Bull in a China shop

July 13 2018 by Nick Ferguson

He might lack finesse and respect for the norms of international diplomacy, but Donald Trump is a virtuoso bully — and that might be just what is needed in dealing with China, according to Allianz’s chief economic adviser, Mohamed El-Erian.

The US certainly has plenty of legitimate grievances with how China conducts trade, including intellectual property theft, asymmetrical technology transfers and non-tariff barriers, such as the requirement that foreign companies enter joint-venture agreements with domestic firms to access the Chinese market.

Trump’s latest salvo in the escalating trade war was a threat this week to impose tariffs on US$200 billion of Chinese imports — far more than the US$130 billion of US imports to China.

The aggressive rhetoric has been widely criticised both by economists and political analysts, who worry that the risks are far too high. If China doesn’t cave under the pressure, the effect of tariffs on Chinese imports would almost certainly be a slowdown in economic growth and higher prices — a catastrophic outcome.

But El-Erian is confident that the US has a stronger hand than many seem to accept.

“A trade war would damage all economies,” he conceded in an op-ed article shared on Project Syndicate. “But the US — which is relatively less dependent on foreign markets, possesses deeper domestic markets and is generally more economically resilient than other countries — would do better than most others in a contracting world economy. Already, Chinese financial markets have suffered, while those in the US have held their own.”

Indeed, the former co-chief investment officer and chief executive of Pimco compares Trump’s approach to that of Ronald Reagan’s arms race with the Soviet Union — a costly escalation of military spending that only the US could ever win.

However, El-Erian does not draw a line from that victory to the current state of relations between Russia and the west. The US might be able to win a trade war against China, but at what cost in the long run?

Certainly China has shown signs of conceding ground, including in the insurance sector. Speaking on a panel at the Boao Forum for Asia in April, Yi Gang, China’s central bank governor, said that foreign ownership limits in life insurance companies would be raised to 51% by the end of June as part of a wider package of policies aimed at further opening the country’s financial sector to foreign investors. The central bank also said on its website that it would remove the foreign ownership cap completely within three years.

“The greater detail on the timing of implementation may indicate China’s desire to avoid an escalation in trade restrictions and to boost market confidence that the announced measures to open up the market will be adopted in practice,” said Moody’s in a note on Wednesday.

Given its slowing economy, falling stock market and weakening currency, China has a lot to lose and on Thursday showed further signs of a shifting tone when it responded to Trump’s US$200 billion tariff threat with less aggressive rhetoric than in the past, promising “necessary” steps rather than a previous promise to match US tariffs.

“Game theory suggests that rational actors, recognising how damaging a trade war would be for them, would see the merit of abandoning a retaliatory strategy, and instead accede to many US demands,” says El-Erian. “All of this could leave the US more able and willing to halt the multi-year erosion of its global economic influence and standing.”

As was the case under Reagan, the Trump approach is more stumbling than strategic, but the end could justify the means. At least in the short term.

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