While Donald Trump and Xi Jinping trade charges and counter-charges, announcing and then canceling tariffs in the seemingly never-ending trade dispute between the United States and China, it is a mistake to view the trade dispute as simply a spat between the two, and that it will end with Joseph Biden’s presidency. It is not a Trump-Xi fight, or even mainly a U.S.-China one.
Contrary to conventional wisdom, trade surpluses are not the result of exceptional manufacturing efficiency or unusually “hard-working” and “high-saving” workforces. Instead, in countries like Germany, Japan and South Korea, large trade surpluses are the natural consequence of policies that in the name of “competitiveness” effectively lowered citizens’ purchasing power for the benefit of the banking, business, and political elite—and the companies they control.
Trade theory tells us that large imbalances cannot persist indefinitely. Usually, automatic adjustments—including rising consumer prices, strengthening currencies, and soaring asset values for surplus countries, and the reverse for deficit countries—eventually eliminate deficits and surpluses. The fact that certain countries have nonetheless run surpluses for decades, while others have run deficits, is evidence that the global trading system is not working as it is supposed to.
There is a cost to this failure. Surplus countries’ ability to export their excess savings and production abroad sharply reduces the pressure on them to rebalance income at home. What is more, in the race for competitiveness with surplus countries, deficit countries must also allow, or even encourage, downward pressure on their own wages. In this globalized system rising income inequality is both the cause and a consequence of international trade competition.
The question, of course, is what the new U.S. president should do. In standard economic theory, the financial inflows from the rest of the world should have added to Americans’ own savings and led to higher levels of domestic investment. But with U.S financial markets already flush with capital (offered at the lowest interest rates in history), and American businesses sitting on piles of unused cash, that is not what happened. Instead, overall spending outpaced production and American savings declined. This too was inevitable: if foreign capital inflows do not cause investment to rise—as was clearly the case in the U.S.—they must cause savings to decline.
Put another way, foreign savings displaced domestic U.S. savings. This happens in countless ways. For example, foreign capital inflows can bid up the prices of stocks and real estate, making consumers feel richer and encouraging them to spend more. Local banks, responding to a glut of cash, can lower lending standards to domestic borrowers in order to increase credit. Infusions of foreign capital can cause the dollar to appreciate, which encourages spending on foreign imports at the expense of domestic production. Factories that can no longer compete can fire workers, who begin to tap into their rainy-day funds or borrow. The government may expand the fiscal deficit to counter the economic slowdown.
All of these actions drive down American savings. Indeed, the widespread belief that persistently low savings over the past four decades reflected spendthrift American habits turns out to have been wrong. The United States does not import capital because it has a low savings rate: it has a low savings rate because it is forced to absorb imported capital.
This was not as much of a problem several decades ago, when the U.S. economy was much larger relative to the others in its trade orbit. During the Cold War, meanwhile, there was added incentive to fill this role because it gave the country added geopolitical leverage. However, as the size of the U.S. economy shrank relative to its trading partners’, the cost of playing the balancer rose, and it was always only a question of time before the country would no longer be able to play its traditional role.
But once the United States was no longer willing or able to continue absorbing so much of the world’s excess savings and deficient demand, the global system risked coming to a chaotic stop. Because no other country is large enough to play this role—and no country wants to—there was no replacement. Trade conflict was inevitable. That is why the trade war with China ultimately has little to do with Trump’s personal animosities or re-election strategy. It simply represents the most visible part of a much deeper global imbalance.
That is also why today’s trade war is not really a conflict between the United States and China as countries, nor is it even a broader conflict between deficit countries and surplus countries. Rather, it is a conflict between economic sectors. Bankers and owners of capital in both the surplus and the deficit countries have benefited from suppressed wages, rising profits and international capital mobility. Workers in the surplus countries paid for the imbalances in the form of lower incomes and depreciated currencies. Workers in the deficit countries paid for the imbalances in the form of higher unemployment and rising debt. Reversing inequality and other distortions in income distribution in both the surplus and the deficit countries is therefore the only durable way to end the trade war.
In the long run, future administrations in Washington will have to tackle income inequality either through tax reform or by tilting the playing field in favor of workers and the middle-class—for example by reducing the costs of health and education, improving social infrastructure, raising minimum wages, or even strengthening labor unions. But before they can do that, they will have to fix the American role in the global imbalances by making it more difficult for foreigners to dump excess savings into U.S. financial markets.
Michael Pettis is a Senior Associate at the Carnegie-Tsinghua Center and a professor of finance at Peking University. His most recent book, Trade Wars are Class Wars, was published by Yale University Press in 2020.
