Trade frictions between China and the United States, a possible consequence from the US’ launch of Section 301 Trade Investigation on China, are likely to undermine the US’ own credit risk control and debt repayment ability.
The US recently officially started an investigation of China under Section 301 of the Trade Act of 1974. If the development leads to trade frictions between the two countries, they will exacerbate the US internal imbalance between its debt burden and debt repayment sources underpinned by its valid wealth creation ability. It is the US national solvency that will suffer in due course.
1. Trade frictions constrain the output of high value-added products from the US, leading to a shrinking external trade market and even accelerating the pace of interest rate rise. There is risk for it creates a stronger dollar, to harm the US’ own export and undercut its wealth creation ability.
Although trade restrictions on China can prevent China from exporting as much to the US, trends in international division of labor and production will remain, in which China still occupies the lower end of the global supply chain, and most value-added products are created by the US or other developed countries. Trade frictions will work to incur a greater loss to the interests of US upstream suppliers and their downstream distributor, hampering the production of high value-added products.
Trade frictions will result in a more limited foreign trade market of the US. China is US’ biggest trading partner, and inevitably trade frictions will cast a negative influence on their bilateral trade relationship. In the meantime, China will turn to work more actively looking for opportunities from cooperation with other countries, such as the BRICS countries, countries with comprehensive regional partnership relations, and countries covered by its Belt and Road Initiative. The Chinese market will become more open to above countries. By contrast, trade frictions will affect the US export and direct investment in China, when the US already sees a more limited export market due to its withdrawal from the TPP and restarting of the negotiation on North American Free Trade Area. Trade frictions with China will add new difficulties to the US exporters.
Even worse, there is possibility that trade frictions will cast a shadow on the effect of the US monetary policy. Consider the fact that China’s per unit labor cost in manufacturing is still lower than that of the US, it is unlikely for the US manufacturers to be motivated to produce all the import substitutes unless there are government incentives in tax cuts and subsidies. If this is the case, restricting China imports will reinforce inflation and squeeze government revenues, and possibly lead to more frequent hikes in the interest rates by the Federal Reserve. As a result, as the US dollar index continues to increase, US exports to the entire world will be negatively impacted.
2. Trade frictions with China are unlikely to improve the imbalance between the US debt burden and its sources of debt repayment underpinned by valid wealth creation ability. There is risk that they may, instead, undermine the country’s wealth creation ability and leave a greater damage on the sources of debt repayment. In the end, it is the solvency of the United States that will suffer.
The imbalance is already severe between the US heavy debt burden and its sources of debt repayment supported by valid wealth creation ability. Trade frictions with China will not in any possible way redress the situation. Over the last 30 or so years, the US has relied on a debt-dependent development model characterized by excessive national consumption, and continuous fiscal deficit and trade deficit. A vicious circle of “rolling over the debt” has already formed and is likely to become a perennial phenomenon. This is a scenario that the Chinese would call “quenching a thirst by drinking poison”. Although the debt risk can be partially shifted to its international creditors by leveraging on the US dollar’s status as the international reserve currency, doing so can do little to improve the nature of the country’s weakening solvency.
Its trade frictions with China are likely to result in a further decline in its wealth creation ability, draining its sources of debt repayment. They will do more harm to the solvency of the United States and offer little impetus to its economic development. In 2016 the outstanding debt of the US accounted for as high as 252.8% of its GDP, and the federal government debt burden was also on a high level. Its debt-driven growth model is unsustainable. And there is little room for debt rollover. Engaging in trade frictions under such circumstances will inflict more restrictions on the US itself to improve its general economic health. Its international credit standing will be further compromised.
By National Risk Research Department
Dagong Research Institution
Released on August 24, 2017
(The Chinese version of the press release prevails to the extent of any inconsistency between the Chinese and the English versions. Any English version of the press release is for reference only.)