The Taiwan Banker

When the People's Republic of China was founded in 1949, it marked a dramatic victory for the Chinese Communists and a crushing defeat for their opponents the U.S.-backed Chinese Nationalists. In the United States, conservatives charged that China had been "lost" to communism. We will never know if greater U.S. aid to the Nationalists could have prevented a communist victory. We do know that at the height of the Cold War, relations between Beijing and Washington stayed on ice. In a sense, the U.S. and China "lost" the chance to engage meaningfully with each other for more than two decades. Today the U.S. and China are on the brink of another rupture to their relationship that will have more far-reaching consequences for the world than the previous estrangement, because we are more interconnected than in the mid-20th century.The two countries are locked in an intensifying year-long trade war that arose from Washington's impatience with Beijing's refusal to carry out market reforms it had promised as a condition for joining the World Trade Organization. The U.S. has grown disillusioned with China's failure to lower market barriers, halt forced technology transfers, and protect intellectual property. As recently as May, a trade deal seemed within reach. But China altered the agreement at the eleventh hour, removing commitments to codify in Chinese law changes to its trade practices. Beijing instead said it should be trusted to make reforms through administrative and regulatory means. Given China's long history of broken promises on market reforms, Washington insists on a legal enforcement mechanism in the trade deal to ensure compliance. U.S. President Donald Trump, no stranger to the art of the deal, responded swiftly to Beijing's chicanery. He tweeted on May 5 that the U.S. would raise tariffs on US$200 billion in Chinese imports from 10% to 25%. The new levies went into effect May 10. Chinaretaliated with new tariffson $60 billion in American exports effective June 1.By digging in its heels, Beijing squandered the remnants of good will it enjoyed in Washington. Not only did China embolden the hawks in the Trump administration, it even managed to irk the doves. Treasury Secretary Steven Mnuchin, who, with market sentiments in mind, has taken a more conciliatory approach to reaching a trade deal with China than some of his colleagues, told reporters in May that the trade deal had been 90% complete but that Chinese negotiators tried to "go back on language that had been previously negotiated." Mnuchin reiterated that point at a press briefing in June. “There’s no question where we are now, that this is a result of them backtracking on significant commitments," he said. “For whatever reasons they decided to do that, I’ll leave to them.”For his part, Trump is threatening tariffs on the remaining $300 billion in Chinese imports if he does not hammer out a deal with Chinese president Xi Jinping at the June 28-29 G20 summit in Osaka. Beijing, meanwhile, continues to strike an obstreperous tone. “If the United States willfully decides to escalate tensions, we’ll fight to the end," a spokesperson for the Chinese Commerce Ministry said in June. The China market's allure Before the trade war began, the U.S. and China had enjoyed stable ties for nearly four decades. Even the Chinese Communist Party's lethal crackdown on protesters at Tiananmen Square in 1989 did not derail bilateral ties. Despite facing pressure to respond more forcefully to Beijing, then U.S. President George H.W. Bush felt that good ties with China were too important to sacrifice. As two-way trade surged, commercial considerations came to dominate the relationship. It's easy to see why. Bilateral trade in goods expanded by a factor of 252 from 1979 to reach US$633.5 billion last year, according to a new report by China's Ministry of Commerce. The U.S. Trade Representative puts that figure slightly higher at US$659.8 billion. By either estimate, China is the U.S.'s top goods trading partner. Inevitably, China has become a major sales driver for some of the largest U.S. companies, including Boeing, Apple, Microsoft and Ford. Large public U.S. firms with high China exposure are loath to upset Beijing, lest their earnings be impacted. This fear of offending Beijing reached an extreme in the early 2010s, when dozens of U.S. firms, aware of blatant Chinese hacking and trade-secret theft, would not come forward to press charges through the WTO. The companies believed too much money was at stake to risk provoking Beijing's ire. The Chinese government has denied involvement in any of the malfeasance. "Looking back on it, in retrospect, I think we probably should have been more active and more responsive," Wendy Cutler, a former USTR negotiator, told NPR in April. "We kind of lost the big picture of what was really happening."Beijing has long skillfully exploited its market size to have its way with U.S. companies. The late Sinologist Lucian Pye, one of America's most sharp-eyed China scholars, noted in the seminal 1982 study Chinese Negotiating Style that American businesspeople "are excited less by current realities and more by their expectations about future opportunities in China. As long as traders want to be in on China's promising future, they will continue to forego current benefits in hopes of bigger ones later." To be sure, some key U.S. companies were and continue to be profitable in China. But frustration with its unfair trade practices have come to the fore in their growing support for Trump's hard line on China. In a February survey, Tim Stratford, chairman of the Beijing-based business association AmCham China, told Reuters that "while people don't like tariffs... they also think that maybe the tariffs have done some good in provoking very serious negotiations between the two sides." The Trump administration has been candid about the need for U.S. firms to endure some short-term pain to gain long-term benefits.“We have had unfair trading practices all these years and so in my judgment, the economic consequences are so small that the possible improvement in trade and exports and open markets for the United States, this is worthwhile doing," Larry Kudlow, director of the National Economic Council, said on Fox News Sunday in May. Ironically, the rationale for this approach is similar to what Pye highlights in his study. The difference this time is that U.S. firms, rather that passively accept the rules dictated by China, must trust tariffs to help them further pry open China's markets. The coming winter Amidst the escalating trade war, the Sino-U.S. relationship is becoming more openly hostile. Tensions are especially evident in the technology sphere. There, the U.S. is pursuing an aggressive campaign to curtail the business of China's telecommunications giant Huawei, a global leader in 5G technology that Washington sees as a national-security threat. While Huawei is nominally a private company, China's cybersecurity laws could compel it to share any data on its networks requested by the Chinese Communist Party. In May, the Trump administration targeted Huawei with an executive order banning U.S. tech firms from doing business with "foreign adversaries." Deprived of U.S. semiconductors and Google's Android operating system, Huawei is in deep trouble. Trump has signaled that the Huawei ban might be a negotiating tactic, and could be lifted as part of a trade deal. Beijing, however, has no illusions about the U.S.'s intent to contain its technology ambitions. Its response has been not to push new market reforms but instead to double down on Maoist themes of self-reliance. Xi Jinping recently exhorted his countrymen to prepare for a new "Long March" during a visit to Jiangxi Province, where the Red Army narrowly evaded extermination by the Chinese Nationalists in 1934, and launched a 5,000-kilometer, year-long path of retreat through western and northern China. "We are now embarking on a new Long March, and we must start all over again," Xi said. Xi may have been speaking figuratively, but the trade war is hurting the Chinese economy and could cleave up to 1% off of its GDP growth this year. Manufacturers of goods from textiles to consumer electronics have or are considering relocating production facilities from China to other countries, such as Mexico, Turkey, Vietnam and Indonesia. Some Taiwanese manufacturers are bringing production capacity home to avoid the tariffs. In the aggregate, China has more to lose than the U.S. because its economy is more dependent on trade. Before the trade war, China's exports to the U.S. contributed 4% of its GDP growth, while the U.S's exports to China accounted for just 1% of its GDP growth. At the same time, China has almost no friends left in Washington. Many businesspeople and scholars have soured on Beijing. Worse yet, the retired officials who have long served as unofficial conduits for Beijing's interests in Washington have no influence on the hawkish Trump administration. Most of these "old friends of China" are ex State Department officials who can trace their involvement with the Middle Kingdom to the early 1970s, when President Richard Nixon initiated a historic thaw in bilateral ties. Their formative China experience came at a time when the PRC was far weaker and less overtly ambitious than today. As former diplomats, they prefer compromise to confrontation. They have not supported Trump's hard line on China. It is tempting for critics of the Trump administration's economic nationalism to blame the mercurial Trump and China hawks in his administration like U.S. Trade Representative Robert Lighthizer and Peter Navarro, director of the National Trade Council, for poisoning relations with Beijing. Yet it is the Chinese who for years ignored the polite requests of business associations and prior administrations to enact market reforms. China's inaction alienated the very businesses that had once been its reliable backers in Washington. Later, when faced with Trump's tariff threats, Beijing didn't take him seriously. Beijing now must contend not only with tariffs, but also intensified scrutiny of its wider presence in American society. Washington is clamping down on Chinese investment, tightening visa policy for Chinese researchers and students, and could move to restrict Chinese fundraising in U.S. capital markets. Losing access to the U.S's academic and financial resources will not benefit China's development. Given the opacity of China's political system, we don't know why Beijing overreached with America. Some analysts attribute it to a combination of resurgent nationalism, buoyed by decades of economic success, and classic Chinese bureaucratic inertia. Some say that Xi Jinping, the most powerful Chinese leader since Mao Zedong, mistakenly dismissed the U.S. as a paper tiger. John Garnaut, an Australian journalist formerly based in Beijing and close watcher of elite Chinese politics, says that Xi sees the CCP in an existential struggle with U.S.-led Western liberalism. In the now infamous Document No. 9, issued in 2013, Party cadres are urged to wage "intense struggle" against nine "false trends," including Washington's efforts "to change China's basic economic system.""In Xi’s view, shared by many in his Red Princeling cohort, the cost of straying too far from the Maoist and Stalinist path is dynastic decay and eventually collapse," Garnaut said in a January speech. Even if the U.S. and China avoid a true cold war, bilateral ties will not easily recover. The U.S. now sees China as a long-term strategic competitor at best, and at worst, an enemy to be contained. Perhaps years from now, a more adaptable Chinese leadership will wonder, who was responsible for the loss of America?