Economic War With China: Obama and Romney Openly Discuss a China Trade War

In the foreign policy presidential debate, President Obama and former Governor Mitt Romney engaged in a brief exchange on China's trade practices with the U.S. and the rest of the world. Both agreed that China didn't do things by the book when it came to Beijing's trade policy, as the Chinese government has been known to grant unfair subsidies to Chinese exports to the U.S. and around the globe.

But the question to ask now is this: are the United States and China engaged in a trade war, and is it in their respective interests to engage in this type of a conflict?

The answer, in a nutshell, is that there is strong tensions in U.S.-China trade relations, but it has not reached a point where the two countries are engaged in an all-out trade war, with both sides retaliating against the other by raising trade barriers against the other, the kind of actions that signify the symptoms of a true trade war.

Despite the fact that both Obama and Romney are rhetorically averse to the notion, there is a risk of a trade war with China. China feels the same way about engaging in a trade war with the U.S.; the China Daily notes that a"[t]rade war will have no winners."

During the debate, both presidential candidates accused China of unfairly boosting exports by subsidizing the costs of Chinese export companies. Furthermore, they have accused China of instituting policies that steal jobs from America by giving subsidies and enacting policies that make it very cheap to manufacture goods in China, luring U.S. corporations to outsource production to China.

Both candidates have positions that risks turning existing bilateral economic tensions into a full blown trade war with China. It's worth noting that both candidates bring a unique prescription to the troubled U.S.-China trade problem.

Romney differentiates himself by saying that he'll label China a "currency manipulator" on day one of his presidency. This action, according to the Council on Foreign Relations, runs the risk of sparking a true trade war with China. The risk is high for the U.S. should a trade war erupt.

As noted by Douglas Irwin of Dartmouth College, trade protectionism is dangerous to countries whose economies are weak and are dependent on international trade. The epic trade war sparked by the Smoot-Hawely Tariff Act of 1930, which caused a reduction of U.S. exports by about 40%, shows the same. Given the U.S. dependence on international trade, it would hardly seem prudent to spark a trade war with China.

Obama, on the other hand, has been more direct in challenging China's trade practices in bringing multiple cases to the World Trade Organization and using his executive powers to counter practices and deals that the Executive Branch sees as being against U.S. interests. The president cited his "toughness" in the tire case of 2009, when he moved to impose tariffs on tires coming form China and "flooding the U.S. market," which was allowed and upheld by the WTO despite protest from China. Under the Obama administration, in October 2012, the U.S. has also won another case against China, over tariffs on U.S. steel. This point was emphasized during the presidential debates (as seen in the above video).

The most important take away from these "anti-dumping" cases is that the Obama administration has done it through legal processes through a intermediary organization (the WTO) and has not invoked trade retaliation from Beijing.

However, the Obama administration still risks a trade war due to its other actions against Chinese trade. More recently, Obama has put forward tough language on solar panels entering the American market and imposed a 24 to 36% on Chinese solar panels due to China's trade practice of subsidizing exports. A spokesperson from the Chinese Ministry of Commerce noted that "the United States had disregarded 'the reasonable defense of the Chinese government and Chinese enterprises'," expressing "strong dissatisfaction" with the Commerce Department’s decision.

Both candidates bring an element of "toughness" on their China trade policy, but it remains to be seen who will finally provoke China into action. Romney has never been in the policymaking position; meanwhile, Obama has been pushing the Chinese for some time with the trade cases.

China doesn't want a trade war with the U.S., but it doesn't mean that it won't react if the U.S., under either Obama or Romney, takes extreme measures to block Chinese goods from entering the U.S. market. China has trade policy measures at its disposal to impose a variety of stiff and potentially devastating costs to the U.S. economy should Beijing feel that the U.S. has gone too far in its "anti-China" trade policies.

Potential Cost #1: China as the Second Biggest Buyer and Holder of U.S. Debt

China is the single biggest buyer and holder of U.S. debt in the world (with Japan a close second), with $1,154 trillion in U.S. treasury bonds. The Pentagon says it isn't afraid of China's possible use of its vast holdings of U.S. treasury bonds, but it hasn't been too shy about overtly threatening Japan, a close U.S. ally in Asia, with a "bond attack" to get its way with the Senkaku Islands dispute.

Should China ask to be paid in full for its holding of U.S. treasury bonds, as well as a another potential lowering of U.S. credit rating, the potential consequence is that U.S. government could be paralyzed and permanently damaged with a severe financial burden.

Potential Cost #2: Access to China's Monopoly on Rare Earth Minerals

China has a monopoly on rare earth minerals — which are critical components in making chips and other parts for high tech goods for both civilian and military uses — due to its large mining operations and the lack of similar mining operations in other potentially rare earth rich countries like the U.S. China has shown that it's ready, willing, and able to use its monopoly on rare earth minerals by blocking exports of the rare resource to target countries like Japan and potentially the U.S., as occurred during the 2010 flashpoint of the Senkaku Islands dispute.

While the U.S. would not be seriously damaged, the move could put pressure on the U.S. government to seek terms with Beijing through multinational companies like Apple, who rely on access to rare earth minerals to produce their high tech products and wares.

Potential Cost #3: Reduced Access to the China Market

China has the capacity to reduce U.S. access to its market, overall, by encouraging Chinese citizens and companies to boycott U.S. goods as it did at the height of the recent Senkaku Islands dispute. Major companies like Canon and Toyota have been hurt by poor sales and lost productivity in Chinese factories.

As seen with the case of Japan, China has shown itself of being capable of inflicting damage to countries that cross its interests The U.S. needs to be wary of the example set by Japan in how it crossed the line with Beijing on the Senkaku Islands dispute. Access to the China market is vital to the U.S. business community, which may make things difficult for American leaders in Washington who want to be "tough on China."

President Obama has done a good job of advancing U.S. trade interests while limiting his actions to prevent a full-blown trade war with China. While Romney's confrontational platform on U.S.-China trade is likely just campaign rhetoric, his ideas nevertheless seem imprudent and unnecessarily confrontational, given the delicate nature of the bilateral relationship and the importance of mutually respectful relations.

By winning a string of trade cases, Obama has shown that the U.S. can stick up for its interests with China. But at the same time, given the slowdown of the Chinese economy and the internal tensions this promises to evoke, Obama needs to be careful not to upset the balance by pushing his luck.  Therefore communication with the incoming class of the Chinese Poliburo and cabinet will be crucial.

The solution is to seek balance between using litigation to uphold U.S. economic interests in relation with China and mitigating the outbreak of a trade war or meltdown of relations between Washington and Beijing.