Nothing sells newspapers like using the word “WAR” in a headline in a large font.

Even if the most dramatic feature of the mighty conflict is a small tariff on a shipment of steel rebar destined to be buried in the columns of a new car park somewhere in suburban Nebraska.

Calling the process of resolving trade imbalances “war” makes it sound much more exciting than calling it a boring “trade dispute”. Though the “trade dispute” that kicked off the collapse of the Jedi “chill zone” in Episode 1 of Star Wars ticks a few boxes in the “this might get interesting” department.

The problem with all the melodrama and over heated language is that trade imbalances are easy to fix and even easier to avoid in the first place.

In fact the USA can fix its trade imbalances whether or not the Chinese agree.

The key reason so many people seem to resort to colourful language and a good dose of panic when talking about trade is that most of the time they don’t seem to understand how it works.

Ending the trade imbalances between the US and China (and the rest of the world) is easily fixed and does not require any action by China at all.

Why?

Because people with things to sell do not sell you things unless they get paid.

It is that simple.

If you make it clear that you cannot or will not pay for something the person selling it will NOT give it to you.

If you refuse to pay or limit (regulate) the ways your people can pay, your trade partner will quickly start limiting what they sell your people.

In other words China will stop selling the US more stuff than it buys from the US ( a trade surplus) the moment it realises it cannot be paid for most of the trade surplus if it continues to deliver it.

Right now China happily sells the US as much as it can because it knows it will always get paid no matter how large the trade surplus becomes.

By making it harder for China to get paid for the extra (trade surplus) they sell, the US will stop China selling extra stuff to the US very very quickly.

So how does China get “paid” for the extra (the trade surplus) it sells the US right now?

In two ways

1. The US sells China financial assets (IOUs) issued by private and public organisations in the US (e.g. US Treasuries)

2. The US sells China physical US assets like land, buildings, businesses etc.

Both of these ways involve China agreeing to buy (and the US agreeing to sell) something other than US trade exports as payment for the extra stuff (imports) it sells to the US.

Australia has been ‘paying’ for its trade deficit this way for about 50 years and this is why almost every major Australian business and a bunch of other economically significant assets have been sold off to our trade partners who most of the time have run predatory mercantalist trade strategies.

China simply cannot and will not run a mercantilist strategy (i.e. running persistent trade surpluses) with the US if its ability to buy US financial and non-financial assets is restricted.

So if the US wants to reduce its trade deficit with China all it needs to do is reduce the number of US assets the US currently sells to China.

And for the most part restricting the sale of local assets to foreigners is something any government can do with ease because all governments have the power to regulate and control the ownership of assets within their territory.

But isn’t restricting the sale of assets to China terrible?

Of course not.

There is no rule that says the US must sell assets to China so China can run a massive trade surplus.

There is nothing remarkable about this either as this is exactly what China does with regard to its own trade partners.

China explicitly and deliberately limits the Chinese financial and non-financial assets it allows to be sold to foreigners and in doing so supports its own export industries.

In certain circumstances it may be in the interest of a government to allow foreign parties to ‘invest’ and create new assets in their country or to acquire limited interests in an asset to encourage knowledge transfers to local people but the terms on which that happens is always up to the government allowing it to happen.

This is exactly the approach taken by China over the last 30 years and many many other countries before them.

What is weird is the bizarre idea of the free trade fundamentalists that a country should surrender its power to determine when, why and how a foreigner can acquire an interest in local assets.

But free trade or ‘liquidity’ in US treasuries is important to the world economy?

This is one of the great modern economic myths.

Yes, the US dollar is the world reserve currency and is currently critical to the operation of world trade.

However that does not mean that the US loses ALL rights to regulate:

1.   Transactions in and out of the USA
2.   Transactions involving foreigners and US financial and non financial assets

There is no sacred rule of national currencies as “reserve currencies” that requires that every last US treasury must be freely tradeable nor for trade in other US financial and non-financial assets to be completely free.

That is just an ideological obsession of free market nut jobs (Wall Street) and their globalist fellow travellers.

The simple reality is that most of the US financial assets being traded are being traded for speculative and unproductive purposes.  The amount actually required for the world trade system to functional is small.   Not that Wall Street and their team of financial press cheerleaders will ever admit it.

World trade can work perfectly fine even if the US regulates or imposes some limits on the trade in US treasuries and other US assets. Considering the current mess that ‘world trade’ is in, it is about time that more people gave some thought to the idea that it is the lack of limits and the lack of regulation of the trade in US treasuries and US assets that is actually the primary cause of the current trade mess as foreign countries buy those assets without limit to distort exchange rates and run mercantalist trade strategies.

In relation to the purchase of strategic US assets the US already exerts plenty of control.  That is why proposed acquisitions of assets by foreign parties in some key industries have been blocked by the US government. Every country does this and it is entirely normal.   Introducing a criteria that foreign purchases of significant US non-financial assets must demonstrate clearly how the investment will expand the productive capacity of the US economy will not be difficult or ‘asking too much’.

Businesses do this all the time. They are called business plans.  The test is not difficult to understand or apply.  Will the investment involve building new plant, new equipment, new buildings, creating new assets or employing more people. Importantly, spot checks will be conducted to check that the foreign investor actually delivered on their promises. If they fail to deliver they can be required to divest their interest or sell the asset. China has done exactly this for the last 30 years when deciding whether it would allow foreign investment.

In relation to US government financial assets (US Treasuries) an easy way for the US to introduce some limits and restrictions is to start issuing some tranches of US treasuries as registered securities and limiting registration to US citizens. Why should the US government be selling bonds to foreigners willy nilly anyway?

By all means some treasuries can remain unrestricted so that the US dollar can continue to operate as the world reserve currency but there is world of difference between some US treasuries being freely traded and all US treasuries being freely traded.

By actively restricting or discouraging capital flows that are speculative in nature or designed to manipulate international trade rather than support productive investment that adds to the productive capacity of the US economy, the US can do a great deal to support fair trade between nations.

Restricting the trade in US Treasuries to make it more difficult for foreigners to use purchases of US Treasuries to manipulate exchange rates and world trade is a no brainer.

Regulating international capital flows

Free market obsessives are ideological purists who rely on blind faith rather than empirical evidence.   They are easy to spot because they start sounding manic if you question even slightly their belief that free capital flows are the cure for the world’s problem and sound deranged if you suggest that unrestricted and unregulated capital flows are likely the cause of many of them.

If they paid attention to empirical evidence they would know that in practice free international capital flows have been a massive flop as they are so easily manipulated by countries with plenty of political reasons to manipulate them.

International trade imbalances, like the one between China and the US, are the result of massive purchases of financial and non-financial assets of the trade deficit country by the trade surplus country. They are purchased in order to manipulate exchange rates. In particular, to stop exchange rates naturally rising as a country’s trade surplus grows.

Australia has been the target of exchange rate manipulating trade partners for decades who insist on buying Australian financial and non-financial assets while strictly restricting purchases of their own assets by Australians.

The sooner that countries like the US and Australia start regulating international capital flows having regard to whether they arise from fair trade or are productive (expand the productive capacity of an economy) rather than from trade manipulation strategies the sooner all these squabbles, trade conflicts and mud slinging will be resolved.

Action Plan

Each country including the USA must start to monitor and distinguish between capital flows that are productive and those that are not.

• Most Government bonds issued by governments should be owner registered and restricted to local citizens.

Restricting bond issues to local citizens places limits on inter generational theft facilitated by governments. Why should current generations be allowed to incur debts to be paid by future generations? Why should they be allowed to sell them to foreign bankers and governments? The Greek crisis is a good example of why governments should be discouraged from selling bonds to foreign parties and banks.

• Only a small percentage of government bonds ( more for the US as it is the reserve currency) to be issued without the restriction in 1 above.

The US is different as its currency is currently the world reserve currency but that does not mean that the US cannot regulate in anyway trade in its government issued financial assets. However now might be the time for the world to start moving towards an new world reserve currency for facilitating “fair” trade that is not also the national currency of one country.

• Mere acquisition of title to local assets by foreign buyers – especially interests associated with governments – are to be limited.

Acquisitions that clearly can demonstrate how the productive capacity of the local economy will be expanded may be approved subject to the investment / expansion taking place within agreed timelines.

• All capital flows to be subject to small transaction taxes (Tobin taxes) to discourage speculators.

Tobin taxes are small taxes designed to make high frequency speculative trading in currencies and capital flows unprofitable.

Taxing unproductive activity to discourage it is a proper job for government and something the US should be leading the world by doing.