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PJ Media encourages you to read our updated PRIVACY POLICY and COOKIE POLICY.

A letter to Larry Kudlow: You Need a Different China Strategy

Cross-posted from Asia Times.

Dear Larry:

China threatens American preeminence and President Trump is right to worry about it. But you’re going about it the wrong way, and your approach will produce results very different from what you expect or want.

When you say: “I do not think President Xi has any intention of following through on any of the discussions we’ve made and I think the President is so satisfied with China on these so-called talks that he is keeping the pressure on and I support that,” Beijing hears: “We can hurt China’s economy so badly by reducing exports to the US that internal political pressure will force President Xi to capitulate.”

This is a very big mistake, for two reasons. The first is that you do not negotiate with China by trying to make its leader lose face.

1. Chinese exports by region

Asia, moreover, provided the biggest growth margin in China’s exports.

2. Increase in monthly exports

Where are you going to impose tariffs on US imports from China? Americans don’t want to pay higher prices for smartphones, or computers, or display screens, or the other cheap consumer electronics that make the tech boom in American equities possible in the first place.

3. China’s largest exports to US

The vast majority of China’s exports to the US are consumer goods, especially electronics. Most of these goods are assembled in China from imported components. China adds only a third or so the value added to these goods. China has a chronic labor shortage and is shifting low-paid assembly to lower-wage countries in Asia. If you tax consumer goods from China, American consumers will pay more, and the Chinese will accelerate the shift of low-wage employment to the new economic zone they are building in Asia through the $1 trillion One Belt, One Road program.

This transition has been underway for years. Here’s a  2013 chart that I published in a presentation for Reorient Group (now Yunfeng Financial), a Hong Kong investment bank where I was a managing director.

4. General vs processing trade

In short, tariffs on consumer goods only will throw Br’er Xi into the briar patch. You’re ten years late and $1 trillion short.

China cheats, China plays dirty, China steals technology, China muscles American companies in joint venture, China does every manner of bad thing. But that’s not the big problem. Don’t worry about the “crown jewels” of American technology, as you said today on CNBC. Those are the old crown jewels. The new crown jewels are coming out of Chinese laboratories.

In 2002, China’s biggest telecom equipment company, Huawei, was caught red-handed with Cisco code, bugs and all. Now Huawei spends more on R&D than Microsoft. It employs thousands of European engineers as well as tens of thousands of Chinese. American graduate programs in math and physics are in trouble because Chinese (and other foreign students) have stopped applying (foreign students now comprise about four-fifths of the graduate students in key STEM faculties). The Chinese aren’t coming to the US anymore because they don’t have to: They can get as good an education in cutting-edge technology at home. If we have lost our edge at the university level, how long will our edge last at the corporate level? There’s virtually no venture capital money going into anything to do with physics. It’s all software.