China has an advantage over Donald Trump in a trade war against the US

By Ian Verrender

The insults and assaults may be global but, increasingly, Donald Trump's war against everyone is being whittled down to a fight for dominance between America and its main rival, China.

It is a war neither side can win.

It's more a question as to the amount of pain either country can endure and which will emerge with the least damage.

While the odds should be stacked against China, given its spluttering economy, America is in the throes of tearing itself apart. It is a nation deeply divided socially and politically and, increasingly, economically.

White House press secretary Karoline Leavitt created an international uproar last week after repeatedly boasting China needed America more than the US needed China. She appeared garbed in a Made In China dress.

Those running the numbers on who will emerge the victor tend to be swayed by partisan views and whether or not they are aligned with Trump.

China, meanwhile, has vowed to fight until the end but has quietly made overtures that it remains open to negotiation. Trump, meanwhile, has beseeched his counterpart in Beijing to pick up the phone, but has repeatedly ramped up the pressure with the imposition of ludicrously high tariffs.

The upheaval on financial markets during the past few months primarily is a result of the confusing and conflicting statements from the White House and the incessant policy backflips.

Are the tariffs permanent? Or are they merely a bargaining chip? No-one seems to know - a situation that ensures the current lull in financial market chaos will only be temporary.

Trade, finance and trust

America is the world's biggest importer. China is the world's biggest exporter. So, the stakes are incredibly high.

What the Trump administration seems to have overlooked is that the US has only ever been able to afford its consumption excesses because it is the centre of global finance, a status that confers upon it the deepest pools of capital anywhere on the planet.

Success breeds success. The rest of the world, including China, throws vast amounts of money at America because it is the world's biggest economy and, by default, operates the global reserve currency. That flood of money, in turn, keeps US interest rates low.

Almost every nation, either through government holdings or private investment, has a stake in US government bonds, an instrument that is considered the benchmark for global interest rates and, in times of trouble, the safest place to park your cash.

A fortnight ago, that all changed. Investors began selling US government bonds and shifting their cash outside the US, sparking crisis talks within the White House and the three-month postponement of the Liberation Day tariffs.

The delicate balance

China owns $US760 billion in US government debt - essentially US government IOUs - the second-largest holding after Japan.

It is a graphic illustration that trade and finance are inextricably linked.

And so, by blowing up the global trading system with a series of uncoordinated and randomly launched incendiaries based upon a faulty understanding of finance and incorrect arithmetic, the Trump administration has inadvertently sown the seeds for a potential financial crisis.

But there are factors, other than the tariff war, at work here too.

America has earned its role as the world's financial powerhouse, not simply because it is the biggest economy.

It has been a trusted destination for global capital because it has open government, a vibrant democracy, efficient bureaucracy, an independent judiciary, a free press, advanced education and a world-leading central bank.

The new administration, however, has attacked almost every one of those pillars since taking control in January.

Late last week, it began its long-awaited campaign against the last stronghold: the independence of the US Federal Reserve and its chair Jerome Powell.

Powell has made it clear he won't quit and that he intends to see out his term. Should Trump take him on, the flight of jittery capital from America that began a fortnight ago could turn into a full-scale retreat, which would make his trade war with China seem like a cakewalk.

It would push interest rates on US money markets higher - regardless of the rate set by the US Fed - blow out the cost of servicing America's $US36 trillion debt and send the country into a financial spiral.

Disturbingly, reports from The New York Times over the weekend indicate the US president has personal holdings in US government bonds which, if correct, would create a huge conflict of interest further undermining confidence.

Who needs who more?

But back to trade.

Those backing America in this battle point to China's reliance upon the US, correctly identifying America as China's biggest trading partner.

The US, on the other hand, counts China as only its third-biggest trading partner. That's why Leavitt, and her boss, arguably can claim that China needs America more than the US needs China.

Unfortunately, America has also gone to war with its two biggest trading partners, Canada and Mexico.

Both are seething at the treatment meted out to them by the Trump administration. Canada, in particular, has threatened boycotts of US purchases and even restrictions on the supply of electricity.

With the latest tariffs of 245 per cent, America essentially has banned Chinese imports, meaning it will have to source them elsewhere.

And therein lies a problem. Neither Canada nor Mexico produce the kind of goods, at least not at scale, that China delivers. That's why America buys them from China.

China dominates consumer goods in everything from electronics and electrical items to machinery, clothing and footwear, a host of manufactured goods and building materials.

It dominates those markets globally, effectively ruling out alternative suppliers for the US at the kind of volumes Americans require.

The combined impact of tariffs and shortages are certain to put intense upward pressure on prices for a range of imported US consumer goods in another inflationary spike that will require a big jump in interest rates.

America's biggest exports to China, by contrast, are agricultural goods, most of which can be easily sourced elsewhere.

Its biggest trade is in oilseeds and grains. Unfortunately for the US, quite a number of other countries produce those, including Australia. So, China will simply buy elsewhere.

Until two years ago, America sold large quantities of semi-conductor chips but that's less of a bargaining chip than it once was because the US already has mostly banned their export, leaving it with little leverage.

Next comes oil and gas. But again, these are generic commodities that can be bought from a range of suppliers.

China's critical minerals

China, by contrast, has a serious trade weapon: critical minerals and particularly rare earths.

China dominates the rare-earths supply in its unprocessed form. More importantly, it accounts for about 90 per cent of all refined product and, when it comes to heavy rare earths, it has a total monopoly.

Heavy rare earths are essential in the creation of super hard magnets that are required for robotics, military and renewables applications.

Not only does China have a stranglehold on the refined product, it has taken a leading position in the production of the magnets themselves.

The US Air Force F-35s can't fly without them and the great boom in artificial intelligence and robotics - the area that until a few months ago seemed to be America's high-tech future - could be severely hampered by their restriction or absence.

As Trump has often said, you should never start a war you can't win.

This story was first published by the ABC.