Saturday, May 18, 2019

New Cold War: Containing China is a dumb policy

At current prices combined US-China GDPs of $21.3trn & $14.2trn is 41% of global GDP of $87trn in 2018. Using Purchasing Power Parities the International Monetary Fund estimates China's value at 19trn & US at 15trn. China had been the world’s biggest economy for about 2 millennia & in the 1890s was overtaken by the United States.

Martin Wolf, chief economics commentator of the Financial Times, this week quoted lines from a poem by Robert Frost (1874-1963), an American poet, “Some say the world will end in fire/ Some say in ice.” Wolf said these lines "capture the world’s possible economic prospects. Some warn that the world of high debt and low-interest rates will end in the fire of inflation. Others prophesy that it will end in the ice of deflation." The more present economic danger this week is addressed in a special report in The Economist and David Rennie, the Beijing bureau chief and author of the Chaguan column on China, writes, "If a vengeful America wants to hurt China, there are few incentives for Chinese officials to propose imaginative concessions or urge reforms that might repair ties with America. In geopolitics as in marriage, contempt is an emotion that leads to bad outcomes."

Trade dispute

America has had persistent deficits in trade, the annual budget (balance between public spending and revenues) and the current account of the Balance of Payments for decades while the savings rate has also fallen (see below). These trends have boosted the demand for imports.

The global role of the dollar is also an important factor and according to J.P.Morgan Chase, the US bank, in February, "foreign investors now hold $28trn in dollar-denominated assets — 130% of US GDPwith an additional $1.6trn to $2trn arriving annually. Over the past decade, these investments have increasingly shifted toward the private sector. Despite worries about foreign banks hoarding massive reserves of US Treasurys, almost 80% of overseas holdings are now in private instruments like corporate bonds, equities and direct investment into American companies."

“I want a dollar that’s great for our country but not a dollar that’s prohibitive for us to be doing business with other countries,” Trump said in March.

Foreign capital inflows reduce funding costs but rather than hiking tariffs, restrictions could be applied to inflows.

The high value of the dollar dampens exports while reducing the price of imports.

Donald Trump is not noted for strategic thinking and he is obsessed with the goods deficit in particular.

There are also services and as US multinationals have many more majority-owned foreign affiliates compared with foreign-owned affiliates in the US, there are substantial sales made overseas by US firms (see at bottom of page).

Official data show that the US had a goods deficit of $891bn in 2018 and a surplus on services exports of $270bn, resulting in an overall deficit of $621bn — 3% of 2018 GDP.

US goods and services trade with China totalled an estimated $737.1bn in 2018. Exports were $179.3bn; imports were $557.9bn. The US goods and services trade deficit with China was $378.6bn in 2018.

China is currently America's largest goods trading partner with $659.8bn in total (two way) goods trade during 2018. Goods exports totalled $120.3bn; goods imports totalled $539.5bn. The US goods trade deficit with China was $419bn in 2018.

Trade in services with China (exports and imports) totalled an estimated $77.3bn in 2018. Services exports were $; services imports were at $18.4bn. The US services trade surplus with China was $40.5bn in 2018.

Technology containment

There is bipartisan support in Washington for containing China's goal to become a leader in high tech rather than an assembler. Pentagon war planners who fear the US will eventually have to abandon the Western Pacific, also fan the flames of paranoia.

However, Trump's 'America First' reflex has resulted in thrashing his allies and invoking national security as a cover for trying to snuff out China's commercial goals, will not get blanket support from Europe and Japan.

Containment is a dangerous zero-sum strategy that would heighten enmity. It would involve the world's two biggest economies and compared with the past, there were little economic bonds with the Soviet Union while trade frictions between Japan and US in the 1970s and 1980s were with a country that needed an American security shield.

On Wednesday this week, the White House and US Department of Commerce introduced an effective ban on Huawei, the Chinese telecoms company that is a global leader in 5G mobile technology, from selling technology into the American market, and which could also prevent it from buying semiconductors from suppliers including Qualcomm in the US, that are important for its production.

The FT said that "In an internal memo to employees seen by the Financial Times, He Tingbo, chief executive of HiSilicon, Huawei’s wholly owned semiconductor subsidiary, wrote: “All the spare tyres we have built have turned to Plan A overnight.

The FT said, [Ms He added: “Today, the circle of destiny turns to this extreme and dark moment, the Superpower has mercilessly interrupted the technical and industrial system of global co-operation, made the most insane decision, put Huawei into the Entity List with no founded basis.” HiSilicon, which has 7000 employees, came into focus about four years ago when it began making chips for smartphones. Last year, the unit produced more than $7.5bn worth of chips, rotating chairman Eric Xu told Reuters.]

The FT also reported that Oracle, the US software giant, said this month it was firing 900 staff from its China team, making up 60% of its research and development effort in China.

The sour relations between China and Japan in recent years have thawed since Trump's trade war began and this week in Tokyo, Shinz┼Ź Abe (r), Japan's prime minister, received a member of the Chinese leadership and they discussed trade and regional issues.

There are legitimate investment and technology issues that should be discussed by G7 member industrialised countries (US, Japan, Germany, UK, France, Italy and Canada) with China. A Brookings Institution commentary noted last January:

"Multilateral approaches to deal with China have been non-existent. The United States pulled out of the Trans-Pacific Partnership trade agreement (TPP), which was designed to address many of the issues raised by state capitalist systems — state enterprises, intellectual property right protection, investment openness, to name a few. The United States has been undermining the World Trade Organisation (WTO) by refusing to appoint new appellate judges. While the WTO’s record has been disappointing in holding China to the letter and spirit of its commitments, partners such as Japan and the EU would like to strengthen its capacities, while the United States is rendering it increasingly irrelevant.

The inconsistency and failure of US economic diplomacy towards China flow in part from a lack of consensus on objectives."

The “Century of Humiliation” – a period between 1839 and 1949 when China's government lost control over large portions of its territory at the hands of foreigners – is viewed as a key touchstone of modern China's founding narrative. The Communist Party today makes sure that every Chinese citizen is aware of this history and the fear of the perception that the leadership surrendered to Trump's bullying, would be a bridge too far.

Lord George Macartney, a native of Antrim and graduate of Trinity College Dublin, in 1773 wrote a book on his period in office as chief secretary of Ireland. He was a member of both the Irish and British parliaments and he made clear that Ireland formed part of “a vast empire on which the sun never sets and whose bounds nature has not yet ascertained."

Twenty years later, Lord Macartney was in China as the British envoy, seeking an agreement on trade as Britain in the first decades of the Industrial Revolution sought to have China open its market for its manufactures and agree to diplomatic relations.

Through conquests in the 17th and 18th centuries China had doubled in size and according to Kenneth Pomeranz’s book ‘The Great Divergence: China, Europe and the Making of the Modern World Economy’ (2000), there were areas like the Yangzi delta, around modern-day Shanghai, where the standard of living before the Industrial Revolution was comparable to some wealthy areas in Europe.

The Macartney visit in 1793 was the most important Western mission to China since the 21-year old Venetian Marco Polo, together with his father and an uncle, in 1275 met China’s colonial ruler, Kublai Khan — a grandson of Genghis Khan — at the Grand Khan’s summer residence in Shangdu, Inner Mongolia (immortalised as Xanadu by English poet Samuel Taylor Coleridge), north of the Great Wall.

In a letter from Emperor Qianlong to King George III issued after meeting Macartney, the Chinese rejected all British demands on trade. “I have already taken note of your respectful spirit of submission, have treated your mission with extreme favour…our Celestial Empire possesses all things in prolific abundance and lacks no product within its own borders. There was, therefore, no need to import the manufactures of outside barbarians in exchange for our own produce.”

Britain eventually succeeded in getting official access in China for Indian opium, which involved two wars and in 1860 with the involvement of French forces, the Western troops sacked and burned the magnificent Summer Palace, northwest of Beijing. Read here on how the British and Dutch operated the world's top drugs cartels in the past.

America's poor economic record

The US last had a goods trade surplus and overall goods + services surplus in 1975. Services have been in surplus since 1971. The current account of the Balance of Payments which in addition to trade balances tracks movements of capital and investments has only been in surplus in 3 years in the last 39 since 1980.

With the exception of the 4 years 1998-2001, the US has run an annual budget deficit every year since 1969.

With a strong economy and another "self-financing" tax cut of $1.5trn pushed through Congress by Republican apostles of fiscal responsibility, trillion dollar budgets deficits have arrived, and in 2019 the deficit will be equivalent to 5% of economic output.

In the 2019 fiscal year for the first time since 1947, the gross federal debt to GDP ratio will be 107% or above. Since 1940 it peaked at 119% in 1946 — the first year after the Second World War.

In the decades before 1980, the US average saving rate of disposable income was 11%; it fell as low as 2% in 2005. Credit has been easier to get in recent decades and income inequality has made saving more difficult for people with low-income rises.

Even though foreign investors now hold $28trn in dollar-denominated assets — 130% of US GDP — which are a counter to chronic US deficits, the position of the dollar as a safe-haven currency isn't going to change soon, in contrast with sterling.

In January 2016 Mark Carney, governor of the Bank of England, warned of financial instability, higher interest rates, and capital flight if Britain voted to leave the EU, saying the country could not depend on “the kindness of strangers” to fund the country’s deficits — "Whoever you are, I have always depended on the kindness of strangers," is the final line from the character Blanche as a doctor leads her away to a mental institution, in the Tennessee Williams' play 'A Streetcar Named Desire' (1947). It is a cruel and tragic irony.

The Financial Times reports that Wall Street is finding new ways to make money off America's poorest:

"In America, trailer parks are a fragmented, 'mom and pop' business, making them ripe targets for consolidation. They are also a shorthand for 'poor' — most people who live in them are part of households earning less than $50,000 a year. Some 22m individuals live in trailer parks; roughly 1 in 15 Americans. Most own their trailers, which depreciate just like cars, but rent the land underneath them, since traditional mortgages on such properties aren’t available.

For investors, trailer parks are cash cows. They offer relatively strong and steady returns of 4% or more — around double the average US real estate investment trust return, according to research data cited in a recent report on the topic by the Private Equity Stakeholder Project and two other non-profit consumer advocacy groups."

Last April John Oliver on HBO said mobile homes may seem like an affordable housing option, but large investment companies are making them less and less so. There is a slight difference between mobile homes and trailers but the majority of them remain immobile.

In February 2019 John Oliver covered the issue of con artists called psychics (YouTube). Early in the segment, the comedian cites a stunning October 2018 poll from the Pew Research Center that found 40% of Americans believe in psychics, helping fuel a $2.2bn industry.

Global role of US multinationals

US multinational firms contribute significantly to US income inequality through 1) massive tax avoidance 2) foreign sales from overseas affiliates where profits are channelled back to the US to benefit the hedge fund and shareholder classes.

According to statistics released by the US Bureau of Economic Analysis (BEA) on the operations and finances of US parent companies and their foreign affiliates, global employment by US multinational enterprises (MNEs) was 42.3m in 2016, almost unchanged from 2015.

Employment in the United States by US parents was at 28.0m workers in 2016 — 22.3% of total private industry employment in the US and accounting for 66.3% of worldwide US MNE employment. Employment abroad by majority‐owned foreign affiliates (MOFAs) rose 1.2% to 14.3m workers.

Employment abroad by MOFAs was largest in China (1.9m); United Kingdom (1.5m); Mexico (1.4m); India (1.2m); Canada (1.2m) and Ireland was at (121,000).

Majority-owned US affiliates (MOUSAs) of foreign multinational enterprises (MNEs) employed 7.1m workers in the United States in 2016 MOUSAs accounted for 5.6% of total private-industry employment in the US.

In the European Union, 18% of employment in German domestic enterprises worked in foreign affiliates in 2014 according to Eurostat. The rate was 36% for French companies.

Global research and development expenditures of US MNEs were at $350.3bn in 2016 and US parents accounted for 85% of the total — countries such as the UK and Ireland with a high dependence on foreign direct investment compared with for example Germany and Denmark, inevitably struggle with local innovation.

In Greater China (mainland, Hong Kong and Taiwan), a fifth of Apple’s global iPhone sales are made, while General Motors sells more cars in China than it does in the United States. The main components of the iPhone come from South Korea, Japan and Taiwan and the total export value to the US is treated as a Chinese export.

In recent years total sales by US affiliates have been valued at $1.4trn or more annually.

Deutsche Bank economists said last year that the bilateral trade balance is misleading because (1) it does not capture the sales of goods and services by foreign firms' local subsidiaries (the FDI channel); and (2) countries such as Japan and Korea have large businesses in China that export to the US.

[US firms sold $372bn of goods and services to China in 2015, while Chinese firms sold $403bn to the US. The net balance, which we defined as "aggregate sales balance", is a surplus of $30bn from China's perspective, much smaller than the $367bn bilateral trade balance. We estimate that from the US perspective, this balance has turned from a deficit of $30bn in 2015 to a surplus of $7bn in 2016 and $20bn in 2017.]

According to US Bureau of Economic Analysis, data on sales of goods and services in China by majority US-owned affiliates were at $479bn in 2016 while sales in the United States by majority China-owned firms were valued at $61bn.

Deutsche Bank says in a 2018 report:

Our studies show that while the US remained in trade deficit, US companies have sold more to the rest of the world than other countries have sold to the US for every year in the last 10 years: the US aggregate sales balance rose from a $0.2trn surplus in 2005 to a $0.9trn surplus in 2015. US multinationals do not sell more in every country than their counterparts do in the US. There is asymmetry: US corporates operate all over the world, but not all corporates operate in the US. Foreign subsidiaries in the US are mostly from Japan, Canada, and a few European countries. In contrast, emerging market corporates generally have limited presence in the US. Interestingly Mexico and Canada show a pattern similar to what we see with China – they ran a bilateral trade surplus against the US, but a bilateral deficit against the US once US multinationals' sales in these countries are taken into consideration. Japan and Germany ran a surplus against the US in both trade balance and the aggregate sales balance. These bilateral balances reflect comparative advantages: US multinationals tend to localise their production only in countries with lower costs (China, Mexico and Canada).

Even estimating Balance of Payments data between the EU and the US results in a huge difference and a German economist argues that Eurostat's data lack credibility.