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Why Trump’s Tough Talk On China May Work

As we near the year end and near a new administration and policy stance, the geopolitical risks have risen.

I’ve talked about the China threat quite a bit.  China’s currency regime was at the core of global economic crisis, and is inching us all toward what looks like an ultimate military crisis.  The seizure of an American drone by the Chinese on Friday was another step toward that end.

Remember, back in January, I talked about six global market themes that would rule for 2016.  Among those, I said “China’s currency manipulation will come home to roost…..China’s currency manipulation (i.e. keeping their currency weak relative to the rest of the world, to corner the world’s export business) was a big contributor to the global credit bubble and subsequent economic crisis. Only after being persistently pressured by key trading partners (namely the U.S.) have they allowed their currency to slowly appreciate over the past several years. But now their economy is slowing, a dangerous scenario for China. Meanwhile, China is losing export prowess to Japan, a country that has weakened its currency by almost 35% in the past two years. The easy fix, in the minds of the Chinese, is to jumpstart exports. How do they do it? Weaken the currency, which is precisely what they have started doing (beginning in August of last year). But, longer term, expect such a reversal on formerly agreed to concessions by China, to be an act of economic war, which may, over the next decade or two, lead to military war (U.S., Europe, Japan v China, Russia, N. Korea).”

Since January (when I discussed the above) China has continued to weaken it’s currency.  They’ve blamed it on capital flight.  But with the economy still running at recession speed, they want and need a weaker currency, and they are walking it down.  They know what works.  A cheap currency drives exports.  Exports have drive prosperity in China.

But they’ve run into new leadership in the U.S. that is talking tough and has the credibility to act (unlike the outgoing administration).  That has money in China seeking the exit doors as more bumps appear to be ahead for the economy (not the least of which are threats of tariffs).  And with that uptick in money leaving the country, the monetary authorities have clamped down on capital controls, more onerously restricting the movement of money out of China.

A weaker currency, tightening capital controls, and an eroding confidence in doing business in China all reinforces a weaker and weaker economy.

Still, as I’ve said before, while many think Trump will provoke a military conflict, that’s far from a certainty.  With the credibility to act, however, Trump’s tough talk on China creates leverage.  And from that leverage, there may be a path to a mutually beneficial agreement, where the U.S. can win in trade with China, and China can win.  But it may get uglier before it gets better. In the end, growth solves a lot of problems.  A hotter growing U.S. economy (driven by reform and fiscal stimulus), will ultimately drive much better growth in the global economy.  And China has a lot to gain from both. Though in a fair trade environment, they won’t get as much of the pie as they’ve gotten over the past two decades. But it has the chance of leading to a more balanced and sustainable economy in China, which would also be a win for everyone.

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Bryan: