Will Economic Sanity Prevail?

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If there is a deal [with China], it will be on Trump’s terms, not on Wall Street’s terms…Trump has done an amazing job. He doesn’t need the help of Wall Street, he doesn’t need the help of Goldman Sachs.

The mission of these unregistered foreign agents [Wall Street types like Hank Paulson], that’s what they are, is to pressure [US President Donald Trump] into some kind of a deal.

Peter Navarro

Peter Navarro is Trump’s most influential economic advisor. Seeing this quote, investors got it. Trump doesn’t need the help of Wall Street. Wall Street is unpatriotic and should stay in its place. In other words, the stock market be damned! Trump will smash the global trading regime that has evolved over the last thirty years and has brought so much prosperity. And, as Navarro advocates in his books, Trump will make China poor and preserve American global hegemony. And if the American stock market collapses as a form of collateral damage, so be it.

Except — and here we can hope. Trump is a politician who wants to get reelected. Trump has just received two clear messages. First, his party just lost control of the House of Representatives which, if nothing else, will mean an intensification of Democratic investigations to find evidence of his real or imagined crimes. And second, over the last few weeks, the stock market has taken a drubbing, thanks in part to worries over Trump’s trade wars, especially with China.

Hence, Trump’s phone call with his “good friend” Mr. Xi. This call was right before the midterm elections and helped postpone(?) a stock market crash. Trump duly put out a happy tweet reporting on his talk with his good friend. For a few days at least, the stock market bought it and had a modest rally just in time for the elections. No happy tweet and the stock market rout would have continued before the elections. The Republicans might have lost the Senate and the House.

Is it possible Navarro’s recent mouthing off is a sign that the evil Wall Street types are getting to Trump and that Navarro had to stiffen Trump’s anti-China backbone? Can anyone seriously listen to Navarro talk and not conclude the man is crazy?

So What Would an Agreement Look Like

The markets are now looking forward to Trump and Xi getting together at their Nov. 30 G20 meeting in Buenos Aires. The stock markets are hoping for a Trump/Xi tango and a beginning of the end of the US-China trade war. Nobody expects a full agreement. The hope is for the start of a serious negotiation between the world’s two economic superpowers.

At a conference in Singapore, negotiating legend Henry Kissinger offered the advice that both China and the US “speak openly to each other about your red lines and the concessions you are willing to make to avoid conflict.”

For China, the concessions would probably be in the trade and IP protection areas. China has already been relaxing its rules that foreign companies must form JVs with Chinese companies and transfer technology. China can make concessions on trade even though no free market economist would accept Trump’s mercantilist argument that China was ripping off the US because it had a trade surplus with America. As for red lines, China would be very reluctant either to give up its Communist/Confucian state-directed economic system or to abandon its quest to become the number one global player in technology.

It is more difficult to know where the American red line really is. Navarro’s book Crouching Tiger states the real American objective is to maintain US global hegemony and make China poor. I suspect Navarro would like all Chinese to be required to wear cone hats and go to work in the rice fields. Navarro fantasizes a stoical Pearl S Buck China. Any Chinese plan that strives for Chinese excellence in technology would be unacceptable. Needless to say, the Chinese will never agree to Navarro-type conditions.

Does Trump share all of Navarro’s anti-China zeal? Who knows. Trump supposedly doesn’t read books and presumably hasn’t read Navarro’s. Trump is a politician and politicians are pragmatists whose first task is to get elected. But what is almost certain is that if the Trump/Xi phone call just turned out to be a clever pre-election ploy and no beginnings of an agreement is reached in Buenos Aires, the world economy will be the worse off and global stock markets including the American will hit new lows.

The American and Chinese Economic Models Have Some Incompatibilities

The American economic model is based on free market principles and property rights. Of course, there have been plenty of deviations from this model. But generally, the government does not allocate capital to favored industries in the US. When other nations do this, this is regarded as an “unfair subsidy”.

China, on the other hand, has a completely different economic model. It follows a state-directed Confucian-based system as have, to some degree, other East Asian countries including Japan and Korea. The state directs capital into favored industries including companies in the vibrant private sector. The public relations disaster Made in China 2025 is filled with plans for what Americans would call unfair subsidies. For example, China will be pouring some $130 billion into the production of memory semiconductor chips. If this money is efficiently used and if China can avoid infringing on Wester patents, China with state subsidies becomes a major force in memory. (These are big if’s since a number of smart observers in the semiconductor field have publicly expressed doubts about China’s ability to catch up at least near term no matter how much money it spends). If it succeeds, many worry that this will create global overcapacity in the semiconductor memory.

I don’t know if anyone has a great solution for this. Countries may feel they can do what they want internally but in a globalized world, they cannot. The US response to the Chinese investment in memory chip fabrication is to prohibit the sale of semiconductor equipment to China. Thus, it has banned chipmaker Fujian Jinhua from buying technology from US companies on national security grounds. According to the Financial Times,” the US does not accuse Fujian of spying. Its explicit worry is that chips made by the business could eventually sell well enough to damage the finances of US rivals.” Pure protectionism. Pure Navarro “make China poor.”

The irony is that the cutoff of semiconductor equipment sales to Fujian Jinhua, along with similar cutoffs to ZTE and others, are signals to the Chinese that economics be damned, they must allocate money at reducing their dependence on the US. The US for China is earning the reputation as NOT A RELIABLE SUPPLIER. Cutting off US technology exports to China gives the lie to the Trump mercantilist preoccupation that the trade deficit with China is such a big deal. The US is number one in tech. So shouldn’t the US be exporting tech products? Putting things another way, how many soybeans can the Chinese eat? Interestingly, when the Fujian Jinhua ban was announced, the initial consensus view was that Fujian Jinhua was finished. Now several analysts have said, “maybe not.”

At any rate, this ban cannot be good for the US technology sector. There are five major semiconductor equipment manufacturers in the world. Three are American — Lam Research (LRCX), KLA Tencor (KLAC) and Applied Materials (AMAT). That’s lost business for them. Collateral damage.

Better the US and China sat down together and resolved this problem.

So Who’s Going to Win the Trade War?

Nobody will win the trade war. There are only losers.

I had a chat with a US-educated Chinese friend of mine who’s done pretty well for himself in venture capital. “China will hurt,” he grinned, “But Trump needs to be elected. President Xi does not. Sooner or later, China will adjust and the American president — whoever he is — will give up.”

Maybe sooner as the US stock market heads down. And inflation due to tariffs rises due to Trump-introduced supply chain inefficiencies. Maybe Trump himself will figure this out.

As a free market advocate, I believe the American economic system, with its bottom-up property and individual rights foundation, is superior to that of the top-down much more centralized Chinese system. But there are 1.4 billion Chinese, only 335 million Americans. As I argued in my last blog, the Chinese are hardworking and, if global IQ comparisons have any meaning, are a nation of bright people. They are obsessed with tech. And they are used to centralized rule going back thousands of years. All this may be an offset to a suboptimal state-directed economic system.

Forecasts sometimes seen in the US that China will collapse under Trump punishments are nonsense. Even if its economic system is suboptimal, sooner or later China will assume the number one global position (though not in income per capita) no matter what Trump and Navarro do. Navarro and his ilk are bound to fail. But they will sow a great deal of unnecessary bitterness along the way. And make a necessary US-Chinese military rapprochement more difficult to achieve.

Technology Is Liberating

Although this once popular view has now been classified as naïve, I still adhere to the concept that technology is overall a liberating force in society. This is true for example in China even if it controls technology in ways not acceptable in the West. Bans on technology exports to China and attempts to technologically isolate China are a mistake.

Technology is driving the 21st-century economy. An interesting article worth reading is China’s Future Is South Korea’s Present, Why Liberalization Will Follow Stagnation by Hahm Chaibong in September/October’s Foreign Affairs. The title of this article speaks for itself. China will eventually move to a more liberalized regime as it becomes more prosperous. I believe technology will play a key role. Yes, the process could take decades. America should be patient, not angry, and not try to isolate China.

Will Economic Sanity Prevail?