Trade War Lessons from Ancient China

Ancient Chinese history provides a lesson about bubble, malinvestment and trade wars. A legend called 种桑误国 describes how minister Guan Zhong of Qi conquered the neighboring countries. It says the minister ordered everyone to wear silk, but forbid the domestic production of silk (no planting of mulberry trees). All farmland was to be used for food production. The price of silk soared and the neighboring countries planted many mulberry trees and shifted into silk production. They became wealthy exporting silk. Then Guan Zhong ordered all of the ministers to stop wearing silk and cut off food exports. Faced with starvation, people fled to Qi. In this way, Qi easily conquered its neighbors.

The legend may have grown from a real event, the war with Hengshan.

In the record of Guanzi Chapter 84, Duke of Huan wanted to restrain the threat from State of Hengshan（衡山国）and asked Guan for solution. State of Hengshan was famous for its weapon production. Guan then ordered officials to buy arms from State of Hengshan in large quantities. After ten months, worrying that the price will continuously grow up, State of Yan, State of Dai and later State of Qin followed up the buying. The price then jumped sharply and, as a result, almost all household in State of Hengshan switched to make weapons instead of farming. One year later, Guan ordered officials to buy rice from State of Zhao, at a price more than three times higher than normal. By seeing the potential huge profit, State of Hengshan sold its rice inventory to officials from State of Qi. Afterwards, Guan suddenly ordered State of Qi's army to invade State of Hengshan. With selling out of weapon and rice, State of Hengshan soon surrendered.

Trade wars are often thought of in terms of kinetic wars. Both sides take losses, each side fights using direct attacks such as blocking trade. A more thorough form of economic destruction requires a long setup using passive strategies. Guan Zhong was a Machiavellian Austrian economist. He wasted money on weapons and rice to draw the enemy into unproductive economic activities. Right until the military invasion, the Fake News of ancient China might have written untold articles about the stupidity of Guan Zhong and the wealthy rising economic power of Hengshan.

Who is Qi today? Both China and the USA cause more economic destruction internally with debt-fueled housing and financial bubbles. Longer-term, both countries are their own worst enemy. In the short-term, a straight comparison of the trade relationship argues for the USA. China is more fragile not simply because trade is a larger share of GDP, but because it is dependent on U.S. demand. Chinese factories do not make goods for Chinese consumers. They serve U.S. customers. The immediate impact of a full-blown trade war in the USA is empty shelves at Wal-Mart and changing consumption patterns. The immediate impact in China is unemployment and factory closures. (If China had a credible currency and debt market alternative, it might qualify as Qi because it could pull the plug on the dollar. But it doesn't, not yet and probably not for at least 10 years.) President Trump has inelegantly described this situation as America having already lost the trade war. The more perspicacious Steve Bannon understands America's "weaknesses" leave it in a momentary position of strength. Steve Bannon even channels Guan Zhong: We Can Take the Whole Thing Down, Total Victory for USA

A more subtle lesson from Guan Zhong is the power of consumption. Trade wars are focused on production, but it is through consumption (yin) that victory was achieved in part because everyone focuses on production (yang). The consumer has the greater soft power because the producer serves the consumer.The people of the United States have made much of China into an extension of the U.S. economy because those factories operate to serve U.S. customers. China's chief representative if WTO accession negotiations understands this deeper truth. He argues China should increase its imports because that is what made America so powerful.

iFeng: 龙永图：美国为什么那么牛？因为它是全球最大的进口国

Why is the United States so powerful? Think about it, come out one - it is the world's largest importer!

As the chief representative of China's WTO accession negotiations, Long Yongtu judged the significant contribution of imports to the US economy. He believes that the importing country has largely determined the price and determined the market. This is "the dream of all of us who engage in foreign trade." Therefore, the entrepreneurs and the government are called upon to give greater attention to imports . Just as President Xi’s positive import increase to the Boao Forum is an important measure for our new opening up, we should do this in accordance with the requirements of President Xi!

Under the global economic situation, our global trading system is still “cutting and chaos”, what should we do? The United States has repeatedly threatened to "retreat the group" and Long Yongtu said, "I hope it will not be retired, and don't be afraid of it." Why is the United States "bullish"? How can China, as the world's second largest economy, be invincible in global trade?

...So what kind of policy choices can we make based on such a chaotic and very complicated global trading system? What should we do in China? Long Yongtu proposed two options for this:

First, continue to support the global system represented by the World Trade Organization and the threat of US withdrawal from the WTO. Take a positive attitude: I hope it doesn't quit, and don't be afraid to quit it.

Second, on the basis of continuing to support the WTO global system, we will participate more actively in global regional trade arrangements. One of the most important things is how to speed up regional trade negotiations in Asia.

For our trade policy, we should pay equal attention to both exports and imports, and we should increase our efforts to increase imports.

Lou Jiwei takes an opposite approach from Guan Zhong, proposing a yang strategy instead of yin:
Caixin: Chinese official: Beijing should target goods needed by US

Speaking Sunday at an economics forum, Lou said Beijing should disrupt supply chains of American companies that rely on China's vast manufacturing industries, the website Sina.com reported.

China's "counterattack strategy needs to restrict exports to the United States as well as (imports of) U.S. goods," Lou was paraphrased as saying.

"Only knowing the pain of fighting will stop the war and cause (the United States) to negotiate seriously," said Lou.

Lou was finance minister through 2016 and serves as chairman of China's 1.9 trillion yuan ($290 billion) National Social Security Fund, which manages assets of government pension plans. He is a former chairman of China's sovereign wealth fund, the China Investment Corp.

Lou Jiwei's approach plays into Trump's hands. As long as the U.S. is willing to accept the pain, it would accelerate the movement of supply chains out of China and into politically secure jurisdictions. The genius of Guan Zhong was in appearing weak and making the enemy believe he was strong (and rich). China has been running a strategy similar to Guan Zhong for 20 years, mainly because the United States was being looted by its financial and political establishment. That regime is losing power and China isn't sure what to do. It has been courting its old Wall Street allies, but their power has waned.

NYTimes: As Trump’s Trade War Mounts, China’s Wall Street Allies Lose Clout

When President Bill Clinton deliberated whether he should loosen trade barriers against China, Wall Street helped plead Beijing’s case.

When Presidents George W. Bush and Barack Obama talked tough about labeling China as a currency manipulator, Wall Street urged restraint — and both presidents backed down.

Today, China is hoping that Wall Street will once again use its political heft to soothe tempers in Washington. But as President Trump ratchets up the trade war with Beijing, Wall Street’s words are falling on deaf ears.

Senior Wall Street executives met in Beijing on Sunday with current and former Chinese officials and bankers at a hastily organized session to find ways to strengthen financial ties between the United States and China. On Monday, the group — which included executives from Goldman Sachs Group, Morgan Stanley and the Blackstone Group, the private equity firm, among others — planned to meet with Vice President Wang Qishan, the right hand man of Xi Jinping, the country’s leader.

As I wrote back in 2014:

The protectionists are ever so slowly gaining the upper hand thanks in part to negative social mood. 2008-2009 will probably mark the peak moment for Wall Street and the Treasury Department, even though there is as yet no sign of it in Washington. Changes can be seen in the form of issues such as immigration, which has turned the grassroots of the conservative movement against the Chamber of Commerce and large corporations (due to an attack initiated by the latter against the former). This has pushed the Overton window of acceptable debate among conservatives who can now take shots at big business. There is also the growing libertarian faction pulled together by Ron Paul that supports his son, Rand Paul, that consistently attacks the Federal Reserve and Wall Street. Put it together and it is not hard to envision an anti-Wall Street, pro-manufacturing political consensus emerging. This will cut across party lines, with manufacturing unions pulling in Democratic support if there are specific bills to vote on.

The alliance grows stronger by the day.

If China wants things to "return to normal" it needs Trump gone and populism ended. Then it can get back to the old strategy with Wall Street as its witting partner and Washington its unwitting partner. Next best is getting back to its grand strategy: lulling the world into a slumber as it peacefully rises. China's Made in 2025 initiative and military expansion in the South China Sea came too early. A renewed focus on economic development is needed.

What can China do to mollify Trump? The CCP doesn't want an open the economy, it has been ratcheting up its control. It would have already granted its own citizens greater economic freedom if this was an acceptable solution. Thus, the only politically acceptable option that will get China back on its long-term track is greatly increased imports. And if they study Guan Zhong, they would know that's the best way to fight an economic war.