Trump’s ‘Madman Theory’ of Trade with China
Economist Patrick Chovanec says it could still work, but the president could play a much better hand by bringing in U.S. allies.
A year of contentious trade talks between China and the United States blew up on Friday as the Trump administration jacked up tariffs on hundreds of billions of dollars on Chinese imports and trade negotiators failed to reach any sort of agreement after two days of talks in Washington. U.S. President Donald Trump, meanwhile, launched a tweetstorm about using tariff revenues (paid by American consumers) to buy off American farmers hurt by Chinese retaliation.
Foreign Policy spoke with Patrick Chovanec, one of the top economists covering China, who is chief strategist at Silvercrest Asset Management and teaches a course on U.S.-China negotiations at Columbia University.
FP: It’s been an interesting week on the trade front…
Patrick Chovanec: Negotiations happen like this. It’s not like this is new. There are impasses and moments where it looks like it’s all going to fall apart, and threats are made, but normally it happens behind closed doors. We normally aren’t front-row observers and along for the ride.
FP: Okay, so now that we have all these increased tariffs, is there any prospect left of a deal, or should we buckle up for a prolonged trade war?
PC: From what I’ve gathered, the trade negotiators on both sides have said, “We’re at an impasse, and the only people who can solve it are [Chinese leader] Xi [Jinping] and Trump talking together.” I’m guessing that they’ll probably talk by phone, and whether that jogs anything loose, I do not know. It really boils down to what each side feels its bottom line is at this point, how much leverage each side thinks it has going forward. Because I think both sides have convinced themselves that they have the upper hand.
The Chinese were really kind of nervous in the second half of last year, they were kind of rattled by the trade rhetoric, and subsequently they feel like they’ve stabilized the situation, they feel like have poured in stimulus, that they have the ability to let the renminbi depreciate, so they feel like they have the upper hand.
Then Trump looks at 3.2 percent GDP growth in the first quarter and says, well, the U.S. economy is getting along just fine, and any damage from tariffs will be just a dent in the fender. And so both of them are going to test their assumptions. I would question both assessments.
I think the U.S. economy is more vulnerable than the headline numbers would suggest. I also think that for the Chinese, even though I don’t think trade is the primary problem, a hostile trade environment doesn’t help them cope with their problems. Nor does it push them in the right direction. I think both sides are more vulnerable than they fully appreciate. And when you have both sides convinced that they have the upper hand, you get the kind of conflict that you have right now. But maybe we wake up tomorrow and they are best friends and we have the best deal ever.
FP: Tariffs are Trump’s weapon of choice, and they were just raised today. How big an impact do they really have on the U.S. economy?
PC: Well, I think it depends on context. One thing is positive for the U.S. is that inflation is relatively low. In terms of the impact on business, it has more to do with the business climate and people’s outlook than it has to do with the direct impact. Right now, you’ve had the government shutdown—that rattled consumer confidence. Recent surveys say people are cautious about making major purchases. Then you hear “trade war.” There are these tariffs, but there might be more tariffs. And there might be more tariffs against other countries, like in Europe. Business investment has also slowed.
So when I say the U.S. economy is somewhat weaker than the headline numbers suggest, I’ll be more specific. GDP growth was 3.2 percent, but most of that came from inventory buildup, and also a decline in imports, which is potentially a sign of economic weakness. Domestic demand drivers came down from above 4 percent in the second quarter last year to 1.5 percent. Now, does that mean we are heading toward recession? No, not necessarily, but that’s a noticeable slowdown. And then you look at corporate earnings. There’s some softness there. It means the economy is potentially fragile. There’s a psychological effect. A lot of the business cycle is psychological, people’s willingness to spend and invest. It comes at a time when the U.S. economy is more fragile than it’s looked for two-and-a-half, three years.
But China has its own problems, and they’ve piled up. China had a whole set of economic reforms that they said they needed to do, and they just haven’t gritted their teeth and gone through with it. Then you put them in a corner on trade. One response China could play if the gloves really came off—and they haven’t really come off—they could devalue the currency. If they really wanted to do this, they could do this. It would be harmful to them, and it would push them in the wrong direction, but if they feel like, okay, we’re getting hammered and we need a way to hammer back, it’s something they could do—and I think it would create very significant headwinds for the U.S.
So there are some things that could happen that would have a negative impact that would go beyond, oh, you have to pay 25 percent more for an iPhone.
FP: On tariffs, given Trump’s tweetstorm, and I’m trying to put this delicately, the president seems terribly confused about how tariffs actually work…
PC: On some level, there are tactics going on here. If you’re threatening to do something, you want to say,“ I can live with that.” But he goes into more detail, with greater enthusiasm, and really describes tariffs as if he quite likes the idea. What’s interesting is that talk about trade goes back decades with him. On the one hand, he believes in protectionism, and he believes that tariffs are a good thing. But then, whenever he threatens tariffs the market doesn’t like it, and he measures his success against the stock market. There’s this cognitive dissonance that takes place sometimes, between what he on a gut level feels would be a great economic policy and what he measures the world’s notion of him by, which is the stock market, which doesn’t seem to agree with him.
Then you have people like [White House economic advisor Larry] Kudlow and [Treasury Secretary Steven] Mnuchin who argue we can threaten tariffs, but the goal is freer trade, and then people like [White House trade advisor Peter] Navarro, who say tariffs are a good way of decoupling from China and bringing back jobs and investment to the United States.
FP: But are they? Is taxing American consumers and businesses really the best way to do that?
PC: No, I don’t agree with this. But that is a set of voices in the administration who genuinely believe that. There’s a tension in his own mind about this, and then there’s a tension in the administration about this as well.
If you talk to the president’s supporters about this, they say he is keeping everyone off balance, and it’s the “madman theory,” and he’s going to get results that nobody else has. I guess the real proof in the pudding there is, what are the results? Because you can tell a narrative of genius, but has it produced an outcome better than the status quo, and has it produced an outcome better than the alternatives?
I think we are playing a weaker hand than we need to. We’ve chosen bilateral tariffs. The more you escalate, the more problematic it becomes, and that’s before the Chinese even retaliate. And in the process, we’ve also picked fights with everyone else—we’ve picked fights with Japan, we’ve picked fights with Mexico, we’ve picked fights with Europe, a lot of people who actually agree with us about China, particularly things like theft of intellectual property. If we set priorities and said the big deal is China, we need to bring concerted effort on them, they’d find it very hard to retaliate, because they’d have to retaliate against all of us. We could have China fight on multiple fronts at the same time, instead of us fighting multiple fronts at the same, because that’s how it is right now.
I just think we’re not playing the strongest card, and if we did, we’d get potentially better results, at a lower cost.
FP: This week, there were a lot of reports that China totally backtracked on its commitments to make the sweeping market reforms that the United States demanded. Was the original sin here being too ambitious, overhauling the entire Chinese economic model by fiat?
PC: What I would say more broadly is, if we want China to embrace structural reform, that requires real commitment—it’s not something we can just twist their arm to do, they have to buy into it. And they have to believe that it is not going to sink them or hurt them. When you basically strongarm them into doing something they really don’t want to do, and they’re convinced it’s harmful to their interests, at some point they are going to cheat, push back, or scuttle it, and it’s just a question of when, because they haven’t bought into it.
The administration might feel they have them on the back foot, but that’s going to change at some point over the next five years. And when it changes, they’re going to say, “Forget it.” And in this sense it did change. They felt very vulnerable in the second half of last year, and they came into this year feeling a bit more confident. And they did what Trump probably would have done: “I’m revising the deal; pray I don’t revise it any further.”
FP: But like the administration, for years you’ve been calling for a return to the reform-minded economic policies of Deng Xiaoping, a return to the famous “southern tour” of the early 1990s—
PC: Yeah, I think that boat sailed a long time ago.
FP: But if China’s leadership is aware they need to make these structural reforms—
PC: Yeah, and like for five years it’s just been … every party meeting, the word was, Xi Jinping is going to consolidate power, and then we’re going to move forward with these reforms. And I was always skeptical. It didn’t seem like the direction that Xi was charting. And then the Chinese stock market blew up, and they did the exact opposite of what they should have done. And by the time you got to the last Party Congress, nobody was even saying that.
Are there still people who will still like to move in a reform direction? Yes, but they are keeping their heads down, because they know they are out of favor. In China, the market reformers exist, but they don’t have any influence.
It’s very interesting—some of them have sort of glommed on to Trump as a savior. Here’s a guy who’s going to shake up Xi’s complacency, and then maybe we’ll get our chance to argue for a different path. It’s not that they really like Trump, it’s just that the dragon is going to come in and burn down the village, and then we will get a chance to rebuild the village they way we want to, and so welcome, dragon.
That actually shows just how desperate the reformers are in China, because they don’t see any other way within their own system of making the case.
This conversation has been condensed and edited for publication.