The US should tame finance to tame China

Economists have criticized President Donald Trump for his seemingly disparate and uncoordinated actions on trade and intellectual property disputes with China. Photo: Bloomberg

In February this year, Ashton B. Carter, defense secretary in the Barack Obama administration, had given an interview to Politico (“Ash Carter: Full Transcript”, 19 February 2018). The interviewer, strangely and yet unsurprisingly, dedicated more than half the interview to real and imagined threats to America from Russia, ignoring the bigger elephant in the room, China. Towards the end of the interview, in response to a somewhat tangential question, Carter spoke about the threat from China to America. He said America did not have an adequate playbook for competition with China and that economists had not given (the government) much of a playbook to protect American companies and the American people. He is quite right. Economists have been quick off the block to criticize President Donald Trump for his seemingly disparate and uncoordinated actions on trade and intellectual property disputes with China. But they had not offered better answers.

There is very little aggrieved nations can do when a sovereign state makes promises knowing fully well that it has no intention of honouring them. President Xi Jinping promised Obama that China wouldn’t turn a series of man-made islands in the South China Sea into military installations. He did just that. William Galston, who served in the Bill Clinton administration in its first term, wrote in The Wall Street Journal last year (“Second Thoughts On Trade With China”, 8 August 2017) that China promised to sign the government procurement agreement, which requires government purchases to be made on a non-discriminatory and transparent basis, when it entered the World Trade Organization in 2001. Sixteen years later, this had still not happened. He concluded that preventing the handing over of America’s technological crowns to a foreign power without blowing up the international trade regime would not be easy. There you go. Even for op-ed writers, there are no facile answers.

The Asia Society that produced a multi-authored report on a set of policy recommendations for the new administration in March 2017 had nothing more than a set of platitudes and homilies on trade, except to note that the American business community had served as a ballast in the American relationship with China. A truer sentence has not been said.

China has been remarkably successful in co-opting business and academia in Western nations and aligning their interests with its interests, so much so that an American president who gets a ton of criticism on a daily basis is a dangerous dictator whereas someone who anointed himself president for life is a champion of liberal values, including free trade. Maybe free trade works at the aggregate level, making it a seeming win-win for nations engaging in it, but even its most ardent champions have been singularly incapable of offering solution to address its intra-national distributional consequences. Some firms win but most workers lose. Justin Pierce and Peter Schott have documented the impact of free trade, particularly with China, on communities dependent on manufacturing in the US. Pierce is an economist with the Federal Reserve and Schott is with Yale University. Their conclusions support the policy stance adopted by the current US government.

Whether or not the US succeeds in making China change its obstreperous behaviour without inflicting damage on its own economy and employment is a matter of conjecture now and predictions are nothing but reflections of prejudices. We know that economists have a terrible record on predictions even on matters that do not involve Trump. But how can Trump improve his chances of success?

The road to success starts with the understanding that the rise of China, the rise of globalization and the rise of finance since the 1980s are interlinked phenomena. The initial and dominant feature of globalization was American manufacturing offshoring its production to China, leading to trade deficits. The financing required for it brought Wall Street to the fore in intermediating Chinese and Asian savings towards US assets. In the process, Wall Street gained in power and influence over policymaking in America. Therefore, an important ingredient for success with China is the recognition of its linkage with the rise of finance and the rise of Wall Street. Both of them have been responsible for the rise of inequality that brought many disaffected voters to Trump’s side. Taming finance and winning the trade war are two sides of the same challenge.

Trump has an ally in the new chairman of the Federal Reserve, who is prepared to quietly reverse the pre-emptively supportive stance of monetary policy towards asset prices. In his latest speech, delivered on 6 April at the Economic Club of Chicago, he betrayed no concern over the recent rise in volatility in stock markets. Trump should make sure that his economic adviser does not interfere with the Federal Reserve’s normalization of monetary policy. More importantly, he too should not view the stock market valuation as a barometer of his success as president. Indeed, he should remember that the swamp is topped up when the stock market is at historic highs. A Federal Reserve doggedly pursuing its unhidden mandate of fostering maximum employment with low and stable inflation would help the president realize both his goals: of draining the swamp and of taming China. He just needs to make the connection between the two.