In the previous column on the topic of the “trade war,” I outlined some of the consensus views regarding the potential impact. In the short and medium terms, we can expect few winners but many more losers. I also presented a more nuanced view of free trade. The conventional wisdom often ignores the de-industrialization free trade caused in most of the developing world after the rise of China. The Caribbean, Africa and most Latin American countries cannot compete with Chinese manufacturing. The multinational corporations are these days integrating Vietnam and Bangladesh, but continue to largely ignore much of the developing world. American and Mexican sugar subsidies hurt small economies like Guyana. Therefore, I implied that small economies need some form of protection for shaping their policy space. Free trade works best among equals.
There has been much speculation about whether China or United States will win the trade war. The ephemeral stock market indexes are saying China is on the ropes. Some investors, like Mohamed El-Erian, think the United States is winning. I see it differently. I expect this trade spat will lead to major long-term realignments that would weaken the US dollar’s place as the main international reserve currency. Guyana and the Caribbean should keep a close eye on this development over the coming decade since the Region has exchange rates anchored against the US dollar.
A few notable economic historians, like Barry Eichengreen, have been predicting the relative decline of the US dollar as the main global reserve currency for some time. I never agreed for various reasons. For example, the euro possibly has already reached its upper limit of around 18% of foreign exchange reserves around the world. One limiting factor relates to the fact that there is not a combination of federal European level bonds and Treasury bills. This relates to the Chartalist idea that Europe needed a unified taxing and debt mechanism first before a unified central bank. As an aside, a few years ago, I applied this Chartalist principle in two Development Watch columns arguing that the Caribbean integration process has the cart in front of the donkey; first, there should have been a unified taxation and debt system before free labour movement, competition commission and such.
The country with the international reserve currency has to be willing to run more deficits than surpluses so that it can feed the rest of the world its debt papers as it buys goodies. Of course, there is an instance of a surplus country possessing the international reserve currency, but that was under mercantilist colonialism and not under the modern fiat money standard. Possession of the international reserve currency is a great privilege in the sense that the powerful nation can print its fiat papers and buy things from the rest of the world. This is essentially the privilege the United States enjoys today. China wants this privilege as well. The ability to print one’s fiat papers and get the rest of the world to demand it has major implications for military spending and power.
In addition to the points made above with respect to the euro’s upper limit, I would tell my students in International Economics the Chinese yuan is still very far away because China faces a major information problem, which its government has to solve before the rest of the world believes yuan debt is credible enough to put vast amounts of pension savings into it. State-owned Chinese corporations have not been entirely forthcoming with data and as a result several were delisted on Western bourses, namely London and New York.
However, I have had to revise my views in light of the Trump administration. Since the disagreements over trade, several important changes are afoot. European countries, also facing the Trump-Navarro-Ross tariffs, are moving towards China for trade deals. China’s efficient government bureaucracy is mobilizing farmers to meet local demand for soybeans and other staple crops and also renting vast unused lands in neighbouring Russia. Once China invests money in these new capacities, they are unlikely to go back to American farmers.
Last week, China cancelled a large oil import deal from American sellers and will replace these with Iranian oil. Most of the payments will be with yuan and not dollars. In addition, China is setting up an exchange in Shanghai that will allow for pricing and trading oil in yuan, as well as arrangements with a few African countries and Russia to accept yuan for oil. What are these countries going to do with the yuan they accumulate? They will buy military hardware and other goods and services from Russia and China. In other words, as China imports more it can increase the world supply of yuan, which eventually becomes part of a diversified portfolio of foreign exchange reserves around the world.
These are likely long-term outcomes. In the shorter term, we can expect a penalty on the foreign car brands that established factories in the United States for serving that market and exporting to Asia. Last week, BMW said it would have to shift some of its production from South Carolina to China. This is one way of circumventing some of the tariffs the Chinese will set as retaliation. Tesla is going to make electric cars in China as the government there dramatically boosts implementation of electric vehicles.
Another factor often ignored during this discussion of the fate of the dollar is the capacity of the American administrative state (the civil service) to do work efficiently for domestic and foreign purposes. As social liberals fight over abortion rights, the new nominee to the Supreme Court is much more likely to vote for weakening the American federal civil service than against abortion rights. He is a lot more likely to vote against the State and its capacity to implement economic policies. For poorer folks, it also means that measures, such as affordable healthcare and labour rights, will be undermined in the name of free markets and liberty. His ideological world view does not allow for scientific principles, such as adverse selection and moral hazard, which are endemic in health insurance (and financial) markets and the primary reason why about 20 million Americans don’t have health insurance. Moral hazard and adverse selection are liberty busters as much as an authoritarian government.
Meanwhile, the Chinese developmental state is only going to get more skilful, nimble and meritocratic. It will have even greater capacity to implement major policies like those promoting renewable energy, strategic foreign policy, infrastructure and electric cars relatively quickly as the American one wanes and becomes bogged down by the lobbyists’ influence. The point is, a great power needs a great state bureaucracy and not just markets.
At this point, the flaws in American democracy are becoming more apparent. One aspect is to throw grass-fed steak to the base and get them to forget or ignore their economic problems, brought about largely by blind faith in free markets and profit-only corporate governance. If the Communist Party of China can solve the information problem of transparency I alluded to above and is willing to run deficits to expand the pool of sovereign yuan securities, the Chinese currency will assert a greater space as a global reserve (and vehicle and invoice) currency and the dollar’s share will decline. The rise of the yuan will see the ascendency of Chinese military power relative to that of the United States.
Trump will be out of power by then. And who knows? The next leaders might still find scapegoats for their base. After all, by then, much money would have been frittered in Iraq and tax cuts for the rich. It will be time to cut social spending for the middle-class and poor. Therefore, some political leaders and special interests will still need scapegoats for their susceptible base.