Economics: China vs USA

Hospitality staff pose for a group photo in front of the Great Hall of the People during a plenary session of the Chinese People's Political Consultative Conference (CPPCC) in Beijing, Thursday, March 9, 2017. China's top leadership as well as thousands of delegates from around the country are gathered at the Chinese capital for the annual legislature meetings. (AP Photo/Mark Schiefelbein)

There is a lot of concern about whether Donald Trump’s personal trade war will send the US into a recession and make Republicans lose the White House next year.  The basic premise is that China holds the ultimate economic weapon – over $1T in treasury notes/bills/bonds.  If the economic standoff gets really nasty they can sell those on the open market, crash the dollar, spike our interest rates, and destroy our economy.

First off, that is 1 year of deficit spending.  Yes, we overspend a lot, but if $1T of treasury notes would crash our economy then we wouldn’t have an economy by now.  Second, China would be the first loser in that situation.  If they successfully tanked the value of our bonds then the value of our bonds would tank (duh) and the value of our bonds that China holds would tank.  That is, they damage their own portfolio.  Third, if this works then the value of the dollar will drop compared to foreign currencies (i.e. the yuan) making foreign goods (i.e. Chinese goods) more expensive and reducing imports.  I think that might work somewhat against China’s goals.

However, let’s look at the two economies and what losing would look like.

USA: Debt to GDP ~100%.  Economic growth 2-3%.  Unemployment ~3%.  Population: relatively stable, but baby boomers entering retirement.  A loss in an economic standoff probably looks like a recession with 2-3% total decrease in GDP and unemployment spiking up to 7-8%.  Interest rates might rise and cause trouble for the mortgage and banking industries deepening the recession.  However, if the free trade group is right the next president would reverse the policies and everything would be fixed in 1 year.

China: Debt to GDP: officially ~65%, unofficial estimates ~300% (including inter-governmental loans).  Unemployment ~5%. Population: Unstable demographics – large population spikes in 45-55 and 20-35 age groups (China is likely to see their working age population drop by 50 million people over the next decade).  A loss in an economic stand off would look like fewer exports driving up unemployment.  Those manufacturing lines would move to other low cost countries.  An immediate response might be to devalue the yuan to make exports cheaper to foreign buyers.  However, that devaluation would drive up interest rates making the debt almost immediately not serviceable.  The government would then wipe out inter-governmental loans, many of which are owed to Chinese state banks.  The banks themselves would have to replace the assets with something – likely newly printed yuan, possibly leading to runaway inflation.  The lack of currency stability would lead to a capital exodus.  This would take place as the old age population begins to spike.  China lacks anything as comprehensive as our Social Security program, and instead depends on children to care for their parents.  However, the 1 child policy took a hammer to that safety net meaning the economic hardship would be further exasperated by couples having to care for two sets of elderly parents.  If China decides to cave afterwards you now have the problem of supply lines having shifted to Vietnam and India meaning the manufacturing work does not return.  Also, foreign capital will have lost faith in your government, and would be very apprehensive about returning.

The reality is that China has much much much more to lose in an economic standoff.  China is facing a situation where their fighting age population is going to decline by half over the next decade, and after that their retirement population will quadruple.  They have one and only one shot at moving up the international ladder.  If they don’t take regional dominance in the 2020’s they are pretty much destined to be regionally replaced by India in the 2030’s.  Also, the other reality is that China does not have to remain our #3 trading partner (after Canada and Mexico).  If we replaced Chinese made goods with Indian, Bangladeshi, Vietnamese, Indonesian, Mexican, Brazilian, Nigerian, Korean, Ugandan, etc. made goods we really wouldn’t be paying more.  The delay to December 15th bought our supply lines 3 months to shift their supply lines with minimal impact to US costs.  That is, import all the crap you can from China over the next 4 months, and during that time spend 1 month deciding on alternative manufacturers, 1 month hammering out contracts, 2 months setting up your shops, and 1 month filling containers to cross the ocean.  You have a 1 month gap (Dec. 15th – Jan 15th.), but that will primarily be Christmas shopping (everything will have landed by the 15th anyway) and post Christmas sales (getting rid of inventory), and your spring collection now comes from Brazil, or Uganda.  The cost to American consumers can be rounded to 0%.  The “delay” wasn’t Trump blinking, it was announcing to American companies that he is serious, and giving them time to manage their supply chains.

China is in for pain.  Even if Trump rescinds the tariffs next summer the work is staying out of China, and they will have a whole host of problems to deal with.