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Monday, September 23, 2019

Realities of the Current Trade War

President Trump is focused on the monetary side of the transaction and has totally ignored all the goods and services obtained from China.

Image Credit: Official White House Photo by Joyce N. Boghosian [public domain]

US President Donald Trump said in a tweet last year:

When you’re almost 800 Billion Dollars a year down on Trade, you can’t lose a Trade War! The U.S. has been ripped off by other countries for years on Trade.

Trump continues to ratchet up tariffs on China, claiming it is stealing billions of dollars by running large trade surpluses with the US. If this view were held by the average Tom, Dick, or Harry it would be irrelevant, but it becomes a serious problem when held by a man who can reduce the real incomes of billions of people, both American and Chinese.

Trade Is Mutually Beneficial

A trade surplus is an aggregate statistic made up of individual transactions. It reflects the yearly difference between the sum of US citizens or companies buying products or services from China and Chinese individuals or companies buying US products or services. Each of these individual transactions is voluntary and therefore mutually beneficial. Our economy is made up of millions of these transactions every day.

You value the money you give up less than the goods or services you receive, and the store’s preferences are exactly the opposite. It values your money more than the goods or services making the exchange. This is also true of the extremely large number of transactions involved in bringing any product to your doorstep, from the farmer, the baker, and the trucker to the manufacturer of the goods that made it possible to purchase a cake and take it home.

The Two Sides to Any Trade

Do you worry about the rising trade deficit you have when you spend $100 at the supermarket? Do you feel “ripped off”? You buy more from the supermarket than it will ever buy from you. If you answered yes to these questions, you are exclusively looking at the monetary side of the transaction—the $100—and have totally ignored the goods and services you received. This is basically what Trump does when he complains about China’s trade surplus. He is focused on the monetary side of the transaction and has totally ignored all the goods and services obtained from China.

The Nationality of Products

We now live in a globalized world. In the past, a BMW could be called a German car. The steel mill had to be close to the manufacturing plant, and the workers making the different parts had to be local. Today, reductions in transportation costs have created a globalized economy where parts can originate from anywhere in the world. It is now a stretch to call a BMW a German product since it can be produced in Brazil with steel made in China.

Besides, labor is now only 10 percent of the cost of a car and could easily be a Frenchman working in Berlin. Any trade restriction is equivalent to throwing a wrench in the workings of the global economy.Furthermore, a shareholder of BMW is more likely to be a mutual fund in Tokyo than a German citizen living in Dusseldorf. This same internationalization is true of most products exported from China or anywhere else in the world.

Globalization has significantly reduced the cost of making any product, as production has naturally gravitated to areas with the greatest comparative advantages. China’s industrialization has not only significantly benefited every Chinese citizen but every active individual in the global economy. Any trade restriction is equivalent to throwing a wrench in the workings of the global economy, causing a diversion of production from where it would be most beneficial to everyone.

Exchange and War

Trade is not a war, and military analogies should not be used to describe a sum of mutually beneficial transactions. Trade, on the contrary, reduces the risks of actual war. Wars have been fought historically to gain access to key resources. Hitler’s main ideological principle justifying his territorial ambitions was to claim that the German people had a natural right, as a manufacturing country with little natural resources, to obtain these resources by force.

Germany’s neighbors had imposed severe trade restrictions, which greatly limited Germany’s access to these resources. Had free trade been the norm, Hitler’s argument may have fallen on deaf ears. We know that trade raises the standard of living of everyone by creating mutual interdependencies and joint interests, making military conflict less likely because the costs of war significantly outweigh the perceived benefits.

The Link between Imports and Exports

When a Chinese company or individual sells a product to an American company or individual, it receives dollars in return. These dollars reflect claims on American goods and services or assets—and nothing else. In general, this Chinese company or individual will convert these dollars into yuan to cover its domestic costs or to distribute dividends to its stockholders.

The people selling yuans for these dollars could be American exporters of wheat, Chinese importers of oil, or those who want to buy a US government bond or any dollar-based asset. This is the essence of an exchange economy: Exports are closely linked to imports. The Smoot-Hawley tariffs that worsened the Great Depression in the 1930s reduced both imports and exports by 50 percent. If China can’t sell, it can’t buy.

Trade Is a Fundamental Freedom

During the 17th century when mercantilism was at its zenith, the Dutch, who had very few restrictions on trade, flourished with superior prosperity and economic growth, while other European countries remained mired in abject poverty. The optimal strategy is simple and can be implemented unilaterally by eliminating all restrictions on both imports and exports, including regulatory constraints. This can be implemented irrespective of the strategy of your trading partners.

Trump’s interferences should universally be condemned as unnecessary and incompatible with the most important aspect of capitalism: the freedom to engage in voluntary mutually beneficial transactions.

  • Frank Hollenbeck is a financial consultant who worked for the State Department as senior economist, Caterpillar overseas as chief economist, and Director of Research at the Banque Eduard Constant in Geneva.