China just showed why Trump can’t win with tariffs

Editor’s note: CPA’s idea of managing capital flows as probably the only way to achieve a trade balance is gaining traction from new sources. The author is sloppy and incorrect in his tariff analysis. The US needs to use tariffs and manage the dollar, not just one or the other. They are different tools for different objectives.

China opened up a new front in President Trump’s trade war on Monday, sending Wall Street into a tizzy.

[Jeff Spross | August 5, 2019 | The Week]

Basically, China’s central bank adjusted the value of its currency down to its lowest point in over a decade. Investors, fearing President Trump will respond with another tariff escalation, reacted by fleeing stocks for the safety of bonds and Treasuries — causing the S&P 500 and the Nasdaq to fall 3 percent and 3.5 percent, respectively, by the end of the day. And they’re likely right. Yet it’s also the case that the low value of the renminbi versus the U.S. dollar really is a problem worth addressing.

So is there any way America can combat China’s currency machinations without a tariff war and the ensuing market panic? It turns out, there may be.

Right now, as we all know, Trump is relying on tariffs to carry out his trade war. The primary strategy here is to browbeat China into accepting various reforms. But thus far, China hasn’t been overly inclined to cooperate, and Trump’s tariff threats keep escalating: He’s already imposed 25 percent tariffs on $250 billion worth of Chinese exports to the U.S. And last week, he threatened a 10 percent tariff on another $300 billion worth, which would basically make every last dollar of Chinese exports subject to U.S. duties.

The drop in China’s currency is a problem for this strategy because it largely neutralizes the pain of Trump’s tariffs. The whole idea behind the tariffs is to raise the cost of Chinese exports in the domestic American market, so that Americans buy less of them. But a fall in the value of China’s currency lowers the cost of those exports for Americans, thus offsetting the tariffs’ effect. Indeed, the People’s Bank of China explicitly said the new, lower value target was retaliation for the “unilateralism and trade protectionism measures and the imposition of increased tariffs on China.” Trump promptly took to Twitter to rage about “currency manipulation.”

The thing is, the Trump administration hasn’t come up with any responses other than to impose even more tariffs on Chinese exports to punish drops in the renminbi. Beyond simply repeating the same strategy and hoping for a different outcome, this perpetual upward ratchet of tariffs is precisely what freaks out the markets. Tariffs disrupt specific industries with specific supply chains, invite retaliatory tariffs that do the same, and generally cause a great deal of headaches for investors.

Beyond all that, Trump’s tariffs have also failed to rebalance the flow of trade between the U.S. and China — ostensibly the larger goal of the president’s economic confrontation with our neighbor to the east. Our trade deficit with China has actually increased since Trump’s trade war commenced.

Bottom line: the tariffs have brought a lot of pain for both sides while achieving little. Trump needs an alternative. And several are readily available.

When China’s central bank engineers a drop in its currency, what it’s doing in concrete terms is buying up financial assets denominated in U.S. dollars. That increases demand for the dollar, hiking its value relative to the renminbi. Bringing the two currencies back into a closer balance requires responding to those purchases in some fashion.

One option is to discourage the buying. For example, the U.S. government could impose a fee or tax on all foreign purchases of U.S. assets. Instead of slapping a tariff on Americans buying Chinese goods and services, we’d essentially slap a tariff on Chinese buyers purchasing U.S. financial instruments. Sens. Tammy Baldwin (D-Wis.) and Josh Hawley (R-Mo.), for example, just put forward a billthat would give the Federal Reserve a new additional mandate to balance America’s trade flows with the world within five years. And the tool they give the Fed to do this is a new fee to be imposed on all foreign purchases of U.S. stocks and bonds and so forth — effectively making it more expensive for China to engage in this sort of manipulation.

Now, Wall Street would probably hate this idea. To a certain extent, wealthy investors don’t like any government efforts to intervene in trade flows because they just want to be left alone. But it should have minimal effects on the real economy. America is awash in cheap financial capital with or without Chinese investors.

Another option is to get even more surgical: America could buy up Chinese financial assets until the effect of their purchases of our assets are counterbalanced. In short, if China (or anyone else) raises the value of the U.S. dollar relative to their currency by creating demand for our assets, we can raise the value of their currency relative to ours by buying their assets, and neutralize the whole affair. Indeed, the easiest way to do this might be to take the same route Baldwin and Hawley did: Direct the Federal Reserve to bring our trade flows into balance by buying up financial assets denominated in China’s renminbi, or in the currency of any other country our trade flows are out of whack with due to these sorts of interventions.

This would be even less disruptive than charging a fee for foreign purchases of our assets. Investors here and around the world could still buy whatever they wanted without interference; the Fed would simply be participating in the global markets with more strategic intention. As for the real economy, business models and supply chains would simply adjust to changing currency rates, which — in our ostensible global free market for currency exchanges — they already do.

Finally, these aren’t just tools for prosecuting a trade war with China. They are tools for reforming America’s trade flows with the entire world. Estimates suggest the U.S. dollar needs to fall by anywhere from 6 percent to 30 percentto resolve our trade imbalances with the globe. Tariffs are, at best, a horribly indirect method of adjusting currency values, and they do a lot of collateral damage. There are better ways to cut to the heart of the matter.

Read the original article here.

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