Trump's currency war and the end of the American-led global trading system
America's trade war with China has escalated and expanded to new frontiers in the past few days. First the Trump administration announced new tariffs on some $300 billion of Chinese goods. The Chinese retaliated by announcing a halt to purchases of all American agricultural products. Finally, the Trump administration labeled China a currency manipulator for (ironically) halting its sales of dollar-denominated assets. Those sales had been propping up the value of the Chinese currency, the renminbi. The value naturally fell when that intervention ceased.
The market's response has not been kind, as stocks tumbled and the yield curve on bonds lurched towards inversion, a fairly reliable predictor of recession. From the perspective of many observers, that's enough to prove that the trade war has gotten out of hand, and that it's time for both sides to step back and cool off.
That's a sensible conclusion if the objective of this economic conflict is to change China. America wants China to open its markets to fair competition from American companies, accept American rules about intellectual property, and stop engaging in piracy and requiring technology transfer. China wants not to do these things, but to continue on the path that has both enriched the Chinese people and strengthened the Chinese state.
But what if those presumptions are wrong? What if the objective was always less to get China to liberalize, as we say officially it is, and more to disentangle America from China permanently, the better to contain China's rise and "beat" it economically? What if the things established, neoliberal commentators like Tom Friedman see as catastrophe are precisely what the Trump administration has been aiming for all along?
This has been a persistent question of mine from the moment it became clear that Trump wasn't just bluffing, but was serious about economic confrontation with China. If the administration's paramount goal is not to change China but to separate from it, then every bad headline is actually a good headline, and a war that seems to be getting out of hand is actually just ramping up.
But is it even possible to disentangle from China without shredding the existing system of international trade?
Consider the basis upon which the Trump administration has accused Beijing of currency manipulation: China stopped selling dollars, which caused the dollar to rise against the renminbi. If this is the standard for manipulation, then the only way to avoid such charges would be for foreign central banks not to hold enormous dollar reserves in the first place. But the reason they do is that most foreign trade — particularly trade in oil and other essential commodities — is transacted in dollars. The dollar is the predominant global reserve currency, and having such a currency provides important grease for the wheels of international trade.
It also benefits the United States — though that benefit is not without its important negative side effects. The Triffin Dilemma describes these tradeoffs: A country whose currency becomes the global reserve currency benefits from lower interest rates than it would have based solely on its underlying economic strength, which benefits consumers and lowers the cost of investment. But it suffers from persistent trade deficits, which reduce its competitiveness in tradable goods and services and subsidize foreign competitors, as well as budget deficits, which can, in extremis, bring into question the ultimate creditworthiness of the country. There's a case to be made that, on the whole, we'd be better off not being the global reserve currency. But it's a rare country that voluntarily cedes that kind of power — particularly in the context of a global confrontation with a powerful rival.
Could the United States decouple from China while keeping the dollar's status as global reserve currency? I'm doubtful. In that world, there would be very little reason for China's trading partners to transact with it in dollars, and little reason for China to hold enormous dollar reserves. And China would be eager to dethrone the dollar for other reasons. Even though its exporters benefit from America's effective subsidy through a strong dollar, China has long advocated for a shift towards some other reserve currency, because the dollar's status gives America disproportionate influence on the structure of international trade.
But even if we wanted to, it would be impossible to bring America's trade into long-term balance without giving up the dollar's status as global reserve currency. As in so many areas, there's a choice to be made between balance and dominance. You can have one or the other, but not both.
It may already be too late to successfully reassert dominance. China is too large and important to the world economy to be contained, and the other participants in the global trading system have too diverse interests to form a united front even if America were led by someone more globally congenial. The choice, rather, is between an orderly or chaotic rebalancing. What we're getting so far looks a lot like chaos, and that's probably spooking the market more than the the disentanglement itself.
Nonetheless, it would be pretty ironic if the advocates of Making America Great Again were the ones to finally bring about the end of the America-led trading system.