If the United States had a balanced budget and IF the U.S. had a low debt to GDP ratio, (much lower) and IF the debt of the United States were vastly lower and not dependent on low interest rates to make the cost of servicing the debt affordable and IF businesses in the U.S. were not so dependent on manufacturing in China to keep costs low and IF U.S. companies were not so quickly becoming dependent on exporting to China, THEN and ONLY THEN would the United States economy be a whole lot stronger and much more insulated in a trade war with China. Unfortunately, that is not how it is. Are all those if’s scaring you yet? They should be. Whether you live in the United States or not, the global economy and all its interwoven inter-dependencies bring about the very biggest and scariest IF of our present time; if the economy of the United States fails, so will the global economy.
Let’s start with some basics; the U.S. has a very large debt and unfortunately, the cost of paying interest on that debt alone is quite significant. Just like any other loan, the more that is owed and the longer it takes to pay it back, the more interest is paid. If interest rates rise, the cost of borrowing also rises. As interest rates go up, the U.S. has to divert more and more money just to service the debt, which means they either have to make cuts to other parts of the budget or raise taxes which drives up costs and makes inflation worse. If they borrow more money to pay for the increased cost of the debt, that raises the amount owed which raises the cost of the debt, making things worse.
What does all this have to do with China? China exports a great deal of goods into the United States. Manufacturing in China is much cheaper than manufacturing in the U.S. and this has allowed consumers in the U.S. to enjoy very low prices for many consumer goods. Cheap manufacturing in China may make for cheap consumer goods but it comes with the nasty side effect of driving U.S. manufacturing out of business. Over the last several decades, as more and more U.S. companies moved their manufacturing to China, layoffs increased significantly. Many would and have argued, pent up anger over the loss of manufacturing jobs is partially responsible for putting Trump in the White House and that is what has led Trump to take action.
As a result, China reacted to the Trump administration raising tariffs on Chinese goods by slapping tariff’s on U.S. goods. Tariffs on U.S. goods raise the cost of doing business. When businesses face increased costs, they protect profits by raising prices. The more the trade war escalates, and more and more firms raise their prices, inflation begins to rear its ugly head. The only way the government can counter inflation is to raise interest rates. Raising interest rates, raises the cost of borrowing which discourages more borrowing and as businesses and consumers borrow less money, the economy slows. If the economy slows too much, it can throw the U.S. economy into recession. As interest rates rise, so does the cost of servicing the debt. If the cost of the debt gets out of control it can effect the credit rating of the U.S. If the U.S. credit rating gets hurt it also raises the cost of borrowing since there is more perceived risk involved. If the cycle gets out of control, fewer and fewer want to risk loaning money to the United States and then things get significantly worse. How worse? Take a look at what happened to Greece recently and you get a pretty gloomy idea.
What can be done? The United States must do two things very carefully if it is to avoid some very unpleasant economic consequences. First, it MUST work out better trade deals with China to grow jobs and the economy WHILE avoiding a damaging trade war. Once that is done, U.S. leaders MUST work together and find a way to balance the budget and begin paying down the debt without destroying economic growth.