Taiwan Was the First Salvo in a Looming Showdown with China Over Trade

A man reads a newspaper with the headline of "U.S. President-elect Donald Trump delivers a mighty shock to America" at a news stand in Beijing, on November 10. Donald Trump's promise to put America first helped propel him to the U.S. presidency. But he also unleashed uncertainty on the global economy by skewering trading partners and offering few specifics that might calm allies or businesses. Andy Wong/AP

Early one evening in January 2009, Xiao Hongzhi walked down a nearly deserted street in the eastern Chinese city of Dongguan, to the door of the factory at which he had until very recently worked. It was shuttered now, and a note on the gate told former workers they should go to the local party office, where they would receive some compensation. Xiao shrugged, and headed off, relieved that he'd at least get something.

Dongguan, in the coastal province of Guangdong, was arguably the epicenter of what Western economists now call the China Shock: the massive impact, for good and for ill, of Beijing's emergence as the world's factory floor. It became, in the years since China's economic opening to the world, home to factories that made almost everything imaginable—and, for the most part, exported those goods to the rest of the developed world.

That is why Dongguan was in turmoil when I visited back in 2009, and why Xiao no longer had a job. A financial crisis in the United States, half a world away, had laid waste to the world's largest economy, and that meant export-dependent China—Dongguan in particular—was in serious trouble. In fact, Xiao was one of the lucky ones—he and his small family got some compensation, with which they financed their trip back to their home province in central China, where he now runs a small business. Earlier that same day, when he and I visited that closed factory, hundreds of riot police had been summoned to break up a demonstration by workers at another factory—one whose owner had shuttered the place and got out of town, leaving nothing behind.

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Ugly incidents like that panicked the Chinese government. To placate those millions of workers whose lives were upended by what had happened on Wall Street, China went on a debt-fueled spending binge, one that's still driving its economy. No matter: The Chinese Communist Party knew that if all those workers weren't mollified, China's rulers might have been looking into an open grave.

During more than a decade living and reporting in China, nothing better illustrated for me the extraordinary impact our two economies have on each other than my trip to Dongguan—the impact of the U.S. financial crisis was immediate and devastating, and both countries are still living with its consequences. That is why Donald J. Trump's election as president of the United States, and his stated policy goals when it comes to China, are fraught with danger.

The mainstream economics professionals have already retired to their fainting couches as a result of the protectionist noises Trump made on the campaign trail and since. They were joined by the nation's diplomats and old China hands, who had a collective stroke when the president-elect accepted a congratulatory phone call on December 2 from the president of Taiwan, Tsai Ing-wen, and then tweeted about it. China insists Taiwan is a renegade province that will someday return to Beijing's mother ship, and longstanding diplomatic protocol between Washington and the PRC has precluded any contact between Taiwan's leader and the U.S.'s. (The last time a U.S. president spoke to his counterpart in Taipei was 1979.) Two days later, Trump again signaled to Beijing that it wasn t going to be business as usual when he takes office. He tweeted that China never "asked us if it was ok" to "devalue" its currency or place tariffs on U.S. exports, or to "build a massive military complex in the South China Sea" (a subject he had said little about during the campaign).

Beijing—and the rest of us—had better come to grips with the fact that this appears to be the real Donald when it comes to China policy, particularly on trade. During the campaign, he called for a 45 percent tariff on Chinese exports and a 35 percent bill on any goods exported back to the U.S. by American companies that send jobs offshore. He repeatedly bashed China for "stealing" U.S. jobs. He has, since the election, nominated as commerce secretary the businessman and investor Wilbur Ross, who in his public statements has indicated he, like Trump, views trade as pretty much as a zero-sum game: If you're running a trade deficit, you are, as Trump might put it, a loser, and if you're running a surplus—which China has for years—you're winning big. Further, one of the president-elect's "brains" on trade (though it's not yet clear if he'll have a job in the administration) is Peter Navarro, an academic whose two most recent books on China are titled Death by China and The Coming China Wars .

Putting that aside, Trump loves the place…

Punish the Impudent Laowei

The economic relationship between the U.S. and China is complicated and ill-served by shorthand versions of the current trade debate: Slap a 45 percent tariff on 'em and all's well versus Cue the references to the Smoot-Hawley tariff, here comes the next Great Depression . It's also remarkable the degree to which mainstream, free-trade economists and their fans in both politics and punditry get wrong basic things about the trade and economic relationship.

That's why the conventional wisdom about a U.S.-China trade war—that it would inevitably blow up in the U.S.'s face—is not necessarily correct. It's widely assumed, for example, that a country running an account surplus will always be in a position of strength relative to a deficit country when trade friction intensifies. But this is not borne out by facts. Michael Pettis, a professor of finance at Beijing's Tsinghua University—and one of the most clear-eyed observers of China's economy and trade relationships—says, "The historical precedents are pretty clear that during times of trade and currency war, it is the surplus countries that are most vulnerable."

Consider one of the prevailing myths about why it's foolhardy for Trump to even think about a trade war with China: Beijing owns more than $1 trillion of U.S. debt, and has over the last decade been the biggest buyer at U.S. Treasury auctions. Hillary Clinton, the smart, seasoned diplomat, once said that picking a fight with China was too risky because Beijing is "our banker." The supposition here is that should the U.S. slap tariffs on Chinese goods, the Chinese central bank would dump its Treasury bills, driving up interest rates in the U.S. and punishing the impudent laowei— foreigner.

The only problem with that theory is that it's almost entirely wrong. Beijing doesn't buy U.S. debt—or anyone else's, for that matter—either as a favor or to attain leverage in anticipation of a trade war (or worse). The Chinese buy it because they try to peg their currency, the renminbi, at a relatively fixed rate to the U.S. dollar, in order (among other reasons) to run domestic-employment-producing trade surpluses. (If Beijing recycled its surpluses into its domestic bond market rather than the U.S.'s, the value of the renminbi would increase relative to the dollar at a faster rate than China's central bank has been comfortable with over the last decade. By selling dollar-denominated debt, in other words, China would be shooting itself in the wallet.)

Should the U.S. start a traditional trade conflict—and based upon Trump's rhetoric, that seems to be his plan—the risks for the U.S. are more obvious and straightforward. Across-the-board tariffs on Chinese-made goods (even those, presumably, made there by American companies and shipped back to the U.S.) would bring almost certain retaliation against U.S. products sold in China. This is why, at a "watch party" on Election Day (Wednesday morning China time), the mood at the American Chamber of Commerce in Shanghai turned "funereal," said one participant, as it became clear Trump was going to win.

U.S. President-elect Donald Trump tours a Carrier factory with Vice President-elect Mike Pence in Indianapolis, Indiana, on December 1. Mike Segar/Reuters

The United States might not sell nearly as much in China as China sells in the U.S., but there are lots of fat targets for Beijing. In an editorial, the Global Times, a vituperatively nationalist newspaper in China, has already said, in effect, "Hey, Apple, nice little iPhone business you've got here in China. Be a shame if anything happened to it."

A minority of economists—Pettis is one—say it's possible for the U.S. to get tougher on trade in a way that would benefit U.S. workers, without triggering a trade war. They argue that a trade policy that isn't implemented "disruptively," as Pettis puts it, "through a series of hasty and clumsy interventions [could benefit] U.S. manufacturers and their workers" even more than it harms the rest of the country through higher import prices.

Ham-Handed Proposals

Pettis and like-minded economists are calling for the use of a stiletto in trade, but Trump seems more inclined to use a blunderbuss. Even some of the president-elect's supporters are a little nervous about his campaign rhetoric. China's initial surge to manufacturing prominence came in industries like shoes, textiles, luggage and furniture—industries that had already migrated from the U.S. (to South Korea, Taiwan, the Philippines). There is no trade policy that will bring back those industries. Thus, an across-the-board 45 percent tariff against Chinese goods "probably doesn't make a whole lot of sense," says Alan Tonelson, a longtime trade hawk who did a research project for Team Trump during the campaign.

Such a tariff would be the ham-handed intervention Pettis and others warn against. It would do all the bad things conventional economists warn against in protectionism: It would harm the most vulnerable, low-income Americans, who spend a bigger percentage of their budgets on clothes, shoes and furniture than do more affluent consumers, while doing virtually nothing to help U.S. employment or wage growth. It would also trigger Chinese retaliation, and thus a potentially ruinous trade war.

Trump's supporters confidently play down the notion that China would respond in kind to any moves to restrict their exports. Even though Beijing's trade surplus now represents less than 3 percent of its overall economy—down from nearly 10 percent in 2007—there is little chance, Tonelson and others assert, that Beijing would jump into a full trade war with Washington.

If Trump believes this, Americans should be worried, because it's a serious misreading of the Chinese government, and seems willfully ignorant of that most basic Asian concept: face. "The notion that Beijing wouldn't retaliate and retaliate strongly is just laughable," says a U.S .diplomat not authorized to speak publicly on trade matters. "In order to retain any self-respect [at home] they'd have to respond." And if that should happen, the possibility of an absolutely ruinous trade war (for both parties) would be very real.

Trump, of course, fancies himself the ultimate dealmaker, and it could well be that his "45 percent tariff" rhetoric is merely his opening bid; that he will sit down with President Xi Jinping, say during a two-day summit in California, as President Obama did in 2015, and figure out a way to ease tensions in what is undeniably a worsening economic relationship. But that would require a detailed discussion—and knowledge—not just of where China is now, but of where it's going. For Trump, that means making a critical choice: Does he base his policy on trying to punish China for the very real economic damage its trade in the United States has done (as outlined by a paper titled "The China Shock," published at the beginning of this year by the National Bureau of Economic Research)?

Or does he focus on where Beijing has very explicitly said it wants to go? One of the myths that trade hawks seem to believe about China is that its government can't be trusted; that it won't live up to trade agreements, and that it's real economic strategy is a well-hidden secret. Since its historic economic opening in 1978, this has rarely if ever been the case. That China would initially use its low-cost labor to succeed in export markets was obvious. So too was its more recently stated desire to diversify its economy away from export dependence. Now, Beijing is again making its economic desires transparently plain.

Consider "Made in China 2025," a document issued in 2015 by the State Council, Beijing's chief policymaking body. Among its chief goals: advancing Chinese manufacturing prowess throughout the entire manufacturing process, not just in innovation. The document sets out clear and specific measures for innovation, quality, intelligent manufacturing and green production, with benchmarks identified for 2013 and 2015, and goals set for 2020 and 2025. "This is where China is headed," says James McGregor, the Shanghai-based Greater China CEO for APCO Worldwide, a consulting firm. "The talk about 45 percent tariffs should be irrelevant. The United States needs to figure out how to respond to where China is going."

That's a lot more complicated than just applying an across-the-board tariff and declaring victory. Trump and his trade team would do well to sit down with the heads of American multinationals in China and hear how the landscape is changing for them (it's not getting better) and how the U.S. government might respond. Many American manufacturing companies, for example, have agreed to bring top-flight technology to China—if not necessarily the crown jewels—in order to be allowed to invest directly in that market. Whatever the wisdom of that may have been 10 or 20 years ago, it now seems questionable if you think Beijing's goal is to dominate virtually all phases of manufacturing in less than a decade. The Made in China 2025 plan can be read as a "go it alone" strategy for Beijing; it's in effect saying, Thank you very much for all of your foreign direct investment over the last 20 years, we'll be OK from here on—and by the way, we're going to eat your lunch.

Responding to China

What might the U.S. do in response? Dan DiMicco, the former CEO of Nucor Steel who's in charge of Trump's transition when it comes to the United States Trade Representative's office (and who many people in Trump world believe should get the job himself), argues that U.S. multinationals have been fearful of upsetting the Chinese government because they've been "understandably fearful of retaliation.'' But now, if "China is going to undermine the investments Americans make and kick us out as soon as it can," the Fortune 500 crowd needs to let the U.S. government reciprocate: look with a very skeptical eye at any Chinese direct investment in the U.S. by a state-owned company. Make acquisition of U.S. high technology companies off-limits, something the Obama administration has already been doing. (In the summer of 2015, according to sources in both Beijing and Washington, the administration quietly made it plain that a Chinese company's interest in Micron Technology, a Silicon Valley producer of microchips, was not appreciated.) In other words, Chinese companies are aggressively trying to set up shop abroad (Beijing calls it the "going out" policy), and the U.S. should make that a difficult proposition if American companies are treated unfairly in China.

Calibrating an effective response should preoccupy the trade warriors in Trump's administration. American, Japanese, German and South Korean companies are still the global pacesetters in manufacturing and services, and China's goal of surpassing all of them by 2025—while perhaps overly optimistic in terms of timing—should not be dismissed as fanciful government propaganda. "They're dead serious about it," says APCO's McGregor. Making sure U.S. companies maintain their competitive edge should be the focus of U.S. trade policy. And you can't do that, nearly all agree, by retreating into a protectionist shell.

That, ironically enough, was one of the reasons President Obama pushed for the Trans Pacific Partnership. Whatever its flaws, it was an ambitious trade agreement, negotiated with our allies, that excluded Beijing. Together, Donald Trump and Hillary Clinton killed TPP during the campaign by bashing it. Now, Beijing has moved in with its own Asia-Pacific free-trade proposal, and not surprisingly, countries from Australia to Japan to South Korea—all of which wanted the U.S.-led TPP—are listening.

Is an Asian trading bloc dominated by China going to be better or worse for the U.S. than the TPP would have been? Do you have to ask?

Trump was not wrong to campaign on the issue of trade. It resonated with a lot of economically insecure voters. The problem is, his solutions to America's trade problems are worse than the problems they're supposed to fix. They could produce the same kind of pain on both sides of the Pacific that were felt in the wake of the 2008 financial crisis. With his campaign over and won, Donald Trump now needs to get smart on trade. The question is, can he?

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