Gasoline on the Trade War Fire

Something happened yesterday with the Trump transition that worried me. By “worry” I mean it is great for me personally, but as I’m a bit of a purveyor of doom and gloom, everyone else should perhaps be a bit concerned.

It is probably not what most of you are thinking.

Many assert that Trump’s push for a deep bench of billionaires in his cabinet is generating the most serious conflicts of interest in modern history. (I find it adorable that some folks think self-interest is new to Washington.) Just look at it in context. Obama’s first cabinet had a combined 122 years in government experience and only five in the private sector. Un-shockingly, the Obama administration proved rather inept when it came to having conversations with people, while proving a champ at enacting regulations. Trump is simply the inverse. We’ve had a change in rulership, which will mean a change in policy and a change in approach. No biggie from my point of view.

No, I’m more concerned about something that was almost glossed over. President-elect Donald Trump announced Peter Navarro, a professor at the University of California (Irvine), would be in charge of trade policy. Specifically Navarro will run a new office called the National Trade Council.

Now I don’t have major concerns about Navarro in general. To put him in what I hope is not an unfair nutshell, Navarro is an anti-China agitator whose most notable book is “Death by China.” He advocates, among other things, a broad-scale economic, strategic, and political confrontation to sever exploitive economic exposure to China completely and, if need be, forcibly break the entire Chinese political and economic system. (Like I said, doom and gloom = good for Peter.)

My concern isn’t so much about his views as his likely style.

Shanghai, People’s Republic of China

Putting an academic in a policy position bears risks. Unlike bureaucrats, they don’t know how systems work. Unlike military officers, they think “chain of command” simply means everyone does what they say. Unlike business people, they have no practical experience in making decisions or compromises or making things happen with limited resources. What sounds great in the classroom sometimes shatters upon contact with hard realities, and it is far from unheard of for academics to then look for what’s wrong with the world rather than reevaluate their theories. As such academics’ record in government service is unsurprisingly patchy. A couple of examples:

Robert McNamara brought in a bunch of quantitative analysis professors to put numbers into the planning of the Vietnam war. The idea was to be able to have metrics for assessing how pacification was progressing, and how hearts and minds could be won. Unfortunately, the methods of the “whiz kids” couldn’t be reconciled with the facts in the jungle, and the profs were unwilling to admit that their formulas were unworkable. The war ended up being far more brutal and bloodier than it needed to be.

More recently, President Barack Obama put Stanford professor Michael McFaul in charge of Russia policy. McFaul’s views of Russian society and governance offended everyone in the Kremlin with breathtaking efficiency, effectively walling off the entire American diplomatic apparatus from Russia.  The result was the fastest, deepest slide in any two countries’ relations in recent history that did not end in war, contributing to Russia’s invasion of Ukraine and Russia’s participation in the Syria war. Geopolitics may all but dictate Russia’s efforts, but (bad) diplomacy certainly sets the course and timing. Reset indeed.

My goal here isn’t to crap on academics. Lord knows I know plenty of academics who are utterly essential to many in and out of government, myself included. I’m simply pointing out that the culture of academia often does not necessarily mesh well with the culture of governance … and we now have a vehemently anti-China academic overseeing America’s primary interface with the rest of the global system. Combine that with Trump’s statements on Taiwan and I think it is pretty clear that a broad-scale competition with the Chinese is now not just baked into the system, but that on the American side it will be incredibly visceral, aggressive and fueled by personal vitriol. And thats before one considers the President-elect’s personality. Things are about to get decidedly lively (again, good for Peter).

If I’m right on this, an uber tradewar with the Chinese is just around the corner. I’ve dealt with many of the likely futures for China in previous newsletters and in The Accidental Superpower so I’ll just hit the highlights here and spend most of my typing on follow-on effects:

  • China faces an internal political crisis. Southern China is far more economically viable than the rest of China, far more exposed to foreign trade, and far more culturally willing to work with foreigners. The portions of China that will suffer the most also are the most likely to not look to Beijing for leadership. Traditionally, secession threats are a very big deal in China. They are about to be once again.
  • Foreign investors in China — especially U.S. investors or investors in interior China — stand to lose everything. The rough translation of “joint venture” in Mandarin is “you pay for everything and we’ll steal all your tech.” Anyone who still has any trade secrets left is about to lose them all, and the Chinese will confiscate your entire physical plant in the name of national security. Time to work on those exit contingencies and shareholder explanations. Might want to start with plans for any key employees of Chinese ethnicity as Beijing doesn’t consider foreign citizenship a barrier to arrest on charges of sedition.
  • Northeast Asia faces massive upsets. Fully half of the world’s manufacturing supply chain steps are in the region, with most of those dependent upon Chinese links. Any meaningful Chinese-American trade conflict breaks many (if not most) of them. The country likely to get the worst of it is Taiwan, since the country’s companies are on the small side (most sell into a single supply chain) and the local market is but 23 million people.
  • The inverse is true for North America’s I35 corridor — in particular from Mexico City to Oklahoma City — which is the piece of the world most likely to pick up manufacturing capacity that will need to relocate. Easy regulation, the large Texas population, good infrastructure, cheap land, underpriced but high-skilled labor, and cheap and reliable energy all add up to short- and long-term manufacturing booms. (Navarro is not known to have particularly blistering opinions on Mexico.)
  • The biggest loser beyond the immediate region likely will be Australia. The Aussies have bet the farm on the Chinese industrialization process and their raw materials exports will flatly collapse. This is hardly the end of Australia, but their golden generation of economic growth is about to go into screeching reverse — and they have a lot of fat to cut.
  • The oil exporters of the Persian Gulf are also about to get hit hard. Anything that crimps Northeast Asian economic activity is going to prove crushing to them, since Northeast Asia takes more than half of the Persian Gulf’s collective oil exports.
  • It is unthinkable that the Americans will take the Chinese to task in a spat of statism, protectionism, and populism; and the far more statist, protectionist, and populist Europeans will not pile on. Expect France and Italy to lead the charge for broad-scale European trade sanctions on China.

At the Edge of Disorder

Last week, U.S. President-elect Donald Trump shook the global diplomatic community to its bedrock by throwing the One China policy into doubt, specifically noting, “I don’t know why we have to be bound by a One China policy unless we make a deal with China having to do with other things, including trade.” He expressly linked One China to possible negotiations over the South China Sea and the North Korean nuclear program.

The One China concept is that meaningful, positive relations with the Chinese are predicated on public proclamations that mainland China and island Taiwan are one and the same country, and that Beijing oversees the whole thing. American acceptance of One China is not something that was agreed to lightly, but is instead part of a deeper strategy.

In the aftermath of the Normandy invasion of Nazi-occupied Europe, the Americans drew their Western allies and their major colonies together at Bretton Woods to prepare for the post-World War II (WWII) world. Pre-WWII global commerce was fiercely competitive with all countries using all levers of power to maximize their overall strategic position. Trade, finance, culture, employment, and war were all simultaneously tools and vulnerabilities. Successful states/empires would use all of them to maximize their gains in others. One result was the all-against-all nature of pre-1945 international affairs, ultimately leading to WWII.

Mount Washington Hotel in Bretton Woods, New Hampshire

At Bretton Woods the Americans changed the nature of the game. From now on the U.S. Navy would guard oceanic commerce for all participants, while the American economy would be opened to all participants. There was, of course, a catch — you had to join the Americans in their Cold War.

As the Cold War took shape new countries were admitted into the Bretton Woods system. Former Axis. Former neutrals. Developing countries. And finally, China. Unsurprisingly, Beijing insisted the Americans adhere to One China. Under Henry Kissinger’s guidance, the United States willingly and knowingly swallowed One China hook, line, and sinker. Bolstered by China, the Bretton Woods system now presented the Soviets with hostility in all directions. It was quite the strategic coup, and contributed heavily to Soviet overextension and eventually, collapse.

Yet the key factor to remember is that Bretton Woods firmly limited how the Americans could pursue trade. American market access was extended to allies for strategic reasons. Anyone could dump products on the American market, so long as they maintained their position in the anti-Soviet wall.

But the Cold War is over. Bretton Woods has outlived America’s strategic needs, and American trade policy is now evolving to serve America’s economic needs. Trump’s statement on One China is (probably) not an off-the-cuff comment, but instead a true pivot away from Bretton Woods and towards a fundamentally new strategic posture. If the American government no longer views trade as a means to an end, but instead an end in its own right, it can and will begin using issues such as trade access, maritime security, and political positions on issues such as One China to cut different deals. That changes the global strategic picture radically.

China is wildly unprepared for such a shift. Everything about the modern Chinese system was designed expressly for the Bretton Woods system. The economy is export-led. Efforts to drive domestic consumption have largely ended in ignoble failure. The economy is driven by an Enronesque flooding of the industrial sector with subsidized capital. Such growth comes at the cost of sustainability and a functional banking system. China’s strategic position is completely dependent upon the United States offering market access and guaranteeing freedom of the seas for China’s merchandise exports and raw material and energy imports. Remove the economic and strategic cover of Bretton Woods, and it all comes crashing down.

Hong Kong Special Administrative Region of the People’s Republic of China

Even mentally the Chinese are not prepared for change. Since the election, the only American that Beijing has reached out to is none other than Henry Kissinger himself, the only statesman the Chinese respect and trust. But while Kissinger remains strategically brilliant, his connections and advice are firmly rooted — critics might say mired in — the Bretton Woods age. Beijing is so in love with its China Rising mantra — again, made possible by Bretton Woods — that it just cannot come to grips with the fact that the Americans might now have other plans.

Or that the Americans hold most of the cards. No surprise that Chinese state media’s response to Trump’s offhand statement could best be described as a seizure.

The Chinese are not alone:

  • Like China, modern Germany was expressly designed to maximize exports to the Bretton Woods system to the point that nearly half of German GDP is export-driven. In fact, the entire EU project relies upon the United States market as well as U.S. military protection for commodity import supply lines. Other countries heavily dependent upon global trade include — but are far from limited to — South, Korea, Taiwan, Singapore, Thailand, Japan, the oil producers of the Persian Gulf, Egypt, Australia, New Zealand, Brazil, Uruguay, Paraguay, Algeria, South Africa, and Israel. If these countries — or any others dependent upon trade — are going to retain market access and maritime trade opportunities, they will need to offer the Americans something in return.
  • A whole host of countries are utterly dependent upon implicit or explicit U.S. security guarantees. A partial list includes Estonia, Latvia, Kuwait, Lithuania, Poland, Saudi Arabia, Georgia, Azerbaijan, Finland, South Korea, Germany, Romania, Qatar, the United Arab Emirates, Taiwan, Japan, Sweden, Singapore, Croatia, Denmark, the Netherlands, Turkey, and Israel. If these countries are going to retain that strategic cover, they must give the Americans something the Americans find useful.
  • Part and parcel of the Bretton Woods system is the guarding of energy flows, in particular those out of the Persian Gulf. Remove American guarantees and the countries of the Gulf have to resolve their security issues themselves. That endangers energy flows at the point of production, within the Gulf, at the Strait of Hormuz, and even globally as importers must take supply protection into their own hands.

Of course, there is still a lot of wiggle room in all of this. And regardless it won’t all change (or fall apart) overnight. Some relations (like U.S.-Japan) have more ballast. Others (like U.S.-Australia) are so rooted in cultural, strategic, economic, financial, and political fundaments that they’ll likely survive on their own merits. But for every relationship that looks solid, there are a half-dozen others that just don’t make much sense outside of the Cold War rubric.

A few specific calls on the countries that are not likely to make the cut:

  • South Korea is too exposed (and expensive to maintain) for the Americans to continue a deep relationship.
  • The United States has been fighting a war of zero strategic relevance in the Philippines for a half century (anyone remember Mindanao?); that’s pointless except as a hedge against China.
  • Egypt’s descent into impoverished, dysfunctional tyranny means that it no longer is a threat to anyone, much less nuclear-armed Israel.
  • Syria’s civil war eliminates Damascus as a concern, eliminating any rational for ongoing alignment with Jordan.
  • Relations with Kuwait, Saudi Arabia, Qatar, and the United Arab Emirates have long been dominated by the concern of oil availability. Because of the shale revolution, the Americans only need that oil to fuel their alliance — an alliance that now is largely strategically irrelevant.
  • Subsidizing German, Polish, Baltic, and Romanian economic and physical security only makes sense if the United States wants to risk a ground war with an increasingly insecure (and yet still nuclear-armed) Russia.
  • Pakistan is nothing more than a giant pain in the ass.

What’s coming can only be described as the opposite of a global order — a Disorder.

Want to know more about what that looks like? Our next book — The Absent Superpower: The Shale Revolution and a World Without America — went to the printer today. It should be available in about two weeks. : )