Vimal Gor

Head of Income & Fixed Interest

Donald Trump is fighting fire with fire

You’d be surprised how easy it is to take for granted the state of the world that you know.

You thought everything was fine, but then the GFC happened. Luckily, central banks covered up the mess with a put and plenty of liquidity.

You believed in the status quo, and then Brexit happens. Populism and nationalism have been ‘on trend’ ever since.

You never questioned the idea that global free trade is good, yet Donald Trump has started a trade war. He might just put the nail into the WTO coffin whilst he’s at it. Seismic shifts are happening right beneath our feet. Globalisation, it seems, can go no further in its current form.

Through all of this and more, China has remained the one constant. For all the talk of reform and economic transition, the recent shift towards domestic easing policies highlight that the old economic model remains dominant. This model has relied on a largely closed-economy system, with a currency that has been artificially kept weak over the last 30 years to support a flourishing manufacturing exports sector.

Cross-border capital flows have not been permitted, thus allowing the Chinese authorities fuller control over the financial system. This control has directed cheap credit to various industries from steel and cement to solar and high-speed rail. Debt-fuelled fiscal stimulus has been used to support growth at every turn.

What’s more, this model exists under a one-party socialist government. We in the West tend to view planned economies with disdain. There is a certain arrogance about governments who believe they can do a better job of allocating resources than the pure signal of market prices. The bad-debt problems now sitting with a swathe of zombie state-owned enterprises (SOEs) in China is case in point.

However, survival of the Chinese Communist Party and the political order that goes with it depends on continued economic progress, and its ability to carry the entire population along. This is a key point of difference between China and other socialist regimes such as Venezuela that have ended in suffering and demise.

Over the last 30 years, through its own poverty alleviation efforts, China has contributed as much as 70 per cent to global poverty reduction. Socialism with Chinese characteristics seems to offer a template for pragmatic implementation of the socialist agenda.

Since World War II, the US has tried to spread the liberal world order across the globe. By inviting China into the WTO, it was hoped that this spread could continue. Instead, whilst Chinese exports have hugely benefited from WTO membership, its industrial and political practices have moved even further away from liberal Western ideals.

The allure of the sheer size of the Chinese market has forced foreign firms to surrender their intellectual property. In return, they get to sell to and operate in China. Under the cover of subsidised cheap debt and de-facto protectionist policies that have limited the force of international competition on Chinese firms, ‘indigenous’ national champions have risen in various sectors across the Chinese economy (alongside many zombie companies to boot).

And if it can have its way, these continued practices to circumvent the spirit of international trade law would enable the success of its Made in China 2025 plan.

But the US has put its foot down. Among other things, Trump is viewed as the disruptor of global free trade. Tariffs and tweets are like hand grenades to him, thrown around to shake up the status quo, irrespective of how and where they land. Whilst his weapons are blunt, his motivations are widely echoed across party lines.

From China’s perspective, its industrial policies have been smart, but the US thinks they have been cheating. And if China’s rapid rise in the global pecking order is down to this type of behaviour, then Trump wants to fight fire with fire.

Theoretically, there is a high road that he could take, by engaging in the rule of law and soliciting support from its traditional allies. However, knowing that the law could never deliver any necessary punch, there really was no alternative for him than to get down and dirty with the same tactics as he’s witnessed from China.

If China’s $US3 trillion foreign reserve position is a symptom of unfair currency manipulation over the last two decades, then the least that Trump could do is talk down the US dollar. If China has been surreptitiously breaking WTO rules, then Trump will turn his back on the institution entirely. And if China has used fiscal stimulus funded by a ballooning debt stock to prop up growth and various industries, then Trump will unleash the largest fiscal package ever to be witnessed outside of times of war or recession.

Is this progress? It’s hard to recognise it as such when it spells the end of globalisation as we know it. Is this creative destruction? We will only know if these protectionist policies lead to a sustainable pick up in US industrial productivity – a tall order given that this declining trend has been impossible to turn for over a decade.

This article was first published by the Australian Financial Review on 26th August 2018.

 

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