Trump Is Right: Time to get Tough on China

Trump Is Right: Time to get Tough on China

First it was the Soviet Union. Then Japan. More recently, China would “inevitably” supplant the U.S. as the world’s number one superpower. Such has been the constant drumbeat from those who chronically overestimate our rivals and fail to appreciate what it is – the special sauce of freedom, individualism and opportunity -- that makes this country great. Ronald Reagan made no such mistake. He capitalized on the profound weaknesses of the USSR’s dysfunctional economy and brought a once-threatening adversary to its knees.

Today, we have an opportunity to rein in China’s territorial ambitions and its chronic trampling of international law. China is in trouble, and the U.S. consumer is key to its renewed success. President Obama will shortly host China’s leader Xi Jinping. Let’s hope he takes advantage of China’s current turmoil to press our national interest -- demanding an end to cyber intrusions and widespread counterfeiting, for instance -- in addition to seeking cooperation on an environmental agreement that he views as key to his legacy.

Related: China’s Currency Devaluation Brings Stocks to a ‘Death Cross’

As their leaders have acknowledged, China’s economic model, dependent on cheap labor and exports, is broken. Beijing’s solution – pivoting to a consumer economy -- has taken a big hit from its collapsing stock market. Meanwhile, their ham-fisted efforts to manipulate their financial markets and their currency have put their ascendance as a global financial power in doubt. The current leadership has crushed dissent and nascent liberties, reasserting central control. Worst of all – just like Japan, China is facing a demographic cliff. Donald Trump is right: we do not have to kowtow to China.

China is slowing down. Insiders in Hong Kong are whispering that growth will be only one to two percent this year – a far cry from the 7 percent target set a few months ago and the 7.4 percent recorded in 2014, a 24-year low. It also falls short of the 7 percent growth the government claimed for the second quarter – a highly questionable assertion.    

Consider the data points: exports in July down 8.3 percent year-over-year, car sales down 6.6 percent, and imports down 8.1 percent. Does that look like an economy growing at 7 percent?  

Historically, Chinese authorities were frantic to maintain growth above 7 percent because they tied job creation to social stability. Each year, millions of young workers migrated from the countryside to urban areas, looking for work; exports provided those jobs.

Related: Blame China for Your Costly Lobster Roll

Today, thanks to decades of China’s one-child rule, the country’s labor force is shrinking. It is expected to drop modestly (less than 1 percent) this year, but then to tumble at a sharper rate beyond 2020. China’s labor advantage has tipped over, with low unemployment and increasingly restive workers driving wages higher (albeit from a very low base). In response, manufacturers are moving operations to lower-cost countries such as Vietnam and Thailand.

This trend inspired Beijing’s 2011 commitment to shift from an economy focused on exports to one driven by the consumer. The change was to capitalize on the emerging middle class; it failed to recognize that the Chinese people need more than money to bolster the economy. They need to trust the government, and the future; lack of confidence has resulted in China’s savings rate being amongst the highest in the world. 

The government also aspired to become a global financial powerhouse. The authorities successfully launched the Asian Infrastructure Investment Bank to compete with western-affiliated development banks, and broadened investment opportunities for the Chinese. Historically, most people had put their savings into real estate; declining home prices drove investors to look elsewhere. The authorities encouraged participation in the stock market by loosening restrictions on using borrowed money to trade.

Related: How a Soaring Dollar Forced China to Devalue Its Currency

Beginning in mid-2014, investors responded. Barron’s reports that “Local investors recently opened new stock market accounts at a rate of 4.1 million a week, up from about 70,000 a year ago.” Share prices more than doubled. Over the course of a year, margin trading in Chinese stocks soared five-fold, to 2.2 trillion yuan, which doesn’t include considerable “off the books” activity.

The government recently went so far as to permit people to use their homes as collateral – literally allowing them to bet the ranch.

This has turned out badly. Though still ahead 67 percent over the past 12 months, the Shanghai composite has retrenched 27 percent since its high in June, wiping out many newcomers and unnerving investors. Some $3 trillion in value has evaporated. Two days ago, the market fell 6 percent in one trading session.

With plunging financial markets rattling consumers, China must resurrect exports to revive growth. Hence the recent devaluation of its currency. With most emerging markets struggling, and Europe stuck in first gear, China depends on the U.S.  We can help… or not.

Related: China Pushes Yuan Down Further, Fuels Fears of Currency War

The Fed can postpone a rate increase, thus preventing any strengthening of the dollar and curbing China’s gain from its recent devaluation. The Obama administration can press charges against Chinese exporters of products like tires, steel or solar panels, where U.S. producers claim unfair dumping. Our government can also prevent Chinese efforts to buy U.S. tech firms, another growth avenue.

In other words, we can play hardball, something that does not come naturally to President Obama. (See: Cuba and Iran.) What should we demand from China? A cyber cease fire, for starters. Though the Obama White House has been reluctant to confirm that Beijing was behind the huge theft of material from the Office of Supply Management, National Security head James Clapper early on connected those dots. That Chinese hackers have stolen enormous amounts of military and commercial secrets from U.S. institutions and businesses is undeniable.  

We should also demand a withdrawal from disputed territories involving our allies. Japan, South Korea and the Philippines have all been bullied by China over the past few years.  

There are many other issues – human rights, counterfeiting, unfair trade practices -- that the U.S. has been willing to overlook, in part because President Obama craved cooperation in securing both a nuclear deal with Iran and a climate pact. Our business leaders, eager to exploit China’s expanding middle class, have encouraged our passivism.  At this moment, we should use our leverage to better level the playing field with China. If not now, when?