China's Plan to End Its U.S. Trade Surplus Is a Red Herring

(Bloomberg Opinion) -- There has been an unexpected development in the U.S.-China trade war. Chinese trade officials apparently offered a huge concession earlier this month: a promise to completely eliminate its trade surplus with the U.S. by 2024. The offer was off the record, but it's still a huge surprise, especially given the haphazard and clumsy way that President Donald Trump has chosen to fight his trade war.

Why is China making this proposal? One possibility is that the government is afraid that the trade war is having a chilling effect on the country's economy. Consumption taxes have been falling, suggesting a slowdown is in progress:

Other indicators all point in the same direction. Even if Trump's tariffs haven't already begun to bite, it's possible that fear of more tariffs, or general uncertainty over the direction of U.S. policy, may be chilling the business climate in China. With so much debt in the country's financial system, and with property prices in perpetual danger of crashing, even a small lapse in confidence might be enough to tip the giant country's economy into a recession.

And since China still has an authoritarian political system, even a modest slowdown could spell huge danger for President Xi Jinping and his ruling clique -- authoritarian leaders who fall out of favor don't get voted out of office, but instead tend to find themselves sitting in a cell (if they're lucky). That means they have an incentive to keep growth smooth and steady at all costs.

So China's leaders might be offering concessions out of panic. The question is whether the concessions are at all realistic. Eliminating the bilateral trade deficit would require raising Chinese imports from the U.S. by almost a factor of three while holding exports constant, or increasing imports even more while increasing exports modestly. One report places China's offer at $600 billion of annual imports from the U.S. by 2024. Those are very large numbers, and would require reversing a long-established trend; the U.S. trade deficit with China has hit records in recent months:

But that's just the bilateral trade balance -- China's trade with the rest of the world is much less lopsided. In fact, China's current account balance, which takes into account both trade and investment income, is now almost to zero:

If China buys more from the U.S. without making any other adjustments, it could tip its current account into a deficit. China probably wants to avoid that.

So China's best bet to increase imports from the U.S. would be to simply divert its purchases from other countries. For example, China imports more than $160 billion a year of oil, very little of which is from the U.S. But since oil prices are set on world markets, it wouldn't cost China anything to start buying oil from the U.S. instead of Africa (African countries could then sell their oil elsewhere for the same price and avoid being harmed much by the shift). That substitution alone would do a good deal to reduce the U.S.-China trade imbalance.

Farm products are another potential source of trade diversion. China already imports about $20 billion in agricultural products from the U.S., but this could be ramped up -- China's total food imports are almost four times that amount. Simply buying less of its food from countries like France, Australia and Peru, and more from the U.S. could take another chunk out of the trade imbalance.

Buying most of its food and oil from the U.S., however, would come at a cost. In the event of a conflict between the two countries, China might find it hard to rapidly shift away from U.S. suppliers. In this case, economic concessions would also be geopolitical concessions -- something China's military might veto.

And together, diverting food and oil purchases to the U.S. would only accomplish about half of the import growth China has promised. The rest would probably have to be in products like machinery, vehicles and aircraft:

Importing a lot more machinery and vehicles from the U.S. would be a big economic reversal for China, which has focused on trying to export these goods. It would necessitate substantial changes to the country's economic model.

So it may be technically possible for China to eliminate its trade deficit with the U.S. Such a move, though, would require big sacrifices -- dependence on the U.S. for fuel and food, changes to its growth strategy -- that the country's leadership seems highly unlikely to be willing to make. So it seems improbable that China will follow through on this big trade-war concession; chances are high that it turns out to be a red herring. This unrealistic offer might also detract from the more important trade issues, such as Chinese intellectual property theft, control of high-tech industries and onerous requirements for American businesses seeking access to China's markets.   

To contact the editor responsible for this story: James Greiff at jgreiff@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

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