Trump’s trade war may spark a Chinese debt crisis


There’s no chance China will cut its trade surplus with the US in response to President Donald Trump’s tariff threats. For starters, Washington has made no specific demand to which Beijing can respond. But its efforts may have an unexpected side effect: A debt crisis in China.

The 25% additional tariffs on exports of machinery and electronics looked, at first blush, like a stealth tax on offshoring. The focus on categories like semiconductors and nuclear components, in which US-owned manufacturers in China are strong, recalled Trump’s 2016 promise to tax “any business that leaves our country”.

It seems, though, that offshoring wasn’t the target after all. Now, with the imposition of new tariffs on low-value exports that mostly involve Asian value chains, the simple fact of selling cheap products that the US buys has become the problem.

Either way, the administration appears set on shrinking its current-account deficit (which, at a moderate 2.4% of gross domestic product (GDP), is far lower than the 6% clocked in 2006-7) just as the US Federal Reserve raises interest rates. Distress has already been registered in China. On July 13, the yuan hit 6.725 to the dollar, the weakest in a year and 5% lower than at the end of May.

Such a move is nothing earth-shaking for less controlled currencies. But a stable yuan is a key plank in the leadership’s promise to its people, and the exchange rate is tightly managed by the central bank.

Chinese investors have been buying official assurances for a year that the yuan would be a fortress, but now they’re not so sure and are exporting money again: May saw net capital outflows and a decline in the foreign-exchange reserves. The currency is the most visible sign of slip-page in the image that China tries to project of an economy so brilliantly managed that the bright sun of GDP expansion is untroubled by even temporary clouds on trade, employment or consumption.

There are many other signs: The Shanghai Composite Index of stocks has declined 7% in a month, drop- ping below the government’s red line of 3,000 for the first time since September 2016. Corporate bonds are about to set a record for the most defaults in a year. Junk bond yields are spiking. The chorus of anxiety about debt is reaching a crescendo, with daily press reports on governments that can’t pay their employees or meet pension obligations. Property prices are tumbling in some cities and frozen in others whose governments have placed a finger in the dyke by halting transactions.

That the massive burden of debt will drag the economy into recession is as obvious as the empty towers that rise on every landscape. Precise estimates are difficult, since the government’s dedication to the optics of invincibility induces financial institutions to push debt into alternate, opaque channels. But on any metric, the amount of new lending each year grows faster than the economy, and the interest newly owed exceeds the incremental rise in GDP. In other words, the whole economy is a Ponzi scheme.

Many analysts point out that the Chinese government owns everything, including the banks, and can just issue yuan to infinity to keep the economy solvent. The flaw in that argument is China’s role in the global economy: It’s the world’s biggest exporter and second-biggest importer. The currency acts as the interface between the domestic and international economies, and its value is a matter of supply and demand.

The Ponzi economy has been sustained by cheap dollars coming in through legitimate or illegitimate channels, and the problem now is that structural surpluses are disappearing and there is less “hot” money from the US seeking yield. When dollars enter, the central bank buys them and issues yuan. If it has to issue more than is justified by the amount of inflows, it creates inflation, and inflation, which has toppled or almost toppled governments from the Ming dynasty to Tiananmen, is the third rail of Chinese politics.

That brings us back to Trump and his trade war. The fundamental idea underlying this salad of a trade agenda is an old one from the right wing of the Republican Party, which believes that the US has paid too dearly for its postwar leadership role under the Bretton Woods regime; putting America first means America marching alone.

The dollar standard, and not trade policies, underpins the global system of commerce. The US runs trade deficits as a consequence of its desire to own the currency that dominates global commerce, not as a casualty of predatory policies by China. The rise of the gold standard in the second half of the 19th century was the key foundation for the expansion of global trade. Its collapse, starting in 1913, drove a trade implosion.

After Bretton Woods, the dollar took over as a global standard, and, when former President Richard Nixon made the greenback no longer redeemable for gold, it was freed to become a pure fiat currency. That meant that the US could project any level of currency around the world to support its national economic growth and lifestyle improvements that exceeded productivity gains. No wonder China wishes the yuan could do the same.

It is tempting to see the recent yuan depreciation as a strategy to blunt the effect of US tariffs, but really, the capital account is of much greater import to China Inc than the current account. China’s central bank will almost certainly try to pull back the exchange rate in the near term: Authorities care more about the pile of reserve gold, successful stock-exchange debuts for Xiaomi Corp and Ant Financial Services Group, and lucrative bond issues than about the private and largely foreign-owned companies that dominate exports.

The truth is that China has followed a mercantilist trading policy since Mao Zedong. Most significantly, the investment splurge in the reform years helped political elites rake billions off the forced savings of the Chinese people. That was enabled by incoming capital, and there is no indication that will change.

Until now, China has managed to keep its huge raft of nonperforming debt afloat thanks to capital inflows, as successive waves of quantitative easing pushed dollars into the world. A tighter dollar would seem to make the bursting of China’s credit bubble an inevitability. When that happens, the yuan will have to depreciate sharply. This will have a deflationary impact on the world. It will also lead to a decline in China’s share of global GDP, dramatically reduce the nation’s demand for commodities, and diminish its role on the international political stage.

Much about Chinese trade practices is genuinely unfair. But the inequity flows as much from US policy favouring big corporations at the expense of workers as it does from Chinese structural subsidies. Both are difficult problems to address — much harder than penalising exports. No one will benefit when China shrinks and turns inward. Trump should be careful what he wishes for. — Bloomberg

  • This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.