Road leading to a full blown trade war

“If it really does get to be a big war, we have many more bullets than any of these other countries…”

These bellicose words from US Commerce Secretary Wilbur Ross are a feature of the US’ approach to trade disputes with friends and foes alike.

Divisions and sudden about turns are also features, causing confusion and contributing to market volatility.

This is pointing to the road leading inexorably to a full blown trade war, becoming more a question of when not if.

Geopolitics and economics

Gold chart overlaid on world map
Geopolitical gold

The US has trade disputes with its NAFTA, EU and Asian partners but these take second place to China.

The fundamental driver behind the US’ trade dispute with China is China’s rise as an economic power. This threatens to upend decades of US global dominance.

Measures by the US are primarily aimed at China’s ‘Made in China 2025‘ industrial policy.

This policy aims to move China up the value chain, become self sufficient and a leader in high tech development and production.

The policy is seen as such a threat that US trade negotiator, Robert Lighthizer demanded China make:

“…fundamental changes that allow U.S. companies to keep their technological edge over Chinese competitors were critical to the future of the U.S. economy.”

Trump has also complained bitterly about damage to the American economy. He claims it’s caused by the trade agreements and practices of the US’ trading partners and competitors.

He points to the US’ $375 billion trade deficit with China. Trump has also slammed German car makers, “Look at the millions of cars they sell in the US. Terrible! We’ll stop that,”.

American midterms and America First

US midterms
US midterms 2018 political landscape

The American mid terms, due 6 November, are also a driver behind the tariff agenda along with Trump’s promise of ‘America First‘.

Trump’s election victory was due in large part in appealing to working class communities in areas like the Rust Belt. Three decades of decline has devastated the industrial base of areas like the Rust Belt.

Steel, aluminium and construction related products are all important Rust Belt industries and have been Trump’s first targets.

Differences within the administration

There are also American policy makers that realise a trade war will not be without casualties on their own side. Bloomberg reports on differences within Trump’s administration:

“Hard-liners such as U.S. Trade Representative Robert Lighthizer and White House trade adviser Peter Navarro are pushing for structural changes to China’s policies. Treasury Secretary Steven Mnuchin and NEC Director Larry Kudlow are more receptive to a deal aimed at lowering the bilateral trade deficit.”

There are further signs of splits in the US’ policy making elites. The U.S. business group, the Chamber of Commerce, has also attacked Donald Trump’s handling of trade disputes. They argue that the, “…retaliation by its partners would boomerang badly on the American economy”.

Lacking in experience

Some of the US trade measures have been ill conceived leading to unintended consequences. The gutting of departments of experienced staff by the Trump administration is partly to blame.

Take for example, the US imposed sanctions on Russian company Rusal, the world’s second largest aluminium producer. The result was to send aluminium prices sky rocketing and cause collateral damage to other sectors and forced the US to modify its sanctions.

A Reuters article remarked on the débâcle:

“Unlike previous cases of sanctions on Russia, European countries did not have a chance to consult with Washington on punitive moves that would have ripple effects in the European economy, the sources said. One reason for the lack of dialogue: the U.S. State Department no longer has a Sanctions Policy Coordinator to liaise with other governments…”

Xi Jinping overreach?

Xi Jinping Karl Marx bicentenary
Xi Jinping celebrating the bicentenary of Karl Marx’s birth

There are those confident that China does not have the fire power to withstand the pressure from the US.

Jude Blanchette, a senior advisor at Crumpton Group‘s China Practice, told Bloomberg that:

“People are going to look back at this year as the pivot point when Xi Jinping overreached and sparked an international backlash against the party and China’s development model on multiple fronts,”

However, former U.S. Treasury Secretary Larry Summers in an interview with Der Speigal, where he reflected business concerns, warned:

“Business leaders fear that this blundering approach will lead to retaliation against them and favoritism by China toward its European and Japanese competitors.”

Painful transition

There is still optimism in some quarters that the US will pull back. In the same interview above, Larry Summers hopes:

“At some point, there will be a turning back. For Trump, stepping back from his policy will take the form of finding a way to declare a victory.”

But there is little evidence that Trump is playing a game of bluff given his readiness to escalate. Any retreats are more in the shape of regrouping rather than concessions.

China has shown every intention of defending its interests. China’s Global Times reports on China’s readiness to fight a trade war:

“Washington disregards fairness, is too self-interested and obsessed with the stick approach. This means Beijing must prepare for trade disputes that cannot be solved quickly. China doesn’t want a trade war, but is not afraid of fighting such a war.”

These trade wars are an expression of a far deeper strategic challenge – The challenge of a painful transition from a uni-polar world to a multi-polar one.

This is why the road is leading inexorably to full blown trade war. It’s now more a question of when not if.

Gary Hollands

3rd July 2018

China’s Belt and Road – Full Version

Lifting China from a regional to a global power

China’s ‘The Belt and Road’ plan is an economic initiative that if successful, will change the world’s geopolitical centre of gravity and lift China from a regional to a global power.

The $4 trillion project will aim to connect land areas and sea routes into an economic block that will cover about; “65 percent of the world’s population, about one-third of the world’s GDP, and about a quarter of all the goods and services the world moves.”[1]

What is The Belt and Road?

Belt and Road
Belt and Road. Source: Xinhua Finance Agency, 2015

The Belt and Road seeks to emulate and extend the ancient Silk Routes which established the region, and China in particular, as one of the world’s most important regions up to a few centuries ago. As a report by China’s State Council puts it:

“The Belt and Road Initiative aims to promote the connectivity of Asian, European and African continents and their adjacent seas, establish and strengthen partnerships among the countries along the Belt and Road, set up all-dimensional, multitiered and composite connectivity networks, and realize diversified, independent, balanced and sustainable development in these countries.”

The scale and ambition of the project is further detailed in the report:

“The Initiative is an ambitious economic vision of the opening-up of and cooperation among the countries along the Belt and Road. Countries should work in concert and move toward the objectives of mutual benefit and common security. To be specific, they need to improve the region’s infrastructure, and put in place a secure and efficient network of land, sea and air passages, lifting their connectivity to a higher level; further enhance trade and investment facilitation, establish a network of free trade areas that meet high standards, maintain closer economic ties, and deepen political trust; enhance cultural exchanges; encourage different civilizations to learn from each other and flourish together; and promote mutual understanding, peace and friendship among people of all countries.”

There are two elements to the Belt and Road, land (The Belt) and maritime (The Road).

The Belt

The Belt, aims to connect a region that encompasses China, Central Asia, Russia and Europe. It joins China with South-east Asia, South Asia and the Indian Ocean.

The Belt is deploying huge resources to develop infrastructure such as oil and gas pipelines, rail and road networks and cargo handling facilities.

As the China State Council report says:

“On land, the Initiative will focus on jointly building a new Eurasian Land Bridge and developing China-Mongolia-Russia, China-Central Asia-West Asia and China-Indochina Peninsula economic corridors by taking advantage of international transport routes, relying on core cities along the Belt and Road and using key economic industrial parks as cooperation platforms”

The Road

The Road, are sea lanes that go from China’s coast to Europe through the South China Sea and the Indian Ocean and from China’s coast through the South China Sea to the South Pacific. China’s State Council report describes The Road:

“At sea, the Initiative will focus on jointly building smooth, secure and efficient transport routes connecting major sea ports along the Belt and Road. The China-Pakistan Economic Corridor and the Bangladesh-China-India-Myanmar Economic Corridor are closely related to the Belt and Road Initiative, and therefore require closer cooperation and greater progress.”

Belt and Road projects

It’s worth getting an idea of the vast scale of the Belt and Road. So far there are some 900 projects worth in the region of $890 billion under way. These include the Khorgos Gateway, a strategically important hub which will serve cargo arriving from China and destined for Western Europe and CIS nations. Another ambitious project is a rail link from China to Iran stretching over 10,000 kilometres connecting China’s eastern Zhejiang province to Tehran that will cut journey times from the 45 days by sea to 14 days by rail. This will expand trade all along the route and the reduced time will increase the variety of goods that can be transported as well as reduce costs.

Malacca Strait oil route
Oil imports through the Strait of Malacca 2009. Source: Daniel Brutlag Tufts University, 2013

Another part of the Belt and Road project is the China-Pakistan Economic Corridor (CPEC) in which China plans to invest just under $50 billion over ten to fifteen years. CPEC is of particular importance as observers have noted that it will allow China to overcome the strategic vulnerability of the oil import choke point of the Strait of Malacca, where between 80% to 85% of its oil imports pass through.

Shaping the rules of the global system

With the changing of the balance of economic power, a change in the world balance of power will eventually follow. Robert A. Manning, a former member of the State Dept. Policy Planning Staff (2003-08) and National Intelligence Council (2008-12), says of China’s rise:

“China is now in a position to shape the rules of the global system, as much as it is to accept them. China’s role in the Asian financial crisis of 1997-98, in the 2008 financial crisis, the creation of AIIB, its enlarged role in the IMF (with the RMB becoming a part of IMF currencies), its growing role at the UN and not least, its One Belt One Road initiative providing new connectivity in Eurasia are all evidence of this.”

The Belt and Road initiative also brings Russia into China’s sphere in a mutually beneficial relationship that eases Russia’s economic dependence on European markets. Jan Masaryk writing in China’s Global Times comments that:

“A key priority for China must be maintaining the steadily warming relations with Russia. The Shanghai Cooperation Organization has proved an effective forum for building trust and confidence between Moscow and Beijing, particularly in the sensitive Central Asian region, critical for the progress of China’s One Belt and One Road Initiative.”

On the strategic risks to China, these are acknowledged in another article by Li Xing, a professor at the Beijing Normal University, but he says the benefits of tying Russia in as a strategic partner outweighs the risks:

“On the contrary, If Russia joins the project, it will be a stakeholder which shares economic risk, especially security risk, and has same or similar goals. It’s a good thing.”

Evidence of Russia’s push to diversify away from Europe can be seen with talks aimed at merging the Eurasian Economic Union regional trading bloc, of which Russia is a leading member, with the CPEC project.

The “Geopolitical and economic drivers of China’s regional integration strategy” was discussed in a European Parliament briefing on the Belt and Road, firstly what brought the Belt and Road to life:

“Sino-US relations – for which President Xi Jinping coined the term ‘new type of great power relations’, implying mutual respect and win-win cooperation rather than confrontation and conflict – were marked by the military and political implications of the US Pivot to Asia, perceived by China as an encirclement and the major cause for problems with its emboldened neighbours.”

Its implications were also touched upon:

“OBOR [GH: One Belt, One Road] is likely to expand significantly China’s political and economic leverage over its neighbourhood, since most of the countries receiving Chinese funds for new infrastructure will ultimately be drawn deeper into China’s trade and finance orbit and be expected to support its rise in all respects.”

In a nutshell, China’s Belt and Road will pull the entire region into its economic orbit and gives it the springboard to shape the rules of the global system.

Military risks

Chinese aircraft carrier: Liaoning
Chinese aircraft carrier, Liaoning, on manoeuvres.

With China’s rise as an economic power it faces the challenge of defending and extending its interests, so by necessity it follows that it will have to develop as a military power. With this goes the risk of conflict with other competing powers for control over resources, trade routes and other areas of strategic importance.

China’s growing global influence, along with the resurgence of Russia, is signalling a shift from the uni-polar world of US hegemony to a multi-polar world. It is in this context the friction between the US and China needs to be viewed.

The US current geopolitical stance is that there are no sphere’s of influence. This was summed up by Vice President Joe Biden in a lecture to a US think tank, “We will not recognize any nation as having a sphere of influence…”. The US’ Asian pivot, along with the accompanying military build up in the region, adds to a problematic relationship which is fraught with danger.

This danger is highlighted in a paper by Colonel Chris Mills, writing as Vice Chief of Australia’s Defence Force:

“…more than 90 per cent of China’s energy requirements traverse Indo-Pacific maritime choke points, including through the Gulf of Aden, the straits of Hormuz, Malacca and Sunda, and the South China Sea. From a Chinese perspective, increased US maritime forces in the region, combined with US defence-treaties with Japan, South Korea, Australia, The Philippines and Thailand, in addition to defence cooperation with Taiwan, Singapore, Indonesia and India, place its energy and trade security at risk of potential US intervention. Consequently, some would argue that China has been left with little option but to look to ways to balance a US policy framework which could constrain its future growth and interests in the region.”

This is behind China’s building of facilities on the Spratly Islands in the South China Seas which extends the range of its navy and air force over these globally important sea lanes, through which $5 trillion of trade passes annually.

The dispatch of the carrier USS Carl Vinson due to reach the South China Sea this month has raised alarm, with Li Jie a Beijing-based naval expert warning that:

“The US will certainly continue to stir up the South China Sea issue. The waters are an effective maneuver to curb China, as 80 percent of China’s crude oil imports come through the South China Sea. If the US controls the waters, it will be a blow to China.”

These actions, along with the need to physically protect the Belt and Road infrastructure, will compel China to further build up its military, adding to the risk of conflict as it challenges US interests.

In the short term economic interdependence between China and the US, there is $650 billion in annual trade between the two, should act as a safety check against conflict. But over the longer term China’s continued rise and the US’ struggle to maintain a uni-polar world will lead to a collision of strategic interests[2] that could result in military confrontation.

Risks to the Belt and Road project

The EU Parliament briefing discussed above also details some of the risks that could derail the Belt and Road project which include changes of governments, flare ups in conflict areas such as Burma/Myanmar, corruption and terrorism. There is also the problem of local scepticism regarding the true benefits of some projects, with the accusation that it is Chinese companies that gain the most or that they result in Chinese colonisation, the charge levelled at the Sri Lanka Hambantota port lease agreement. The impact of global financial shocks such as the financial crisis of 2007-2008 would also pose a risk.

Transition to a new multi-polar world

In the transition to a new multi-polar world order, recognising and working with the strategic interests of other powers will be in the strategic interest. The skill will be in accomplishing that without compromising one’s own interests. In China’s case this includes issues of territorial integrity in regards to Tibet and Taiwan, its interests in the South China Seas.

For the lesser powers, including European, putting all their eggs into the US’ strategic basket will become a less viable option. They will find themselves in the gravitational pull of The Belt and Road and will either have to accommodate China’s strategic interests that flow from the project or risk the possible consequences, military and economic, of giving unqualified support to the US’ struggle to maintain a uni-polar world.

History turns a full circle

With the Belt and Road initiative the world is on the verge of turning a full historical circle in placing the region at the centre of the world again with China at its apex, just as with the old Silk Road, this time on a higher level with its influence reaching into every corner of the globe…

Gary Hollands – January 15th 2017

Notes and references

1. McKinsey Global Institute: China’s One Belt, One Road: Will it reshape global trade?

2. There are several potential flash points, for example Taiwan, US anti-missile deployments in South Korea and energy security.

Taiwan

Donald Trump has attempted to intervene in China’s One China policy, which states Taiwan will not be treated as an independent state, to force the issue on trade.

An opinion published in the state run Global Times spells out bluntly that; “They [GH: Taiwan] have relied heavily on the US protection in case of military conflicts between the mainland and Taiwan. But now, it is almost impossible that the US will confront the mainland militarily to protect Taiwan. In the past, the US military strength is much stronger than that of Chinese mainland. However, due to the mainland’s development in recent years, the US military advantages are shrinking. A confrontation between the two will lead to a great loss for the US. Therefore, the US will be hesitant about military confrontations against the mainland.”

THAAD

Speaking on the deployment of the US’ THAAD anti-missile system in South Korea under the guise of countering North Korea’s nuclear programme, China’s Foreign Ministry Spokesperson said:

“Relevant parties must be well aware of our concerns and clear opposition on the issue of THAAD which has been repeatedly expressed. The THAAD deployment by the US in the ROK severely disrupts regional strategic balance, undermines the strategic security interests of regional countries including China…”

Energy security

In the ODNI report into alleged Russian influence in the 2016 US presidential election, one of the motivations listed was on fracking:

“RT runs anti-fracking programming, highlighting environmental issues and the impacts on public health. This is likely reflective of the Russian Government’s concern about the impact of fracking and US natural gas production on the global energy market and the potential challenges to Gazprom’s profitability (5 October).”

The statement appears to lack some strategic sophistication in its assessment of Russia’s concerns on fracking.

The US has been pursuing the aim, quite sensibly, of energy independence. This policy is more likely to be a threat to China as it reduces the US’ reliance on shared oil routes and therefore the US would be more inclined to disrupt them in a dispute with China.

Lin Boqiang, a dean at the China Institute for Studies in Energy Policy at Xiamen University, outlined China’s fears:

“The US’ pursuit of energy independence may deteriorate China’s role as a gas and oil importer. US reliance on international oil markets have brought contradictions and conflicts in its energy policy and diplomatic policy, which can be seen in the gas and oil pipelines in the Middle East, Iraq and the Caspian Sea. Following the gradual realization of energy independence, the US could possibly loosen its strategy of maintaining stability in the oil-producing Middle East, which would likely make the region more unstable. Additionally, the US would likely step up sanctions against “problematic countries” like Iran and Sudan, which are significant sources for China’s imports. Those two factors could negatively impact the country’s energy security and lead to strategic conflicts between China and the US over certain international issues, such as Iran’s nuclear program.”

“US energy independence might also aggravate the safety of China’s energy transportation. China is heavily reliant on two of the world’s six major oil transportation arteries – the Strait of Hormuz and the Strait of Malacca – and that reliance is increasing. With US military maintaining the safety of these oil routes, China’s energy lifelines are heavily dependent on US political and military strength and China is given an easy ride. As such, the reliability of China’s oil supply is a weak link, when factoring in the country’s lack of resources to keep oil routes flowing smoothly and to safeguard shipping safety.”

“As the US pushes for energy independence and reduces its reliance on these oil routes, we need to stay vigilant against the reliability of the US upholding the oil arteries. To maintain hegemony, the likelihood that the US will eventually withdraw is small, however, it cannot be ruled out that the US may take advantage of China’s fragile oil imports, particularly when conflicts flare up between the two countries.”

In these circumstances Russia would gain, Russia and China are jointly developing energy transport projects, so for Russia it’s more a case of strategic swings and roundabouts.

However, it should be borne in mind that US manufacturing plants abroad, export markets and US allies would be seriously affected by disruption to oil transport.

This work is licensed under a Creative Commons Attribution-ShareAlike 3.0 Unported License.

Government budget deficits

How useful are comparisons of different countries budget deficits?

Definitions of what a budget deficit is and how to calculate it as a proportion of GDP are fairly easy to find. What is confusing however, is when and how to compare the deficits of different countries. This has become a much enjoyed game of politicians engaging in justifying austerity programmes since the ‘Great Recession‘.

An example is the practice of some UK politicians to compare the UK’s deficit to that of Greece or Ireland to justify implementing similar policies of cutting government expenditure.

Are budget deficits alike enough to make direct comparison useful? Or is an approach of greater depth required?
It’s best to start with a brief overview of what budget deficits are and how they are measured.

A budget deficit happens when a government’s expenditure, on such things as health care, defence and interest on debt, exceeds its income through taxation and other earnings. For convenience, the figures are usually quoted as a percentage of GDP. Budget deficits should not be confused with National Debt, which is the total amount of debt owed.

Direct comparisons between the budget deficits of different countries can be misleading. This is especially the case when trying to use the comparisons to argue that a particular deficit is too high however an alarming picture pundits may paint.

When trying to judge the affordability of a deficit it’s worth bearing the following criteria in mind:

  • Ability to pay the debt. Can they afford the repayments on the debt?
  • The sustainability of the debt levels. How secure are their circumstances over the period of the repayments?
  • Robustness to internal or external shocks. How resilient are they to events such as natural disaster and recessions?

When comparing deficits between countries, it’s important to remember that not everything in the universe is an apple. In other words, very few things are exactly alike and comparing deficits carry the danger of comparing apples and pears. The example below uses an analogy to illustrate the point.

Take two workers. One earns £1000 per week with outgoings of £1200, a deficit of 20%. The other worker earns £200.00 per week with out goings of £210, a deficit of 5%. Which one would better sustain payments on a £5000 loan?

Comparisons become even more difficult when looking at economies of different sizes and balance. The UK for instance is biased towards the finance and service sectors with a declining manufacturing sector. Ireland on the other hand, appears better balanced with service and manufacturing sectors of similar proportions but it’s the Irish economy that’s in intensive care.

There is an important difference to remember between individuals, companies and governments when using analogies to discuss budget deficits. Governments can grant themselves binding pay rises at will by raising taxation. They can also switch on the photocopiers and print their own money…