- Who will win a trade war between the US and China?
- The US has a more stable economy, but China has some advantages too.
- When you’re about to inflict pain on your own people, authoritarianism has its benefits.
The US just slapped tariffs on $50 billion worth of Chinese products in an effort to punish China for stealing US intellectual property.
And China says it’ll retaliate with steep taxes on a slew of American products, including soybeans. China buys more US soybeans than any other country.
So while President Donald Trump seems confused about whether we’re in the trade war he started, Wall Street is not. Soybean prices took a dive in Chicago on Wednesday, and in New York the stock market is bleeding – the Dow Jones industrial average opened off 500 points.
If you’re an American soybean farmer or trader – or simply a concerned citizen – you’re most likely asking yourself two questions: How long will this last, and what does China have going for it in a trade war?
To answer the first question, consider this: Trump cannot back down until the midterm elections later this year, and China, as we’ll discuss in a minute, is a state-run economy; its government has shown a willingness to intervene in business, public and private, anytime things go awry.
Plus, because the US and China traded just under $650 billion worth of goods with each other in 2016, the numbers we’re seeing bandied about here are relatively low.
We just started the first inning of this thing.
As for the second question, it’s more complicated. This trade war is coming at a time when the Chinese economy is looking pretty stable. But that’s just on the surface.
- Deutsche Bank
State of the nation
This year, for the first time in a few years, China’s stock market or currency didn’t start the year with a violent puke or an unnerving slide. Economists and politicos at the World Economic Forum in Davos, Switzerland, didn’t tear their hair out wondering whether the country’s massive debt bubble – which is approaching 300% of its gross domestic product and still growing – would burst.
Thanks to all that, Chinese officials have been successfully selling the narrative that everything is under control – that the central government’s plan to slowly deflate the debt bubble through supply-side reforms is working. Things have been quiet.
But analysts think that will soon change.
“China’s growth momentum was undeniably solid at the beginning of the year, albeit not as solid as the headline readings might have suggested,” Wei Yao, an analyst at Societe Generale, wrote in a note to clients last month. “However, most of the leading indicators are pointing to at least some softening from here and the policy stance, as signaled at the National People’s Congress, remains hawkish on balance.”
That means that the economy, which for years has lived off the creation of more and more credit, is likely to slow. And despite a potential slowdown, the government is signaling that it will tighten policy conditions.
Some indicators are already reflecting this situation. One of the most important in the country, property transaction volume, fell precipitously last month. On a year-over-year basis, overall transactions fell 33.6%.
In the largest so-called Tier 1 cities, volume fell 20.9%. In midsize Tier 2 cities, it fell 44%, and in smaller Tier 3 cities, it fell 29%.
In March, the Caixin/Markit Purchasing Managers’ Index came in at 51, down from 51.6 in February. (A reading below 50 indicates a contraction in spending.)
Independent China-watchers still insist that the reforms the government promised have yet to come. Last month, the data firm China Beige Book reported that deleveraging hadn’t started and that corporates were still sucking up credit to survive.
- China Beige Book
Other reforms China has promised also haven’t come. The government has yet to crack down on commodities sectors like steel, which have for years been suffering from overcapacity.
One would think that in a country controlled by one man, President Xi Jinping, the government would be able to snap its fingers and make these things happen. Not so.
A few weeks ago, I sat down to lunch with Dinny McMahon, a former Wall Street Journal reporter based in China who wrote the book “China’s Great Wall of Debt.” He explained to me that despite all the directives from Beijing, reform had been slow going.
McMahon told me that in China there’s a saying that “the mountains are high, and the emperor is far away.” That is to say: The central government’s edicts are not always followed on the local or regional level.
Regional governments don’t always want to shut down factories and deal with angry, unemployed citizens. Local governments don’t always want to stop issuing financing vehicles.
In a country as vast as China, even with an authoritarian central state, it can take a lot to get everyone on the same page. One big takeaway, though, is that we’re looking at a country still very much dependent on exports for its economic health.
From China Beige Book’s recent report (emphasis retained):
“While Q1 revenue looked strong, every sector this quarter except manufacturing saw profit growth weaken from Q4 2017 … Retail’s weakness is of particular concern. If China’s exports suffer from President Trump’s upcoming trade actions, and any copycat barriers elsewhere, domestic consumption hardly looks robust enough to carry growth.
“Credit and investment trends are also a concern. While our borrowing and capex gauges look stable at the national level, a truly healthy and rebalancing economy wouldn’t see retail and services firms borrow and invest less while commodities firms again lead nationally in both hiring and borrowing.”
So long-term, the Chinese economy is not as stable as the US economy. But this might not be a long-term battle – and in that case, we have to consider other features of the Chinese economy that could work in its favor. Authoritarianism has its benefits.
What the Chinese central government can control it can change at breakneck speed – for example, it can force healthy private-sector companies to buy into debt-laden state-owned enterprises to prop them up in the face of collapse. It has done that before in the face of threats within its own economy.
Last year, China Unicom, a flailing state-owned telecommunications company, announced it would raise about $10 billion in cash from private investors including Alibaba, Baidu, JD.com, China Life Insurance Company, and Tencent, among others. Together, they’ll have a 35% stake in the company.
That didn’t happen because these tech companies suddenly got an itch for the telecom business, but because the government said it had to happen.
When China must, it can marshal all its resources to deal with a problem. The US doesn’t work like that – you’ll recall the horse trading (and stock market carnage) it took to pass the bailout that stabilized our banking system in 2008.
Another advantage the Chinese are likely to have in a trade war is a forced tolerance for economic pain as a result of a not-always-responsive government.
Americans can express a desire for change in the face of an economic downturn through the electoral process. People living under authoritarian governments, on the other hand, have no choice about that. Their leaders aren’t going anywhere, and they control the media. They can convince citizens that the US is the enemy – and in many ways, they already have.
In a trade war, that can be an advantage, as it means the government can pull out all the stops. China might do just that.
An earlier version of this piece was published on Business Insider on April 2, 2018.