The word from China’s state media is that the country is making three demands of the US in order to end the trade war.

  1. China demands the US remove all tariffs on Chinese goods.
  2. China demands that the amount of goods it must purchase from the US be realistic.
  3. China demands that its sovereignty and dignity” be preserved.

Multiple outlets carried this message, including the People’s Daily, Xinhua, and the Global Times. Both the first point, the removal of all tariffs, and the third point, the preservation of Chinese sovereignty, are inextricably tied to the country’s negotiations with the Trump administration.

US negotiators are demanding that China pass laws that would give foreign companies legal recourse in China if they had their intellectual property stolen, or if they were forced to transfer technology, for example. To China, passing such laws at the behest of a foreign power is a violation of its sovereignty. To the Trump administration, it’s part of the trade deal’s enforcement, and it won’t remove the tariffs until it sees those mechanisms in place.

So there’s that.

All that aside, though, on the second point, China’s demand is legitimate. The US is asking China to buy more goods than the US can realistically produce, without messing up global supply chains, in some cases.

The Trump administration is asking China to buy so much US product that it could change the very nature of China’s economy, transforming it from a net creditor to a net debtor.

The goods

In March, the Citigroup analysts Dana Peterson and Catherine Mann wrote that there actually isn’t much the US can sell China without disrupting trade with its partners or changing US production.

Citing data from the International Trade Centre, Peterson and Mann figured the US could send about $19 billion more of its soybeans and select meats to China — but that’s about it. They said:

The US likely can increase supplies of soy products to China in the short run, as well as select meats. However, meeting the proposed US$1.2 trillion of additional shipments of goods to China over six years, including energy, machinery and tech products, will require major adjustments in the US and China’s current trading partners, as well as a reconfiguration of US domestic production of these items.

Part of the problem is that there’s a disconnect between what China wants and what the US has to sell. For example, the US would like to sell China more aircraft, but China isn’t interested. China wants more US electronics, but the US doesn’t want to sell them.

According to Peterson and Mann, “China has the greatest demand for soy beans; smart cards, electronic integrated circuits, LED lamps; passenger cars, motor vehicle parts and accessories; large aircraft; pharmaceutical products; and ‘other machinery.'” All these goods, aside from soybeans, come with their own complications.

In some cases, the US would even have to change national-security protocols in order to trade goods China actually wants. In other cases — like high-tech autos — there are intellectual-property concerns.

Citing data from the Federal Reserve, Peterson and Mann point out that when it comes to foods, motor vehicles, semiconductors, and aerospace, the US is at or near full-production-capacity-utilization rates. When it comes to energy and poultry, the US doesn’t have enough to sell to meet China’s demand.

One solution to these problems might be to take goods from other trading partners and sell those to China instead. That’s just about as bad as it sounds.

Changing China

And then there’s the problem with buying more US goods on the China side. In January, China floated the idea that over the next six years it could make enough purchases of US goods to close the trade deficit between the two countries.

President Donald Trump would love that, but it’s not happening.

In a note to clients, the Barclays analysts Michael Gavin and Ajay Rajadhyaksha dismissed that idea because China’s balance of payments can’t actually sustain those purchases without the Chinese economy transforming from a net creditor to a net debtor.

From their note:

Although China’s record 2018 bilateral trade surplus with the US captured headlines and many policymakers’ attention, the country’s broader current account balance continued its multi-year decline and recorded a slight deficit in the first half of the year.

As recently as 2015, China ran the largest current account surplus in the world (in absolute terms, though not relative to the size of its economy). We now project modest deficits in 2019 and 2020, transforming China from the world’s largest exporter of capital to a modest capital importer.

There’s nothing wrong with being an importer of capital — the US is one — but in order to maintain a current-account deficit, you need plenty of liquid assets for foreigners to buy. And China doesn’t have those. Where the market cap of the S&P 500 alone is nearly 110% of US GDP, the Shanghai Composite has a market cap of 30% of China’s GDP, for example.

“For China to finance a persistent 3% current account deficit would require gross foreign liabilities of nearly 80% of Chinese GDP,” the analysts said. “This sounds high, but it is not inconceivable. For example, the US now maintains gross foreign liabilities equal to 175% of GDP.”

Building out assets like these takes time. And China is trying, but it just joined the game. It’s still developing a real domestic bond market, for example.

Plus, becoming a net debtor would subject the Chinese economy to the whims of the market more than policymakers may like. And it would be directly in contrast with China’s ambitions to finance its Belt and Road Initiative, which was previously known as One Belt, One Road.

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