China-Japan Ties

China Needs To Be Punished – The Question Is, How?

FORECASTS & TRENDS E-LETTER

by Gary D. Halbert

August 13, 2019

Q2 hedge fund letters, conference, scoops etc

China-Japan Ties

Free-Photos / Pixabay

IN THIS ISSUE:

  1. China Needs to be Punished, But Are Tariffs the Answer?
  2. China’s Repeated Broken Promises Got Us to This Point
  3. Trade Options Other Than Tariffs For Punishing China
  4. The US Could End China’s “Most Favored Nation” Status

Overview

I’ve written a lot about our trade war with China in recent weeks. I’ve made clear I’m not a fan of President Trump’s tariffs. Fortunately, the US Trade Representative announced today that most of the new tariffs on China, which were set to go in place on September 1, have been postponed until December 15.

While this was good news for stocks, the new 10% tariff on $300 billion of Chinese is still expected to go into effect before the end of this year. So today, we’ll look at some alternatives for punishing Beijing, including revisiting China’s Most Favored Nation status. No one’s talking about that, so I will.

China Needs to be Punished, But Are Tariffs the Answer?

As regular readers know, I have disagreed with President Trump’s decision to use tariffs to punish China for its many unfair trade practices – including decades of trade cheating, theft of US intellectual property and exploitation of American companies in China.

I have argued that trade tariffs are not very effective because they most often result in higher prices for American consumers for goods we import from China. President Trump continues to claim that Chinese companies that sell us goods pay the tariffs. It is widely agreed this is false.

Now it should be noted that US consumer prices on goods we import from China have not gone up much over the last year. That’s because China has devalued its currency to offset the effects of Mr. Trump’s tariffs so far. Of course, that can’t go on forever, and President Trump is calling for yet another big round of tariffs on most everything else China sells us starting in December.

While I have maintained that Trump’s tariffs are not the best way to deal with this problem, I want to make it very clear that I definitely believe China should be punished. It’s just a question of how.

To underscore why China should be punished, I thought it would be helpful to review what China has done over the years and why some significant actions – tariffs or other measures I will outline below – are more than warranted at this point.

China’s Repeated Broken Promises Got Us to This Point

Regardless whether I believe tariffs are the best way to go, President Trump’s strategic counter-tariffs on China have been deliberate, predictable and business-like. He’s telegraphed the tariffs well in advance and has been very specific about what China needs to do to avoid them. If they don’t, he implements them. That’s contrary to Beijing’s series of broken promises at every turn.

The president announced two weeks ago that the US will implement a 10% tariff on an additional $300 billion worth of Chinese imports starting in December. This 10% tariff had been put on hold after a personal meeting between Trump and Chinese President Xi Jinping at the G-20 Summit in Japan in late June. At that meeting, Xi again agreed to “very substantial” purchases of US agricultural products and other important trade concessions. Yet nothing happened.

The Chinese government is now attempting to portray President Trump’s latest threat as erratic and dangerous, but nothing could be further from the truth. China has completely failed to uphold the commitments President Xi made during the Trump-Xi meeting at the G-20 (and earlier), thus forcing President Trump’s hand to do something.

If President Trump goes ahead with the new tariffs in December, that will mean we have trade levies on virtually everything China sells us. As I discussed last week, the new tariffs will be more focused on consumer goods this time, and thus will mean higher prices on US consumers just ahead – unless China continues to devalue its currency significantly.

The point is, if China had lived up to its promises, we wouldn’t be at this point. In any event, I think it’s entirely possible that President Xi has decided to wait out next year’s election before doing a new trade deal with the US.

Trade Options Other Than Tariffs For Punishing China

As I’ve pointed out previously, China can’t match us in the tariff war since the Chinese sell the US so much more than we sell them. Unfortunately, we learned last week that China is willing to devalue its currency significantly to make its goods cheaper – another way to offset the tariffs.

The People’s Bank of China explicitly said the new, lower currency target was retaliation for the “unilateralism and trade protectionism measures and the imposition of increased tariffs on China.

President Trump promptly took to Twitter and accused China of “currency manipulation.” Foreign exchange experts differ over whether what China did two weeks ago is currency manipulation or not, since the value of the yuan would have already been lower had the Chinese government not been actively propping it up the last several years.

The point is, we now have not only a tariff war that’s not working, but also a potential currency war with China on our hands. The question is, are there other ways we can punish the Chinese? The answer is YES, but some of the other options can also be complicated and messy.

Here are two other ways being talked about to punish China on trade, aside from tariffs. The first is, we could levy a tax on all Chinese consumers who purchase US investment securities (ie – stocks, bonds, etc.). While this option sounds simple enough, it would be difficult to enforce and perhaps even more difficult to collect upon. Furthermore, Chinese investors could quickly halt their purchases of US securities.

The second option is to have the Fed buy up Chinese financial assets until the effect of their purchases of our assets are counterbalanced. In short, if China raises the value of the US dollar relative to their currency, by creating demand for our assets, we can raise the value of their currency relative to ours by buying their assets and neutralize the whole affair.

There is actually a bill pending in Congress to allow this. I don’t know about you, but I’m not crazy about authorizing the Fed to buy hundreds of billions worth of Chinese securities in addition to the $3+ trillion in US securities it already owns.

As I said, these two options are also complicated, and I must admit that I don’t know for sure how much better they would work than President Trump’s current tariffs. But at least they don’t punish US consumers as tariffs usually do. At the end of the day, trade wars are never productive.

But I have another controversial idea to deal with China that no one is talking about.

The US Could End China’s “Most Favored Nation” Status

The Most Favored Nation status applies to members of the World Trade Organization (WTO), of which China is one. Basically, Most Favored Nation (MFN) status requires a country to provide any concessions, privileges, or immunities granted to one nation in a trade agreement to all other WTO member countries.

The MFN designation was designed to facilitate free trade, and it is highly sought after.

China was first granted provisional MFN status if it met certain conditions in the 1980s, and it had to be renewed annually by Congress. This annual renewal led to heated political battles each year.

So in 2000, Congress made the fateful decision to extend “Permanent Normal Trade Relations,” or PNTR, to China. At the time, there was political opposition to granting China, a communist dictatorship, permanent MFN status, but Congress did it anyway. They just called it PNTR. Just like MFN, PNTR ensured that China would have favorable access to the US market.

This was a huge boon to China! With PNTR in hand, the floodgates of investment were opened, and US multinationals worked hand in glove with Beijing to create new China-centric supply chains, both in the US and China.

My point is that Congress bestowed PNTR status on China nearly 20 years ago, and we could revoke it today. This would reduce China’s access to US markets and relegate it back to “non-market” status, along with Russia and other communist and socialist countries.

Do I think Congress would do this? I highly doubt it – it’s not even being talked about. But could Congress do it? Absolutely.

The US could also lobby to have China be removed from the World Trade Organization, but this is probably highly unlikely, too. No one is talking about this either.

I’m sure I’ll catch flak for suggesting these ideas as they would be anti-trade actions. But as I’ve argued today, China needs to be punished for its unfair and illegal trade practices. Revoking China’s PNTR status would be a better way to do it, in my opinion, than using tariffs that don’t work and ultimately penalize American consumers in the form of higher prices – unless China is willing to continue devaluing its currency.

There’s an old saying: “If China stops buying from the US, we catch a cold; if the US stops buying from China, they get pneumonia.”

Sure, that sounds crass, but we need to get a handle on China’s aggressive trade policies.

Best regards,

Gary D. Halbert

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