| -- | April 10, 2018 Tariff Tough Talk By Patrick Watson International trade policy shouldn’t be headline news. We just need stability, so everyone can conduct business—but that’s not where we are. Trade and tariffs are all over the news because President Trump is going after China. This vexes financial markets, which want minimal trade barriers. Regular readers know I’m not a Trump fan… but on this, he’s partly right. China hasn’t reciprocated US trade policies, and some changes are necessary. However, which policies the president attacks and how he tries to change them is important. Flawed methods usually produce flawed results. In this case, the problem is more than a flawed method. It’s flawed economics. 
Photo: Getty Images Little Pieces of Deficit The president’s tweets and public statements tell us he doesn’t like trade deficits, particularly the one with China. He seems to view it as a win-or-lose proposition. That’s not exactly right. For one, a trade deficit between two nations isn’t unusual. Precise balance would be strange. Countries have different needs, so some import more than others. Furthermore, it’s not like the side with the deficit loses anything. In this case, China gets our dollars and we get Chinese-made goods. Your house is probably stuffed with little pieces of the US-China trade deficit. Is that bad? As an economic matter, it’s just reality. - Americans want Chinese goods more than we want the dollars spent on them.
- Chinese want those dollars more than they want the goods.
It’s not about winning or losing. Everybody gets what they want. 
Photo: Getty Images Not Winning There is a wrinkle to this, though. I said, “The Chinese want those dollars,” but they’d prefer to use their own currency. Eventually they will, too, but for now we still settle our trade in dollars. Just as our homes hold Chinese goods, Chinese bank accounts hold trillions of greenbacks. That’s the other side of the trade deficit President Trump hates so much. It’s the same money. What do the Chinese do with those excess dollars? Well, they invest many of them in US Treasury securities—to the point that China is our government’s largest foreign lender. Some people see this as ominous, fearing China will dump this paper and cause a crisis. But doing so would probably require Beijing to take a big loss, and that’s not its style. The bigger danger is that China may simply buy fewer Treasury bonds. This is simple math. Chinese investors can’t buy our T-bonds unless they have excess dollars—and they won’t if the president succeeds in reducing the trade deficit. See the problem? - The US government spends way more than it collects in taxes.
- Treasury must finance the difference by selling bonds.
- Someone with dollars must buy those bonds.
- China’s dollar surplus makes it a natural buyer.
If China doesn’t buy our bonds, somebody else will… but probably at higher interest rates. Prices rise when an external force constrains supply. This will raise Washington’s interest costs and further enlarge the debt. And when Treasury rates rise, other long-term interest rates (like mortgage rates) rise too. That could make home purchases more expensive, reducing other consumer spending and maybe hurting the housing industry. So attacking this trade deficit problem—which isn’t really a problem—risks making some actual problems even worse. That’s not “winning.” 
Photo: Getty Images Burning Bridges Now, some say all of this is a negotiating tactic, that the president’s unpredictable tough talk leaves opponents off guard and sets up a “win.” Such tactics worked for Trump in private business. In fact, the president’s business skill is why many folks voted for him. He promised to negotiate great deals and had a track record for doing it. The problem: governing isn’t a business. In a transactional business like real estate, you probably won’t deal with the same counterparty again. Burning bridges behind you can make sense if you have thousands more unburned bridges in front of you. In politics, both domestic and international, you must negotiate with the same people repeatedly on different topics. If you’re unreasonable on Item A, it also affects Item B. Trade negotiations are particularly hard because so many groups have a stake in the outcome. Overt threats rarely help. They might even hurt, by sparking opposition that prevents the other leader from offering concessions. 
Photo: Getty Images Risk for Everyone Trump is right that China hasn’t always played fair. Many other nations feel the same way. That’s a negotiating tool the US could use to our advantage. As China’s biggest export market, the US has plenty of leverage. We could have even more leverage by working with China’s other top customers, primarily Western Europe. But Trump isn’t doing that. He is doing the opposite by openly threatening Canada, the EU, Japan, and other developed countries with tariffs as well. This makes it hard to ask their help against China—and even gives China an opening to seek EU support against the US. Consequently, the chance of getting significant reforms from China is lower, and the risk of a negative outcome like trade war is higher. Maybe President Trump sees that as a risk worth taking. But it highlights another key difference between business and government negotiations. In his real estate deals, the people at risk were Trump himself and the business partners who willingly joined him. As president, he’s generating risk for everyone. No one gets to opt out. Financial markets see this and don’t like it at all—nor should they. Events could easily spiral out of control, with harsh economic consequences. China’s response so far is to threaten its own tariffs on US agriculture and other Trump-friendly sectors. They think penalizing the president’s supporters will make him back down. I’m not so sure, for two reasons: - First, those same business groups failed to stop the president’s earlier trade actions. Their influence on the White House appears to have waned.
- Second, being punished by China might make the president’s supporters more loyal, not less. Outside attacks often unify people who might otherwise split.
If so, the trade fight is likely to get worse before it gets better. So get ready for a long siege. See you at the top,  Patrick Watson P.S. If you’re reading this because someone shared it with you, click here to get your own free Connecting the Dots subscription. You can also follow me on Twitter: @PatrickW.  | Subscribe to Connecting the Dots—and Get a Glimpse of the Future
We live in an era of rapid change… and only those who see and understand the shifting market, economic, and political trends can make wise investment decisions. Macroeconomic forecaster Patrick Watson spots the trends and spells what they mean every week in the free e-letter, Connecting the Dots. Subscribe now for his seasoned insight into the surprising forces driving global markets. |
 Senior Economic Analyst Patrick Watson is a master in connecting the dots and finding out where budding trends are leading. Patrick is the editor of Mauldin Economics’ high-yield income letter, Yield Shark, and co-editor of the premium alert service, Macro Growth & Income Alert. You can also follow him on Twitter (@PatrickW) to see his commentary on current events.
Share Your Thoughts on This Article
Use of this content, the Mauldin Economics website, and related sites and applications is provided under the Mauldin Economics Terms & Conditions of Use. Unauthorized Disclosure Prohibited The information provided in this publication is private, privileged, and confidential information, licensed for your sole individual use as a subscriber. Mauldin Economics reserves all rights to the content of this publication and related materials. Forwarding, copying, disseminating, or distributing this report in whole or in part, including substantial quotation of any portion the publication or any release of specific investment recommendations, is strictly prohibited.
Participation in such activity is grounds for immediate termination of all subscriptions of registered subscribers deemed to be involved at Mauldin Economics’ sole discretion, may violate the copyright laws of the United States, and may subject the violator to legal prosecution. Mauldin Economics reserves the right to monitor the use of this publication without disclosure by any electronic means it deems necessary and may change those means without notice at any time. If you have received this publication and are not the intended subscriber, please contact service@mauldineconomics.com. Disclaimers The Mauldin Economics website, Yield Shark, Thoughts from the Frontline, Patrick Cox’s Tech Digest, Outside the Box, Over My Shoulder, World Money Analyst, Street Freak, ETF 20/20, Just One Trade, Transformational Technology Alert, Rational Bear, The 10th Man, Connecting the Dots, This Week in Geopolitics, Stray Reflections, and Conversations are published by Mauldin Economics, LLC. Information contained in such publications is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The information contained in such publications is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in such publications are those of the publisher and are subject to change without notice. The information in such publications may become outdated and there is no obligation to update any such information. You are advised to discuss with your financial advisers your investment options and whether any investment is suitable for your specific needs prior to making any investments.
John Mauldin, Mauldin Economics, LLC and other entities in which he has an interest, employees, officers, family, and associates may from time to time have positions in the securities or commodities covered in these publications or web site. Corporate policies are in effect that attempt to avoid potential conflicts of interest and resolve conflicts of interest that do arise in a timely fashion.
Mauldin Economics, LLC reserves the right to cancel any subscription at any time, and if it does so it will promptly refund to the subscriber the amount of the subscription payment previously received relating to the remaining subscription period. Cancellation of a subscription may result from any unauthorized use or reproduction or rebroadcast of any Mauldin Economics publication or website, any infringement or misappropriation of Mauldin Economics, LLC’s proprietary rights, or any other reason determined in the sole discretion of Mauldin Economics, LLC. Affiliate Notice Mauldin Economics has affiliate agreements in place that may include fee sharing. If you have a website or newsletter and would like to be considered for inclusion in the Mauldin Economics affiliate program, please go to http://affiliates.ggcpublishing.com/. Likewise, from time to time Mauldin Economics may engage in affiliate programs offered by other companies, though corporate policy firmly dictates that such agreements will have no influence on any product or service recommendations, nor alter the pricing that would otherwise be available in absence of such an agreement. As always, it is important that you do your own due diligence before transacting any business with any firm, for any product or service. © Copyright 2018 Mauldin Economics | -- |
