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Foreign Policy

Trump, China, and a “Nixon Trade Shock”?

Apr 03 , 2017
At the recent G-20 summit, breaking from precedent, U.S. Treasury Secretary Steven Mnuchin vetoed a declaration which affirmed the consequentiality of free trade, and sent shockwaves across the world. Since the advent of Donald J. Trump to 1600 Pennsylvania Avenue, economists and international strategists alike have spilled much ink theorizing the disruptive trade policies that the Trump administration will follow: a 45% unilateral tariff against China, the end of NAFTA and special subsidies to rust belt industries?
 
Donald Trump and his close circle of advisors have argued that the current U.S. trade deficit is unsustainable and it has mainly been created by the protectionist policies of U.S.’s major trade partners. Germany is enjoying a significant competitive advantage due to an “undervalued Euro” and China has long subsidized its industrial sectors distorting global prices and dumping its cheap products to the U.S. market, the president’s advisors declare. Consequently, Trump has warned that if the beneficiaries of U.S. market openness do not recalibrate their currencies and facilitate market access for American exporters, he will act unilaterally and even bypass the rules of the WTO.
 
Surprisingly, commercial unilateralism is not actually new in the post-WWII American economic diplomacy. The most notorious U.S. commercial unilateral moment took place in 1971 when Nixon shocked the world by announcing—without any consultation with U.S. allies—that the convertibility of the U.S. dollar to gold would be halted. Nixon also declared that the United States would impose a 10% imports surcharge – a tariff essentially – to ensure that “American products will not be at a disadvantage because of unfair exchange rates.”
 
Nixon – a Machiavellian political genius – understood well the effect of his announcement to U.S. allies and the severe objections that Paris, Bonn, and Tokyo would raise to his neo-protectionist trade policies. In an effort to create a fait accompli Nixon summoned his treasury secretary, John Connally, and fourteen of his closest aides in Camp David, demanding that the issues discussed remain strictly confidential from all other institutions including the State Department, and even their own wives. He then announced his decision and shocked the world. “Nixon action echoed like thunder” the Chicago tribune reported on August 22nd, 1971. After Nixon’s public statement, the Bretton Woods system, the very system that the U.S. set in place in 1944 to promote post-WII economic recovery, was no more.
 
Could Donald Trump act in a similar way if his negotiations with Beijing fail at the forthcoming Xi-Trump meeting in Mar-a-Lago or the June 2017 China-U.S. Strategic and Economic Dialogue? Could Trump like Richard Nixon “echo like thunder” by unilaterally announcing a high tariff regime to balance U.S. trade deficit and break the WTO system? While some of Trump’s advisors would wave their heads affirmatively, the institutional and commercial leverage of the U.S today is much inferior from Nixon’s America. Unlike 1971, the United States in 2017 is bounded both by serious institutional commitments and power dynamics to act multilaterally and avoid “strategic surprise.”
 
GATT VS. WTO
 
In 1971 the global trade regime was overseen by the General Agreement on Tariffs and Trade (GATT) which was created in 1947 to protect the world from the perils of trade war. The memory of the mid-war mercantilism and its contribution to the outbreak of WWII was still vivid. Yet the GATT’s dispute settlement mechanism was “a court with no bailiff” and the enforcement of a ruling could be vetoed by a single country. The European Community in 1971 could have taken the United States to GATT’s dispute settlement but the U.S. could easily veto a ruling it disliked. In essence the “free trade” institutional framework was weak and could be bended at will by powerful nations.
 
However, since 1994 the GATT has been transformed into the World Trade Organization (WTO). The WTO has become the “backbone of the global commercial order” and its dispute settlement system is more immune to political coercion and cannot be vetoed by a single member. So successful has the WTO dispute settlement been in neutralizing protectionism, that a renowned professor of law named the WTO’s appellate body the “Supreme Court of Global Commercial Justice.” If the Trump administration unilaterally imposes a 45% tariff on imports from China, then Beijing could easily win the case in the WTO in less than 15 months.
 
Once China is armed with a favorable WTO dispute settlement ruling, then according to WTO rules it can retaliate (article 22) by targeting any sector of the U.S. economy it decides, and impose countermeasures equaling the damage the U.S. tariffs have incurred upon Chinese exporters. It needs no advanced strategic acuity to realize that Beijing strategists have already designed the potential retaliation in such a way as to maximize the political cost on members of Congress and the President himself. China for instance could target imports from critical swing states and the rust belt, undercutting the constituencies that could reelect Trump in 2020. The cost for the U.S. president would be his own reelection.
 
U.S. in a multipolar world
 
In 1971 Nixon faced serious economic pressure at home with enormous spending in the Vietnam War in an effort to deter the expansion of Soviet Communism in Asia. At the same time, the U.S. nuclear umbrella protected Western Europe and Japan (extended deterrence) from Soviet conventional superiority in Europe and the Far East. While the then German Chancellor Willy Brand and the French President George Pompidou were infuriated by U.S. monetary unilateralism, they eventually gave in to Washington’s demands and calibrated their exchange rates, understanding that the U.S carried the burden of European defense against a forceful Soviet Union.
 
As Berkley’s Barry Eichengreen has put it, Nixon in 1971 knew exactly how dependent the Europeans and Japan were on the U.S. security umbrella and “chose the former Texas governor John Connally to play bullyboy on the manicured fields of international finance.” When Nixon announced the 10% tariff, the outraged Europeans at first objected but then caved in as Connally demanded concessions “theatrically holding his ear and telling the Europeans that he heard no suggestions” at a finance ministers summit in September 1971. Nixon then announced that the new agreement with the Europeans was “the most significant monetary achievement in the history of the world.”
 
Nixon in 1971 also had complete authority over all institutions of executive economic policy including the Federal Reserve run by Arthur Burns a legendary Columbia professor and loyal republican. In 1971 Nixon strategically played domestic politics and geoeconomics and won a landslide reelection in 1972. Yet today the U.S. role in the world is much less singular than 35 years ago, Trump doesn’t control the FED and Mnuchin cannot repeat Connaly’s theatrical gestures toward the Europeans, let alone the Chinese. American GDP in 1971 was almost a quarter of the world’s while today (2017) is below 19% and falling. Most importantly today there is no Soviet Union ready to unleash its tank battalions and occupy Germany thus European dependency on the U.S. security umbrella has significantly weakened. Neither will the Chinese remain idle observers to U.S. economic unilateralism and Beijing looks determined to align with Europe and impose heavy cost on U.S. businesses.
 
Trump’s “mini” trade war and China’s Market Economy Status
 
The WTO’s collective trade security architecture and the less circumstantial U.S. role in global power dynamics leave the Trump administration with limited trade strategies and mostly with a sole option for operating within the system of the WTO yet, perhaps, on the boundaries of WTO’s legalism.
 
As Joseph Stiglitz, a Nobel laureate in economics has put it during his lecture series at Columbia University, the Trump administration will take anti-dumping and countervailing duties to an all new level and play this card in its negotiations with China. The current WTO system, Stiglitz iterated, allows the United States to determine the price of Chinese products in dumping cases by arbitrarily choosing third markets as production cost anchors. This stems from the status of the Chinese economy as a “non market economy” and the enveloping WTO regulations. Even though China according to the 2001 WTO entry agreement was to be granted market economy status automatically after 15 years, the EU and the United States have denied to grant it and the issue is currently examined by the WTO’s dispute settlement body. Along with anti-dumping tariffs the U.S. could also impose countervailing duties targeting sectors of goods that China has illegally subsidized. In addition, the U.S. could strengthen CIFIUS and screen Chinese FDI to the U.S. aggressively – particularly in the tech sector.
 
As the WTO’s dispute settlement could take 15 months for a binding verdict, in the meantime China would also look for ways to retaliate and a limited tit-for-tat would take place yet the range of trade injuries that U.S. and China would inflict upon another would be seriously bounded by the WTO framework. China, Stiglitz argued, could call into question the bailout of the U.S. auto industry and state support to U.S. financial institutions. The ultimate outcome would be a “soft” trade war which would harm both economies yet it would not signify the end of globalization and free trade. A major trade war between U.S. and China would lead to what former Undersecretary of State Robert Hormats has described as “Mutually Assured Depression.” A full-fledged trade war is unlikely.
 
Trump and Xi at Mar-a-Lago and the future of the global trade order
 
After Trump’s taking the telephone call from the Taiwanese leader and the shock that this incurred in Beijing, I had argued that Trump emulated Nixon’s “madman strategy” in an effort to win trade concessions from Beijing by showing his willingness to renegotiate issues that China took for granted. China froze all contacts with the U.S., and it was only when Trump affirmed his commitment to one China in his first discussion with Xi over the phone, that the U.S. Secretary of State was invited to visit Beijing. Pundits argue that Trump’s pledge over the one China policy won him some trade concessions or at least a promise from China on righting the trade balance.
 
While such an optimistic assessment of Xi responding to Trump’s Taiwan game with trade concessions seems unrealistic (Chinese usually avoid concessions when core interests are at stake), it is, however, possible that China could be willing to support more market openness and also invest significantly in the United States. In the high temple of Globalization – the World Economic Forum in Davos – Xi declared that “no country can emerge victorious from a trade war.” Xi iterated that China “will expand market access for foreign investors, build high-standard pilot free trade zones, strengthen protection of property rights, and level the playing field to make China’s market more transparent and better regulated.”
 
At Mar-a-Lago, Trump and his team should work with Xi and design a framework for trade and investment reciprocity. The U.S. automobile industry, the U.S. airplane industry, the U.S. services sector could be great beneficiaries from Xi’s promise in Davos to expand market access and build high standard free trade zones. Yet, reasonable concerns over the “Made in China 2025 plan” which supports import substitution and raises barriers against foreign investors should seriously be addressed.
 
In 2009 the U.S. and China agreed to put strategic and economic interests together and kicked-off their 1st Strategic and Economic dialogue realizing that the interaction between the world’s two largest economies is consequential for peace and prosperity. At Mar-a-Lago Trump and Xi will have an opportunity to have high level discussions and prepare the strategic agenda for the S&ED that will take place later in 2017. They must realize that the United States and China are not beneficiaries but fiduciaries of the global system and that their partnership is essential to secure Nuclear Non-Proliferation, deal with pandemics, and alleviate resource scarcity and global warming.
 
Nixon was famous for two things: First for his strategic novelty of an opening to China and second for being the only U.S. president to resign from office. Liberals in Washington hope that Trump will follow Nixon’s political destiny and depart from office indicted by scandals and corruption. Perhaps they should truly hope that the president will look to Nixon’s policy toward China and solidify Sino-U.S. partnership.
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