Hold the trade war talk: The EU and China know they must cut excessive surpluses with the US

March 26, 2018 -The U.S. wants to negotiate trade issues with the European Union and China despite the fact that they ignored, for more than a year, Washington's constant warnings about unacceptably large surpluses on their American trades.

In doing so, China and a Germany-led EU have put themselves in an economically and politically untenable position. These two economic systems represent more than one-third of the global economy and 60 percent of demand and output in the industrialized world.

With their estimated trade surplus on goods and services of $713.6 billion at the end of last year, the Europeans and the Chinese live grandly off the deficits they cause in the rest of the world. They are exerting a powerful drag on global economic growth and, by virtue of their excessively high trade imbalances, they operate as a hugely destabilizing factor for the world economy.

I doubt that present EU leaders would want to place their post-modern community in that kind of a position. Insensitive economic policies are not exactly what they need in a world where they want to shine as heirs to the Enlightenment, "leitkultur" (leading culture) and civilizing missions.

With their customs union, the Europeans also have to think about the destruction they are causing to trade flows outside their tariff walls.

China's major policy blunder
China deserves greater understanding as a country emerging from two centuries of economic and political hardships, and still looking for an effective path of development.

In its quest for jobs and incomes, China had set itself up, since the late 1970s, as a global manufacturing workshop on the basis of an inexpensive and widely available labor force.
That phase of development is over, but manufacturing still remains one of the key segments of China's economic activity. The Chinese estimates indicate, for example, that about 40 percent of the country's exports to the United States are now generated by American joint-venture production facilities operating in China.

That is probably one of the reasons why a group of large U.S. retailers appealed to the White House last week to avoid trade tensions with China.

Beijing is apparently trying to wean its economy off exports while seeking a larger output in service sector industries and greater consumption spending from its rapidly increasing middle class. Some progress has been achieved, but all that still looks like a work in progress, and probably one of the reasons why Beijing's pledge of a "win-win cooperation" rings hollow when it comes to foreign trade. China's trade relations with the U.S. are a case in point.

Indeed, it is surprising to see that China's astute leaders have allowed themselves to be maneuvered into a totally unsustainable negotiating position with a $375 billion surplus on their American trade transactions.

They even managed to embarrass President Donald Trump with an 8 percent increase of China's trade surplus with the U.S. during last year. Particularly galling is the fact that this came after an apparently successful and convivial meeting last April in Florida with China's President Xi Jinping, where trade issues were discussed in detail.

At any rate, the Chinese will most likely agree to the process of a fast and substantial reduction of their bilateral surplus with the U.S. in some combination of rising American exports to China and declining Chinese exports to the U.S.

The US will force Germany's policy change
A similar trade adjustment mechanism should be set up to deal with a $151.4 billion trade deficit the U.S. ran with the EU in 2017.

As a practical matter, however, Germany should be the focus of America's trade policy toward Europe. At the moment, Germany is running a trade surplus well in excess of $300 billion, or about 8 percent of its GDP, which accounts for nearly 70 percent of the euro zone's total.

In the case of the U.S., Germany's trade surplus - $64 billion in 2017 - represents 42 percent of America's total trade deficit with the EU.

The U.S. and the world community have every right to insist that Germany must change its economic policy to reduce its huge trade surplus. Washington should also introduce a numerical target to force a rapid decline of its bilateral trade deficit with Germany. That deficit is large enough, and structurally grounded, to warrant a quick action to plug trade leakages that are undermining American growth dynamics.

Predictably, the Europeans are kicking and screaming. They complained last Friday that they don't want to negotiate with a "gun to their head" - a reference to suspended U.S. trade tariffs on steel and aluminum.

There were also the usual invocations of trans-Atlantic unity, solidarity, Western values and a Western world order. None of that is threatened by "clear agreements, good friends" ("clara pacta boni amici" in Latin). The U.S. just has to stop being taken for a ride in the name of Western leadership.

Back to China: The U.S. should not pick unnecessary fights on intellectual property. Technology transfers to China were not an extortion; they were part of the cost-benefit analysis of American firms investing in local joint-venture facilities. The Chinese just pushed through an open door.

But that can be easily stopped by prohibiting technology transfers as part of American joint ventures in China. In addition to that, the U.S. can prohibit imports of Chinese products incorporating illegally obtained and unlicensed American technology.

Linking the U.S.-China trade and investment relations with geopolitical issues should also be avoided. These are vastly different problems that should be considered on their own merits.

Surely, weaponizing trade is a tempting shot when you want to throw the proverbial kitchen sink at the country (China) designated as a "strategic competitor" and a "revisionist power" challenging the Pax Americana - the American world order. But think where all that leads, and what is the ultimate objective.

A military confrontation of nuclear-armed states is not a simple skirmish. The MAD (mutually assured destruction) doctrine has been established ever since the 1950s when the Soviet Union acquired nuclear and thermonuclear weapons and their intercontinental delivery vehicles. That is still the case. The wisdom of putting trade in there is not obvious when you have to figure out what to do about potential adversaries with nuclear-armed submarines along America's Atlantic and Pacific shorelines, undetectable hypersonic weapons, etc.

A patient search for an acceptable state of affairs with China should not be an obstacle to building a highly competitive U.S. economy, and maintaining a forceful defense of American national interests.

Investment strategy
At the beginning of this year, the EU and China were running their trade surpluses with the U.S. at respective annual rates of 8 percent and 15 percent above their 2017 levels.

Unless something is done quickly, these numbers indicate the possibility of another year of an embarrassing defeat for Trump's most vocal pledge to stop, and reverse, leakages of American domestic demand in the form of wealth and technology transfers to U.S. trade competitors.

That is an issue where the Republican Party should strongly support their man in the White House - if they want to see more of the fiscal and monetary stimulus benefiting American jobs and incomes.

And hold the trade war rhetoric. The Europeans and the Chinese know that they have maneuvered themselves into an untenable position with their excessive trade surpluses. They are angry and screaming because they know that they have to yield.

Washington should push on with its drive for fair and reciprocal trade. We should all hope to see a principled determination to stop the people undermining the stability of the world economy by ignoring the long-standing and widely accepted rules of an orderly trade adjustment.

Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York, and taught economics at Columbia Business School.

Source: CNBC