Sunday, June 9, 2019

Trade War Heats Up; Will America or China Blink First?

Originally published May 10, 2019 on America Out Loud,

Donald Trump and Xi Jinping have a lot to talk about the next time they meet. The two men lead the two superpower economies of the world. The United States of America and the People’s Republic of China are bound together in what geopolitical strategists current call Grey Zone conflict; a 21st century version of the 20th century’s Cold War fought in economic, political and technology space with the occasional saber rattling of military power projection bravado.

The current hot part of the Grey Zone is trade and tariffs. The US is upping the tension by imposing roughly $200 billion in new tariffs as a way to create pressure to bring the Chinese back to the bargaining table following China’s surprising reneging of a pending trade agreement sending the US a red lined draft deleting almost all of the proposals the US had negotiated with the Chinese in good faith.

The Chinese have done this negotiate then take it away tactic before. They are known to seek to exploit perceived weaknesses in the American bargaining position when the US presidential election cycle begins.

They blunted trade agreement attempts by former President Barack Obama and seem to have believed current President Donald Trump was equally vulnerable to election cycle flaccidity.

It looks like they may have read the tea leaves wrong this time. President Trump doesn’t seem to care about the 2020 election as much as he cares about tending to the business of America in 2019. I don’t know why they thought the man they nicknamed “Donald the Strong” would change his modus operandi because a “circular firing squad”, as former President Barack Obama called it, of twenty plus mediocre Democratic presidential hopefuls are canvasing every bar and stage they can stand on and stump from.

Instead, the US moved to activate tariffs creating a real increase in friction for the global manufacturing supply chain that goes between the US and Chinese economies. Adding fuel to the tension, the US signaled that President Trump is willing to pursue taxing “everything the Chinese sell us” if we must in order to get their attention.

The two countries will next return to the bargaining table with the US likely demanding that every word in the language the Chinese deleted in the last draft of the trade agreement be restored. We’ll soon see how that plays out in the coming episode of the “Art of the Deal”.

Here’s the thing, trade friction is normal.

In an ideal world, there would be free trade between nations with the balance of trade between each counter-party being perfectly equal going both ways. But it’s not an ideal world. In the real world, imbalances are normal and fixing them requires constant tending by the governments to equalize the balances between trading partners.

The trade friction between the US and China is significant. It didn’t happen overnight though. Prior to Richard Nixon opening the door to Red China in the early 1970’s, China was a minor trading partner of the US. Things began to open beginning in the late 70’s and blossomed in the 1980’s under the leadership of Deng Xiaoping. But the explosion in trade volume and the path that would eventually lead to a severe trade imbalance really began in the 1990’s.

The US globalization and outsourcing of manufacturing and supply chain logistics starting in the 1990’s helped spark a vast economic boom in China that transformed Mao Zedong’s “Cultural Revolution” into Deng Xiaoping’s “To Be Rich is Glorious” vision for the centrally planned Communist nation. It would see China’s economy grow to become the equal in Gross Domestic Product (GDP) with the United States of America. It has indeed been a glorious run of growth and prosperity. Entire industries transformed and grew in both the United States and China feeding on the cost of production savings of global outsourcing. The economic system became addicted to it and it benefitted from China’s infrastructure base grandly even as the US infrastructure base atrophied in strategically important industry sectors. America became a factory poor service economy and China forced its indigenous people off their lands and into factory cities for the greater glory of China. But there’s no such thing as a supernormal return that lasts forever.

The most successful beneficiaries of the global economy, the US and China have become conjoined twin 21st century economic superpowers very much the same way the US and the Soviet Union were conjoined twin military superpowers in the late 20th century. But both countries are now reaching inevitable growth plateaus. Both countries are beginning to adapt to reality.

The US has realized that it outsourced too much. America now needs to shift the locus of production back onshore to create job capacity for a population about to experience a massive technological change due to the arrival of artificial intelligence and robotics changing the nature of how work is done. It’s a simple formula. There will be fewer workers needed per business entity or process. To compensate for this, the US needs to increase the number of business entities and processes within its borders in balance with its domestic workforce size. Count that any way you want to; we need jobs for the bodies.

The Chinese plateau is that it needs to wean itself of an excessive dependency being the world’s largest export economy in a world where all their first and second world customers, not only the United States, will be adapting to the coming AI and robot workforce revolution.

China is, to be blunt, the world’s largest factory reduction in force waiting to happen. They need to reduce their exposure. They need to restructure the design of their economy, probably even their culture and governance, so it is not as dependent on the outside world’s need for goods to be internally rich and glorious.

Desperately seeking balance.

Economic negotiations have been ongoing to rebalance the costs and incentives to improve the trade balance positions between the US and China for years. People have worried about the consequence effects of becoming addicted to outsourcing since it began. The two countries struggle in parallel trying to create a way to evolve from a house of cards to an equilibrium that is sustainable and perpetual.

While American and Chinese leadership negotiate, it turns out, there is a narrower set of self-interests in the domestic socio-economic realities of both nations that retards their ability to find that equilibrium.

In the US, many industry sectors have calibrated their economics such that they are dependent on outsourced manufacturing of both finished goods as well as components and subassemblies. Distributed supply chain manufacturing was one of the great achievements of globalization and it has turned many US industry sectors into industrial outsourcing drug addicts.

Wall Street has a heart attack anytime this river of industrial cocaine hints at slowing down or being cut off. No one in the US wants to make the capital investment to replace what can be ordered over the internet from China. Capitalism is entirely myopic and short sighted.

US markets see only the now of the next earnings report. But that’s not going to stop the day the American labor force takes a cold shower. The machines and bots are still coming.

It’s, to use an old term, an inconvenient truth. No one other than Trump really wants to face it. It’s impossible to even discuss something this difficult in DC because Congress is so busy playing political games about hating the president it’s completely ignoring the national interest. There are even some Congress who want the country to fall into the losing side of a trade war thinking maybe the turmoil is good for their political fortune. Really? Since when is plunging a country into a depression a good thing?

If you think we have problems, a trade war is far worse for the Chinese. They have the same professional class myopic greed and addiction to an outsourcing business model planet economy too. It’s been very, very glorious. The Roman concept of Momento Mori applies here; the legend of the slave Auriga whispering in the ear of the victorious Roman general on his chariot that “glory is fleeting”.

Historically, the Chinese are in a quandary they’ve been in many times over their 10,000-year history. Simply put. What happens when the aspirations of your professional class depart from the existential needs of your peasant base? Chinese dynasties, including the present communist one, have struggled with this repeatedly and the solutions have mostly not been “nice”.

For the Chinese, the Xiaoping glory period of high growth is rapidly reaching a limit line. China’s leadership knows this probably more acutely than anyone else on the planet. They know they stand at a difficult precipice.

They must either seek a peaceful equilibrium with the league of nations as trading partners taking account of the realities of what technology is about to do to everyone, a path leads to working with the community of nations constructively. Or, the Chinese must begin to prepare to become Asia’s next pretender to the throne of hegemonic owner of Greater East Asia to manufacture artificial prosperity by force. It’s a decision point that is coming for the Chinese and it is something the world needs to be dealing with head on and helping the Chinese make the right choice.

My observation? The hegemon option is a really, really bad idea for China. The People’s Liberation Army is good but it’s military might is best used as a projection of power for negotiating leverage vs. in actual imperial conquest. Basically, it’s not going to work. China shouldn’t make the mistake of thinking it’s better than Japan was at such an endeavor. Chinese hyper patriotism is an admirable thing for the pride of the Chinese people in themselves and their achievements. It’s also a slippery stone on the path to the dangers of Bushido. The Japanese lost by the way. To the United States of America. Just saying.

Going operations analyst for a paragraph, the conflict calculus prognosis in any form of protracted economic conflict between the US and China, once fully engaged, is the same. The odds heavily favor the Americans. All conflicts are about one’s financial staying power. While both the US and China have $16 trillion GDP’s, the GDP per capita available for sustaining so-called Grey Zone conflict, meaning at a high state of open animosity on the ragged edge of war and peace, overwhelmingly favors the US at 300 million mouths to feed on a $16T base vs. Chinas 1.4 billion people sustainment load.

An economic war will stress the Chinese cultural-political system 4 ½ times more per day of conflict than it will America.

That is a simple siege warfare cost multiplied by time formula as old as conflict itself. It determines who’s house of cards will crumble first. It’s icky. Everyone will lose. Don’t do it.

Something Better to “Get to Yes” About.

As I step back from the noise of the moment, I’m struck by the realization that there actually is a straightforward and sensible outcome that both Donald Trump and Xi Jinping need to work towards.

The US needs to get to a trade level and mix that brings back onshore enough industry to sustain the quality of life of its population.

The US and China both need to redesign their foreign trade models so that they work together to target a long run 1-to-1 balance of trade such that most favored nation status with as close to friction free tariffless interaction becomes sustainable between the two counterparties.

For the US to achieve its aims, it needs to mobilize domestically to recapitalize what was excessively outsourced while continuing to interact with the global supply chain fairly. The US clearly cannot do this while the political climate of America is fractious. Until then, America has no unified national direction. That means, election year acrimony be damned, President Trump needs to find a way to bring selfish political tribes together, at least on this issue, to the point that the US begins to work on matters of national interest, even if as a very reluctant team. If this doesn’t happen, China will win.

For the Chinese to achieve their aims, they need to similarly reorganize their culture and politics to develop a stable domestic economy that is internally self-sustaining and balances interaction with the global supply chain fairly. I suspect that to do this will be more problematic for China. The Chinese will likely have to explore alternative national designs such as creating interdependent regions within their country much like the US has natural regions of separation that allows it to have internal cycles that smooth things over time. The single nation centrally controlled model they have now is probably too difficult to sustain. If China cannot do this, then America will win.

If the two countries can begin to discuss these things constructively, the world wins.

To be honest, an uncomfortable tariff skirmish might be just the thing to get both countries scared enough to start thinking about the 21st century more productively.

So be it.

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