Talk about waving a red flag in front of a raging bull. Yesterday, on the eve of Donald Trump’s White House return, the Chinese government announced that last year it recorded a trade surplus of almost $1 trillion, a third of which was with the US. That surplus exceeds any trade surplus ever recorded by the United States, Germany, or Japan in their heydays as trade surplus countries. This is bound to increase Trump’s belief that China is stealing our manufacturing jobs and to intensify his resolve to do something about it. That in turn could spell real trouble for the world economy.
Underlying its outsized trade surplus is the fact that China saves more than it invests. Whereas consumer demand in most countries constitutes around 50 to 75 percent of the overall economy, in China it is barely above 40 percent. With little domestic demand for the large amount of manufacturing goods it produces, China resorts to the world’s export market to get rid of its excess capacity. It does so by keeping its currency cheap and by encouraging its exporters to look to the world market as an outlet for their goods.
Now that China’s housing and credit market bubble has burst, there is every prospect that the Chinese government will continue to turn to the export market in an attempt to kick start its flagging economy. Until recently, the property sector constituted almost 25 percent of the economy and provided it much support. However, with the bursting of the bubble, construction activity has declined as housing demand has ground to a halt. It has done so as many property developers, including most notably Evergrande, have defaulted on their loans. Simultaneously, falling home prices have dealt a severe blow to consumer confidence. Those declines have been particularly painful since housing constitutes around 70 percent of household wealth.
One way that the Chinese government could reinvigorate China’s economy while reducing its trade surplus would be to engage in fiscal expansion and economic reform. That reform might aim at rebalancing the economy away from over-investment and towards consumption by providing households with a safety net that would reduce their need to save. However, with China already facing a high debt-to-GDP ratio, particularly at the local government level, President Xi is cautious about exacerbating financial vulnerabilities that could undermine long-term stability.
All of this heightens the prospect that Trump will keep his campaign promise to pursue a more aggressive Chinese trade policy than he did in his first term. On the campaign trail, Trump repeatedly indicated that once elected, he would impose a 60 percent tariff on all imports from China. While it is unlikely that Trump will be so bold as to fully deliver on this threat, it would be surprising if he did not ramp up substantial pressure on China to stop using the US as a dumping ground for its excess manufacturing capacity.
While punitive US import tariffs would deal a body blow to the export-dependent Chinese economy, it is highly unlikely that it will correct the United States trade deficit problem. Indeed, there is every prospect that the US trade deficit will widen substantially in the years immediately ahead. That is because at the same time that Trump is proposing higher tariffs, he is also planning on making large tax cuts that will worsen the US saving-investment imbalance. According to the Committee for a Responsible Budget, Trump’s proposed tax cuts would add $7.75 trillion to the budget deficit over the next decade.
There is a real risk that as the US trade deficit widens, Trump will resort to an ever more restrictive trade policy in an attempt to cure the trade deficit. That in turn could invite Chinese retaliation either in the form of import tariffs of its own or of withholding the rare metals it mines that are essential for our manufacturing sector.
A heightening of US-China trade tensions is to be regretted in that it casts a long shadow over the world economic recovery. It does so by increasing the chances that we could be drifting towards the economically unfortunate beggar-thy-neighbor policies of the 1930s where countries get themselves into a retaliatory import tariff hiking cycle. It also does so by increasing the chances that China, the world’s second largest economy and previously its main engine of economic growth, would succumb to an economic recession.
A better solution to the US-China trade imbalance problem than import tariffs would be for US-China economic policy coordination. China might commit itself to fiscal expansion to reduce its savings level in return for the US agreeing to engage in budget belt tightening to bolster its saving level. However, based on President Xi and Trump’s past economic policy track records, I am not holding my breath for this to happen.
Desmond Lachman
January 17, 2025
aei.org