China and the US are on the eve of a new cold war

China and the US are on the eve of a new cold war

I have written frequently on Wall Street’s underestimation of the impact of the China-US trade war.

This war began in a formal sense in January 2018 when President Trump imposed steep tariffs on imports of solar panels and certain appliances.

The immediate victims were China, South Korea and Canada. But there was no doubt that China was the principal target.

Still, this war had been brewing since the early 2000s.

China had been granted a long list of acceptances in major global trading and finance organisations.

These included permanent ‘most favoured nation’ status in trading with the US (2001), admission to the World Trade Organization (2001), and inclusion of the Chinese yuan in the basket of currencies used to calculate the exchange value of the IMF’s world money, called the special drawing right (2016).

IMG 1

Your strategist discussing international monetary policy with former Fed chair
Ben Bernanke at a conference in Seoul, South Korea. China was a main topic of concern
because of South Korea’s exports of high-tech components to Chinese assembly plants.

This extension of international trading privileges to China was led by the US, with other nations tagging along.

The purpose, as believed by US intellectuals and policy elites, was that if China were included in the global trading system and started to see the benefits of free trade in terms of increasing wealth, it would gradually become ‘more like us’ and encourage free debate and free elections alongside free trade.

Just a mirage

This vision was always misguided and always a mirage. China is run by the Chinese Communist Party (CCP).

The sole interest of the CCP is perpetuation of power of the CCP itself.

Everything else is incidental.

Increasing wealth and welfare as a result of inclusion in the global trading system was just fine, but not if it came at the expense of CCP dominance.

When I pointed this out to globalists in the 1990s, I was routinely ridiculed.

The elites would say in condescending tones, ‘Jim, the communists are down to a handful of 80-year-olds on the politburo. The bankers and bureaucrats are just like us and waiting for their turn. If we keep the free trade bandwagon rolling, they’ll get richer, the communists will die out, and they’ll end up as a liberal economy.’

I disputed this rosy scenario at the time, and today facts bear out my warnings.

China is full of concentration camps for Christians and Muslims (euphemistically called ‘re-education centres’), where targets face indefinite incarceration until they show true repentance and strict adherence to the thoughts of Mao Zedong and Xi Jinping.

China has implemented a ‘social credit’ system enforced by facial recognition software, and ubiquitous internet censorship and monitoring.

If you say or do anything that is not in strict accordance with CCP doctrine, your social credit score will be diminished.

This can result in being banned from air and rail transportation, access to entertainment, and exclusion from jobs and highly ranked schools for you and your family members.

It is the next thing to total thought control and amounts to total behavioural control.

This is the ‘liberal’ society the elites promised. In reality, it’s a nightmare.

China broke all the rules

This was not the only downside from the free trade charade.

Internal policies aside, China immediately broke every rule of every organisation it joined.

China exploited its ‘most favoured nation’ status to achieve lower tariffs on its exports, while continuing to impose tariff and non-tariff barriers to trade on its trading partners.

China used the WTO to obtain relief from export subsidies provided by other nations, while ignoring WTO rulings against its own subsidies.

China claimed great power status when its currency was included in the IMF’s world money basket, but then shut its capital account in violation of IMF rules.

China has lied, cheated and stolen its way through the international system in violation of every promise it ever gave.

As if communist orthodoxy and repeated lies were not bad enough, China has engaged in a multi-trillion dollar, multi-decade reign of intellectual property theft aimed at all developed economies, involving both private property and government information, including classified information.

This is done through a network of hackers, informants, traitors and spies posing as ‘students’ at top Western universities.

In short, the elites’ dream of a more liberal China has now smashed upon the rocks of reality.

Even the elites realise this, although they are at a loss as to a proper policy response.

Trump’s trade war is a good beginning, but just a beginning.

The US and China are on the eve of a new cold war.

None of this was evident to Wall Street.

China won’t concede and the US won’t give in

Financial analysts claimed that Trump was just ‘posturing’ when the first tariffs were imposed.

When the tariffs escalated, Wall Street claimed that it was just ‘the art of the deal’ and Trump would soon find an exit ramp and reach an agreement.

As bilateral China-US tariffs escalated to the US$400 billion range, Wall Street next pinned its hopes on a Mar-a-Lago summit with Trump and Xi that would resolve the trade disputes once and for all.

Now Wall Street is looking forward to ‘side talks’ at the G20 summit in Osaka, Japan in late June.

One by one, these pipe dreams have been shattered.

The prospects for resolving trade issues in Osaka are no better than the already failed attempts.

The truth is that China cannot make concessions because it fears losing face and concessions would undermine the power of the CCP.

The US does not want to make concessions because Trump sees benefits in collecting the tariffs and reviving US jobs lost to Chinese factories in recent decades.

Neither side has strong incentives to solve the trade war, and both sides see benefits in continuing to fight. That’s not a recipe for peace and stability on the trade war front.

What does this China-US confrontation have to do with South Korea?

The answer is: A lot.

South Korea may be the biggest loser

South Korea is caught in the crossfire, and both its economy and trade surplus will suffer as a result.

Two of South Korea’s largest and most important bilateral trading relationships are with China and the US.

South Korea is a major exporter of cars, vessels and consumer electronics to the US.

At the same time, South Korea is a major supplier of components for the iPhone and other mobile phones assembled in China.

Few people realise that the value-added in Chinese exports to the US is quite small.

When trade deficits and surpluses are calculated, the gross value of the individual goods is counted.

This means that a US$1,000 iPhone X shipped from China to the US counts as US$1,000 of exports in calculating China’s trade surplus with the US.

But China’s value added to the iPhone is only about US$60.

China must import US$940 of components (or pay substantial licence fees) in order to assemble the US$1,000 iPhone.

Those components come from high-tech sources including South Korea, Japan and Germany.

This means that Chinese exports of iPhones are really South Korean exports of semiconductors and ‘gorilla glass’, shipped via a low-value-added Chinese assembly line.

When the US slaps high tariffs on iPhones from China, the real losers are the South Koreans and other component suppliers.

Unintended consequences

Another depressing effect on the South Korean economy from the trade wars is the loss of tourism from China.

This is due to a depreciating Chinese currency and capital controls imposed on Chinese consumers, including tourists.

South Korea loses directly as well as indirectly.

Any trade war as large as the US-China dispute tends to have a depressing effect on world economic growth.

Slowing world growth means fewer direct exports of automobiles from South Korea to the US in addition to indirect exports of components assembled in other nations.

Finally, South Korea is caught squarely in the middle of tensions between the US and China related to the North Korean nuclear weapons program.

The US was relying on Chinese cooperation with sanctions on North Korea to force North Korea to the bargaining table. The process worked well in 2018 after a near-war in late 2017.

Now, the North Korean negotiations have broken down and North Korea has resumed testing missiles, something it had suspended doing in November 2017.

The US has resumed turning up financial pressure and economic sanctions on North Korea.

But this time, China’s cooperation cannot be taken for granted because of the deteriorating relations between China and the US.

Any increase in North Korean hostility with the US results in reduced confidence in the future of the South Korean economy.

This can lead to reduced direct foreign investment, which is another drag on growth.

The Chinese-US trade war (really a new cold war) will impose many costs on all sides.

The first loser may not be China or the US, but rather South Korea.

All the best,

Jim Rickards Signature

Jim Rickards,
Strategist, The Daily Reckoning Australia