Here’s Why Concessions From China On Trade Are Big Wins

May 23, 5:00 pm EST

There has been a lot of attention over the past couple of days on China and trade relations.

China has moved down tariffs on auto and auto parts imports. And a source today said the government has “encouraged” China’s largest oil refiner to buy more U.S. crude oil. Based on the reports, China is now taking about 8 times the daily volume of U.S. crude imports, compared to averages a few months ago.

These are concessions! This is a distinct power shift. Not long ago, the world was afraid to rattle the cage of China. They (global trading partners) tiptoed around touchy matters like Chinese currency manipulation prior to the global financial crisis a decade ago, and even more so after the crisis.

But now, you can see the leverage that has been created by Trump. This is exactly what we talked about the day after the election.

Here’s an excerpt from my November 9, 2016 Pro Perspectives note, back when the experts were predicting Draconian outcomes for poking the China giant: “As we’ve seen with Grexit and Brexit, the votes came with dire warnings, but have resulted in creating leverage. Trump’s complaints about China are right. And a threat of slapping a tariff on Chinese goods creates leverage from which to negotiate.”

Now, we have an economy that is leading the global economic recovery. China wants and needs to be part of it. And we have a President that has a loud bark, and the credibility to bite. And that is creating movement. Let’s revisit, also from one of my 2016 notes, why this China negotiation is so important …

TUESDAY, SEPTEMBER 27, 2016

China’s biggest and most effective tool is and always has been its currency. China ascended to the second largest economy in the world over the past two decades by massively devaluing its currency, and then pegging it at ultra-cheap levels.

Take a look at this chart …

In this chart, the rising line represents a weaker Chinese yuan and a stronger U.S. dollar. You can see from the early 1980s to the mid-1990s, the value of the yuan declined dramatically, an 82% decline against the dollar. China trashed its currency for economic advantage—and it worked, big time. And it worked because the rest of the world stood by and let it happen.

For the next decade, the Chinese pegged its currency against the dollar at 8.29 yuan per dollar (a dollar buys 8.29 yuan).

With the massive devaluation of the 1980s into the early 1990s, and then the peg through 2005, the Chinese economy exploded in size. It enabled China to corner the world’s export market, and suck jobs and foreign currency out of the developed world. This is precisely what Donald Trumpis alluding to when he says ‘China is stealing from us.’

China’s economy went from $350 billion to $3.5 trillion through 2005, making it the third largest economy in the world.

This next chart is U.S. GDP during the same period. You can see the incredible ground gained by the Chinese on the U.S. through this period of mass currency manipulation.

And because they’ve undercut the world on price, they’ve become the world’s Wal-Mart (sellers to everyone) and have accumulated a mountain for foreign currency as a result. China is the holder of the largest foreign currency reserves in the world, at more than $3 trillion dollars (mostly U.S. dollars). What do they do with those dollars? They buy U.S. Treasurys, keeping rates low, so that U.S. consumers can borrow cheap and buy more of their goods—adding to their mountain of currency reserves, adding to their wealth and depleting the U.S. of wealth (and the cycle continues).

This is the recipe for big trade imbalances — lopsided economies too dependent upon either exports or imports. And it’s the recipe for more cycles of booms and busts … and with greater frequency.”

Again, China has to be dealt with. And we’re starting to see signs of progress on that front. Good news.

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