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September 28, 2018

The U.S. Has More to Lose in Trade War with China

I view the tariff war as a tremendous gamble. Its outcome, I fear, will favor China far more than the U.S.

Soren Skou, head of the world’s largest shipping company, has an intimate knowledge of global trade. He thinks that tariffs could slow U.S. growth by as much as 3% to 4%, compared to just 0.1%-0.3% for the world at large.

But economics is just part of the story. U.S. tariff actions, and the generally more aggressive tone the U.S. has been taking toward China, are serving to bolster China’s role as the East’s hegemon. In particular, the South China Sea, through which nearly $3.5 trillion worth of trade flows every year, is deeply implicated.

Investors are underestimating these risks. Here’s why you should be worried and adopt a defensive posture with your portfolio.
Flexing Naval Muscle
In the South China Sea, China recently conducted massive naval exercises. The demonstration featured more than 40 ships along with submarines and an aircraft carrier.
The country also held major aerial exercises to showcase China’s ability to counter any U.S. attempt to command the airspace in the area.
The New York Times described China’s military power in an article in August:
“While China lags in projecting firepower on a global scale, it can now challenge American military supremacy in the places that matter most to it: the waters around Taiwan and in the disputed South China Sea.”
That means a growing section of the Pacific Ocean — where the United States has operated unchallenged since the naval battles of World War II — is once again contested territory, with Chinese warships and aircraft regularly bumping up against those of the United States and its allies.
To prevail in these waters, according to officials and analysts who scrutinize Chinese military developments, China does not need a military that can defeat the U.S. outright but merely one that can make intervention in the region too costly for Washington to contemplate. Many analysts say Beijing has already achieved that goal.
Earlier this year, Peter Jennings, head of the Australian Strategic Policy Initiative, predicted that sometime next year “China’s armed forces will hold exercises in the international waters of the South China Sea and that, to protect public safety, it will close the air and the sea space in the area.”
Of course this would be presented as a temporary measure. But in effect it would represent stunning proof of China’s de facto control over the world’s largest commercial trade artery.

An Incentive to Ditch the Dollar

China’s strengthening military position in the East is just one aspect of how the world is changing in ways that don’t serve U.S. interests. I see our stance on trade as also surely further incentivizing China and other countries to transition from dollar-based trade to something else.
Our ability to penalize other countries, via measures that include sanctions as well as tariffs, stems from the dollar’s role as the major reserve currency. Take away that role, and suddenly the U.S. can far more easily be ignored.
As expressed in a recent CNBC posting by Gal Luft, co-director of the Institute for the Analysis of Global Security, the U.S. currently is waging economic warfare against two billion people with a combined gross domestic product of more than $15 trillion. Brazil, Russia, India, China, and South Africa — the so-called BRICS group — have strong ties with each other and a combined population that dwarfs the entire developed world.
These all represent a potential anti-dollar constituency that would be happy to go along with a new monetary system, something that is clearly part of China’s plans. It’s a system that I believe will be tied to gold and that will take away some of the dollar’s power.
In its pursuit of a supposedly better trade environment, the U.S. is being shortsighted. It’s failing to see the interconnections among trade, the military, and the overall economy. America has set in motion a domino effect that will come back to hurt it.

Rare Earth Metals

One area where the U.S. seems woefully shortsighted is China’s dominant position in rare earth metals. China arguably has more rare earth ores than any other country in the world. Even more significantly, it also has a near monopoly on the complicated supply chain that takes rare earth ores through multiple complex steps to transform them into permanent magnets.
These are essential in a wide variety of electronic products in both the commercial and military spheres, including missile guidance systems.
Remarkably, rare earth metals along with other critical and China-dominated metals, such as cobalt, were originally on Washington’s list of Chinese imports to tax. Fortunately, President Trump was told the folly of making strategically important items more expensive and removed rare earths from the list. However, this highlights how unrealistic it is to force China to bend to Washington’s will.
The upshot: stay cautious. Wall Street is delusional in thinking the trade war will blow over or that America will win. You ignore these realities at your peril.
Courtesy of Stephen Leeb, Investing Daily (More from Investing Daily Here)  
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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