Earlier this week, China took a dramatic step in the escalation of the increasingly severe trade war between itself and the United States. China dramatically reduced the value of its currency (yuan) in relation to the American dollar. In response, the United States labelled China as a “currency manipulator” and threatened to take action against this step. But this move is only the latest in a series of escalations between the world’s two largest economic powers. So how did we get here, and what does this all mean for the average American consumer? This week, we’ll explain the complications and implications of the China-America Trade War.
First, how did this all start? The history of modern economic relations begins with the opening of relations between the United States and China during the Nixon administration. Prior to this move, the United States essentially shunned China due to its communist ideology. The United States began trading with China in the hopes that eventually American influence and the power of democracy would turn China into another Western-friendly democratic nation. Obviously, this has not happened. Instead, China has worked extremely effectively to marry state-controlled economics with some measure of free market capitalism. The result is a system that generally provides the means of economic success for many Chinese citizens, but does not allow for the democratic freedoms commonly found in Western nations. All throughout this process, the United States and China have continued to rely on each other more and more for economic and trading success.
What has emerged in the first decades of the 21st century is a global economy dominated in large part by China and the United States. In 2013, China surpassed the United States as the largest global exporter, with Germany closely following behind the United States. While the United States is shifting more of its economic focus from manufacturing to providing services (like technology support or business consulting), China is ramping up its manufacturing capabilities. This move undercuts American manufacturing and helps contribute to the loss of such jobs in the United States. In recent years, China has often engaged in other tactics to undermine the American economy by dumping large quantities of goods such as low-quality steel into the global market. This has the consequence of lower global prices, pushing some American companies out of business.
But as if that friction wasn’t enough, China has also engaged in a massive corporate espionage scheme. As we have discussed previously, China uses several tactics to engage in this type of behavior. One tactic is to force foreign companies to partner with similar Chinese firms if they wish to do business in China. Then, these firms will gather the intellectual property of the company and funnel it back to the Chinese government. Once the government has all of the secrets of that foreign company’s success, it will kick that country out of the Chinese market and manufacture its own version of that good or service. Another method the outright hacking of companies or spying on them using China’s increasingly ubiquitous technology. This is one reason the United States has effectively banned the use of Huawei devices as it is believed these devices could be directly controlled and monitored by the Chinese government. All of these factors have combined to form the extremely toxic economic relationship between China and the United States that we see today.
With the onset of the Trump administration came a new approach to resolving these disputes. Shortly after taking office, the administration announced a new measure to attempt to negotiate a bi-lateral trade deal between the two countries and began imposing tariffs to pressure the Chinese government. As you may recall, tariffs are a tax on all imports coming from a particular country (China in this case). This increase in prices hurts China by decreasing demand for that nation’s goods, but it also effectively acts as a tax on American consumers since prices increase for a large variety of products within the country. Not wanting to look weak, China has been responding in kind with tariffs of its own. This cycle of escalating tariffs has resulted in what many economists consider a trade war. As the name suggests, this is where two or more nations attempt to dramatically damage each other’s economies in order to achieve an economic or political agenda. As trade talks have continued to break down throughout the summer of 2019, these tariffs have continued to dramatically escalate.
But just this past week, China took an even more dramatic step in this fight. China lowered the value of its own currency in relation to the American dollar. China is able to do this by printing its own money and releasing more of it into the global economy, making it more plentiful and cheaper. The end result of this is that Chinese exports become cheaper as well, so people buy more Chinese goods and fewer American ones since American goods become more expensive. But this action can set off a dangerous chain of events where other nations look to devalue their own currency in order to gain an advantage too. When nations begin aggressively competing to lower their own currencies, it can set off global economic instability and recession. Naturally, this type of thing should be avoided, which is why organizations like the International Monetary Fund have declared such practices illegal. In response to China’s actions this week, the United States formally listed China as a currency manipulator. The action is somewhat symbolic, but does allow for the United States to take limited steps to pressure China to reverse this trend.
How does this all impact you? These tariffs, intellectual trade theft, and currency manipulations all conspire to raise prices on goods and services throughout the American economy. The latest round of tariffs will directly raise the price of nearly everything imported from China in the United States. This impacts not only goods at the grocery store, but impacts nearly every link in the supply chain of companies that interact with Chinese products or natural resources. Manufacturing plants are forced to find new sources of steel and companies need to adjust their entire operations to account for higher costs along the supply chain. Companies are also having a much more difficult time planning for the future, as the economic situation is increasingly tense and prone to unexpected, dramatic shifts. Factories are then forced to reduce costs or outsource labor to foreign markets that are not directly impacted by tariffs. All of this helps depress the economy at a time when there are many worrying signs of an impending recession.
In all, these latest moves could just be posturing for a better negotiating stance. Or China could be settling in for an even longer term battle. China’s tariffs are in some ways designed to hit American factories and farmers the hardest (as these industries tend to have more Trump supporters). So China could be holding out until after 2020 to see what happens. But in the meantime, the trade war is having a substantial drag on the global economy as well. The economic benefits of a comprehensive Chinese-American trade partnership would be extremely beneficial. But it is not yet clear if this will be realized or if a deal will be truly meaningful if one is reached. What’s clear is that trade wars with the world’s largest trading economy are not, in fact, easy to win.