Trump's tariffs could sink Washington

Politicians have figured out that bashing China is a good way to attract vote. That’s why Donald Trump is doing it. It appeals to people who work and see jobs lost to cheaper products made across the Pacific. Hillary can’t appeal to those people because most of her constituency doesn’t work at all or works in government jobs that don’t compete with anyone anywhere.

But if Trump becomes president, as is likely, and he succeeds in raising tariffs on Chinese imports, he could destroy the federal government here’s why:

The federal government is spending about a trillion dollars per year more than what it takes in through taxes. That means it must borrow a trillion dollars. Who has that kind of money? The American people don’t because we don’t save enough and if we did we certainly wouldn’t loan it to that deadbeat Uncle Sam. Europe doesn’t have the savings. Japan has some but not enough. So most of what the federal government borrows comes from China.

Now the federal government requires US dollars, not Chinese yuan (officially the renminbi, but who can pronounce that?) No one can spend yuan in the US. Chinese save about 30% of their income, but in yuan. How can they get the dollars to loan to the US? They do it by selling stuff to US consumers for dollars. They sell those dollars to the Chinese government for yuan they can use in China to buy more Chinese made Cadillacs and ride their bullet trains. The Chinese government then uses those dollars to buy US debt and fund the US federal government deficit.

When I tell this simplified story to students, someone always asks “Why can’t the Chinese just exchange their yuan for dollars in the international currency market?” The answer is they can and they may do some of that on a small scale. But think about this: who would sell US dollars for Chinese yuan? No one in the world can use yuan to purchase anything outside of China. So if someone is looking to exchange dollars for yuan, they must be planning on spending those yuan in China, right. Who could possibly want to do that? The answer is companies like Walmart who want to buy Chinese goods for sale in the US. So whatever winding road the currencies take to the States, it still requires selling Chinese goods to US citizens.

We can see, then, what would happen if President Trump manages to raise high tariffs on Chinese goods. The prices of Chinese good would rise in the amount of the tariffs. US consumers would buy fewer Chinese goods so that the Chinese would have fewer dollars to loan to the federal government. Less demand for US debt would mean higher interest rates for Washington, which in turn would increase interest payments on the debt and increase the deficit further. Of course, the Federal Reserve could buy more US debt, but that strategy has its own problems.

This simple story demonstrates the silliness of the Greenspan excuse that a savings glut in Asia caused the low interest rates on his watch as Fed Chairman before the Great Recession. Asians save in their own currencies, not US dollars. Those savings can only get to the US if American consumers buy Asian goods.

All good economists support free trade because it boosts the economy in the long run, all other things being equal. However, as I wrote earlier, socialist countries like the US don’t benefit from freer trade because socialist policies destroy all of the good that free trade can generate. So the US economy will neither benefit nor be hurt by such tariffs. And since the US produces few of the products we buy from China, especially clothing and consumer goods, that production will just shift to some other poor country such as Thailand or the Philippines.

The major problem will come from reduced demand for US government debt, but that is a thing in the long run. Nothing changes public attitudes and government policy as well as a good crisis.