© FT montage; Dreamstime

Donald Trump earned ridicule for declaring on Twitter that for the US, a trade war would be “easy to win”. But economists say there is some truth to the observation that in a trade war, deficit countries hold an advantage over those with trade surpluses.

China’s trade surplus swells its economy each year, while net imports subtract from the US growth. From this perspective, economists say Mr Trump is correct that he has less to fear from a decrease in trade with China than President Xi Jinping.

However, White House actions to date have offered little reason to believe that Mr Trump and his advisers understand how to play to their own advantage. 

“In principle, trade war is something that deficit countries with diversified economies should win and surplus countries always lose. So it’s not really an even battle,” says Michael Pettis, finance professor at Peking University’s Guanghua School of Management.

“That’s not to say that deficit countries can’t screw up, and unfortunately, the approach that the US is taking isn’t really going to address the deficit.” 

A graphic with no description

Understanding why surplus countries typically fare worse requires stepping back from a focus on specific products such as soyabeans or steel and understanding the macroeconomic forces that create trade surpluses and deficits.

A basic economic principle states that the balance between exports and imports corresponds to the difference between national savings and investment. Economists generally see the latter balance as more significant: the savings-investment gap determines the trade balance, rather than vice versa. 

On this view, specific trade policy measures are mostly distractions. A steel tariff will cut steel imports, but if the savings-investment balance cannot adjust, other imports will rise correspondingly, leaving the overall trade balance unchanged.

For the US, closing the trade gap requires more savings relative to its level of investment. Fiscal policies designed to increase US savings would help, though recent deficit-financed tax cuts and spending increases push in the opposite direction.

“Tariffs won’t have much impact on a country’s overall trade balance. As long as US demand is rising while the economy is near full capacity, we’re going to be importing from somebody,” says David Loevinger, former senior co-ordinator for China affairs at the US Treasury and now managing director of emerging markets sovereign research at TCW Group. “It’s like a water balloon. If you restrict one end it just flows somewhere else.”

Beyond fiscal policy, the US could restrict the ability of China and other surplus countries to finance American deficits through purchases of US Treasuries and other dollar assets.

The imposition of capital controls would be a fundamental repudiation of the US commitment to financial openness and liberalised capital flows, which underpin the dollar as a global reserve currency. Yet there are few signs that Mr Trump or advisers care about such things, especially now that globalists led by Gary Cohn have been sent packing

A trade war fought this way would inflict significant pain on China and bring some benefits to the US.

Wei Li, senior China economist at Standard Chartered in Shanghai, estimates that a broad-based trade war between the US and China would cost China 1.3 per cent to 3.2 per cent of GDP, with the latter estimate representing an extreme scenario in which the US bans all Chinese imports. For the US, the comparable loss would be 0.2 per cent to 0.9 per cent.

For an example of how a trade war using capital controls might be fought, one need look no further than China in the 2000s.

Chinese foreign exchange controls are designed to restrict capital flight, while the country increasingly opens up to foreign inflows through its stock and bond markets. But when China’s surpluses were at their peak a decade ago — the current account surplus hit nearly 10 per cent in 2007 before falling to 1.4 per cent by 2017 — China blocked financial inflows to domestic financial markets.

“Any kind of capital flow restriction is ultimately a way of managing trade imbalances,” says Mr Pettis. 

Donald Trump (left) and Xi Jinping
Trump and Xi: the US could restrict China and other surplus countries to finance American deficits through US Treasuries and other dollar assets © Reuters/AFP

The difficulty for the US is that capital controls cannot feasibly be deployed only against “ strategic competitors” such as China. Military allies Germany and South Korea are also big contributors to the US current account deficit.

This is where China sees its protection from the ravages of global trade war. Arthur Kroeber of Gavekal-Dragonomics, a Beijing-based research group, says China’s focus is to isolate the US to prevent allies such as the EU and Japan from entering the fray.

“China knows it can hold its own in a commercial conflict with any individual rival, including the US. But a concerted effort by the industrial democracies to constrain China’s mercantilist development programme would cause it much more pain,” he wrote last week. 

Mr Kroeber saw German Chancellor Angela Merkel’s recent agreement with Mr Xi to co-operate on steel overcapacity as a “German rejection of US efforts to bully it into an anti-China alliance”.

China’s other main point of leverage is the reliance of US companies on China’s huge domestic market. Such dependence does not show up primarily in figures on goods trade but rather in services as well as corporate earnings by the local units of US companies such as Apple, General Motors and Caterpillar

US businesses are vulnerable to myriad forms of disruption, much of which would likely occur through regulatory harassment. China Inc, by contrast, remains more domestically focused, despite a recent wave of outbound investment. 

“There are so many ways that the Chinese can slow or block your business,” says William Zarit, chairman of the American Chamber of Commerce in Beijing. “The unwritten rules will often trump any written guidelines. They won’t certify your product, they look at your taxes, maybe they even start looking at visas,” he says.

Follow @gabewildau on Twitter

Get alerts on US-China trade dispute when a new story is published

Copyright The Financial Times Limited 2019. All rights reserved.
Reuse this content (opens in new window)

Follow the topics in this article