Tough talk on tariffs, but little risk of trade war

The tiff over tariffs on Chinese tires has sparked a tug-of-war among pundits: Some are rushing to reassure us that China and the U.S. wouldn't be foolish enough to let this little spat blow up into something nasty, while others are labeling this the opening shot of a long-brewing trade war.

Predictably, a smattering of voices on both sides of the Pacific are reacting with passion. But without wading too deeply into the murky political and economic waters this trade kerfuffle has churned up, we might profitably consider this old proverb: Be careful what you wish for.
If there's a hidden subtext to the tough talk, it's the vulnerability of China's vast manufacturing sector -- not just to the global recession, but to the very kind of opportunistic poaching that has fueled its own growth over the past two decades.

It's the natural order of economic growth that costs rise with success. Governments raise taxes, workers demand and receive higher pay, and lower-cost rivals sprout up. All three trends are firmly established in China. The government has increased taxes, workers were granted large increases in pay, benefits and protections last year, and lower-cost rivals such as Bangladesh and Vietnam have been siphoning off textiles and other light manufacturing from China.

But that's not surprising or even necessarily worrisome. China has been rapidly moving up the manufacturing food chain, recently reaching one large-scale, high-tech industrial peak: a homegrown wide-body commercial aircraft.

That's the standard line of progress for industrializing nations. They start with making cheap trinkets and clothing, move to light manufacturing and then step up to high-value, high-tech products for export. China is following the well-worn path pioneered by Japan in the '50s and '60s and pursued with great success by Korea and other "Asian Tiger" economies.

But there is a new trend which runs counter to the "onward and upward" script. Nations that have lost manufacturing to China are winning it back as transport costs rise and the price advantages long held by China erode. For example, BusinessWeek recently reported a movement of global manufacturing back to Mexico, which had lost it to China earlier this decade.

Lost in the bellicose rhetoric is the fact that global enterprise is opportunistic. To gain a market advantage, it constantly seeks out the lowest-cost commodities and raw materials and the lowest-cost manufacturing. What few Americans realize is that much of the manufacturing base in China is owned, co-owned or controlled by U.S., European, Japanese, Korean and Taiwanese global corporations who reap much of the profits.

Examples of this phenomenon are easy to find. Take the iPod, for instance. The Chinese contract manufacturers who actually assemble them generally work on razor-thin margins of 1 to 2 percent, while Cupertino, Calif.-based Apple (AAPL) has enjoyed gross margins of 40 percent or more for years.

For better or worse, that's the nature of global enterprise and global supply chains. When it becomes cheaper to manufacture goods in someplace other than China -- not just in labor costs, but in transport and quality control, too -- then global companies will move on. From their point of view, they have little choice. If they stay put, their transnational competitors will eat their lunch.

So will United States become an attractive place to open a factory? It could happen. The key is the relative valuations of currencies. As China has slowly allowed the value of its currency to rise, the dollar has weakened. If the dollar were to drop substantially from its current levels in relation to other major currencies, then that would give the United States a major global cost advantage.

A big drop in the value of the dollar would have two main consequences: Imports such as oil and manufactured goods would rise in price. And the cost of American goods would fall to overseas customers.

From the point of view of nations exporting to the United States, the dollar's plunge would be catastrophic. The goods they sell here would leap in price (in dollars, not in their "home" currency) even as the U.S. gained substantial price advantages as a manufacturer, further undercutting their exports.

So those voices in China who are demanding that their leaders dump their nation's $2 trillion stash of U.S. bonds and dollars might not find such retribution very satisfying. Such a massive dumping of U.S. bonds would likely drive the dollar down to levels which would make all imports into the U.S. pricier even as the lower dollar made U.S. manufactured goods suddenly much more competitive on the world market.

Beneath the bluster, China has far more compelling reasons to fear a weaker dollar than it does tariffs on tires.

Charles Hugh Smith writes the
blog Of Two Minds and is the author of numerous books, most recently Survival+: Structuring Prosperity for Yourself and the Nation.

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