to ones that are sustainable.
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