Trump tries to woo Federal Reserve in China trade fight

Trump tries to woo Federal Reserve in China trade fight

Shortly after trade talks with China broke down acrimoniously in mid-May, US president Donald Trump very publicly turned to Jay Powell, head of the Federal Reserve, for help in confronting Beijing. 

“China will be pumping money into their system and probably reducing interest rates, as always, in order to make up for the business they are, and will be, losing,” Mr Trump wrote in a tweet.

“If the Federal Reserve ever did a ‘match’, it would be game over, we win!”.

Later this month, Mr Trump’s wish could come true since Mr Powell is steering the US central bank towards a possible interest rate cut, in a sharp reversal from last year’s tightening of monetary policy.

The Fed is tilting towards looser policy largely due to the uncertainty caused by trade tensions, which remain unresolved — even after the latest truce struck at the G20 in Osaka, Japan — and are casting a cloud over the global economy.

Mr Powell and other Fed officials, who have stressed their independence from Mr Trump, would bristle at the thought that they are in any way following the White House’s lead. But while an interest-rate cut would arguably represent a legitimate attempt by the Fed to protect the US economy from damage inflicted by Mr Trump’s trade wars, it also carries the risk of encouraging his brinkmanship.

A traditional argument against monetary easing in major economies has been that it creates moral hazard: encouraging bad behaviour on budgetary policy and fomenting asset bubbles. We can now possibly add protectionist trade measures to that list.

With equity markets at record highs, and the Fed on an easing path, Mr Trump might feel emboldened to press ahead with more tariffs on Chinese products, and aggressive action against the EU in coming months.

A key byproduct of Fed easing would also be a less valuable dollar, which the White House also sees as a desirable goal in the trade wars, in contrast to previous administrations which have stressed the importance of a strong US currency.

Mr Trump could yet be disappointed by the Fed. Whereas administration officials want at least a 50 basis point rate cut now, the US central bank is expected to press ahead with only a 25 basis point interest rate reduction at its next monetary policy meeting on July 30-31.

At that point, the Fed could decide to pause the easing to gauge how far the trade wars are affecting the real economy, before pulling the trigger on more cuts. Such a delay could frustrate White House officials and again make Mr Powell a target of presidential attacks.

But for now, Mr Trump can draw comfort from the fact that his disruptive trade policies have more of a monetary crutch to support them than they did in 2018.

Dovish Trump and an olive branch for Canada

Mr Trump’s trade stance is so difficult to interpret because he waxes and wanes between hardline positions and more conciliatory moves. 

On Friday, his inner dovishness prevailed, as he decided against imposing restraints on uranium imports for national security reasons, rejecting the conclusions of a probe by US commerce secretary Wilbur Ross. 

“I do not concur with the secretary’s finding that uranium imports threaten to impair the national security of the United States as defined under section 232 of the act,” Mr Trump concluded late on Friday. 

“Although I agree that the secretary’s findings raise significant concerns regarding the impact of uranium imports on the national security with respect to domestic mining, I find that a fuller analysis of national security considerations with respect to the entire nuclear fuel supply chain is necessary at this time.”

The decision is an olive branch for Justin Trudeau, the Canadian prime minister, who made the case against any curbs on uranium imports when he visited the White House last month. Canadian companies are among the biggest exporters of uranium to the US.

It is hard to draw any firm conclusions from Mr Trump’s move ahead of the November deadline for a decision on car imports from the EU and Japan. But it does show that he is willing to flout hawkish recommendations from the commerce secretary, and that everything — even matters ostensibly tied to national security — is negotiable.

In reply

Two epochal arbitrage plays created the foundation for China’s rise and the “coupling” with the US economy that Donald Trump is now attempting to reverse, writes Free Trade co-author Lucy Hornby.

The first was the enormous difference in wages that caused manufacturers from around the world to turn China into the “world’s workshop”. The second was an interest rate arbitrage that has held sway since roughly 2005, sucking capital into China and helping fund its steroid-charged development. Shadow banking rates in China today are about 8.5 per cent.

The Federal Reserve’s governors probably don’t think of their jobs this way, but since the global financial crisis, they have been grappling with the combined effects of two continent-sized, integrated economies, with detailed insight into only one of them.

Many years of deflation plus the soaring cost of capital in China starting in about 2012 were met with minimal interest rates in the US, helping encourage Wall Street’s money to flow into China’s high-interest-rate market.

Now non-bank lending has also taken off in the US, and has become the standard recourse for many businesses — the socially malignant effect of money finding higher returns outside the formal, low-interest banking system that the Fed oversees. If decoupling is truly Mr Trump’s goal, leaning on the Fed to maintain low formal interest rates in the US could be tremendously counter-productive. 

The number — 9.8 per cent

The year-on-year decline in US seaborne imports from China last month, as shipments from the rest of the world rose 2.8 per cent (including a 20.6 per cent increase from Vietnam). (From Panjiva)

Chart choice

Is China weakening the yuan to fight US tariffs? (From Michael Klein of Econofact and Tufts University, with lots of useful background)

Further reading

● The EU-Mercosur text — worth digging into (European Commission)

● Chinese economic growth has slowed to 6.2 per cent, and Trump is gloating (FT) 

● Is Wilbur Ross on his way out? (NBC)

● Not all trade fights involve Trump. This one is between Japan and South Korea (Trade Talks podcast)

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