East or West: UK faces a critical choice as Trump's launches his trade war

The challenges facing the United Kingdom have been piling up of late. Brexit in particular promises to isolate the UK from its largest trading partner, while dramatically reducing the country's influence within - and relevance to – the European Union and beyond. Never mind, say the Brexiteers, UK can forge a bright future for itself outside the EU by striking free trade deals with third countries, notably the US.

Sadly, recent developments in the US suggest otherwise. US President Donald Trump's lurch toward protectionism, including the announcement on March 22  tariffs imposition of up to $50 billion on Chinese exports to the United States and on April 5 the consideration of an additional $100 billion tariffs on China and his previous unprovoked attack on China show that America's commitment to free trade is not what it used to be. The protectionist urge comes from the very top; Trump himself says there is more to come. It would be naïve of the UK to dismiss the warning signs.

A protectionist America poses a difficult dilemma for the UK. On the one hand, Britain has strong historical ties with the United States. Colonial ties gave way to successful defense alliances. A common tongue and cultural links tie the two countries together and both nations used to prefer small government with less regulated markets.

Today, however, Trump's America appears bent on abandoning free trade precisely at a time when the UK needs free trade more than ever due to Brexit. This means that the UK's national interest may no longer be best served by always siding with the US, especially when it comes to economic policy.

The good news is that as UK severs its ties with the EU it does not have to depend entirely on the US to make up for the loss of markets. The single most important development in the global economy in recent years has been the rise of China from a secluded backwater to major economic powerhouse. China's economy is now on track to be two to three times larger the US economy by 2050 with major implications for the UK.

Most obviously, London will care. Size matters in finance. Due to the scale of China's economy, her financial markets are destined to replace US markets as global benchmarks for stocks, bonds and currencies in exactly the same way that US markets replaced UK markets in the interwar years. If London wants to retain its standing as the world's largest financial center the UK must turn East, not West.

But the case for looking East extends far beyond London. The UK's current uncertain future as a free trading nation outside the EU can readily be made less precarious by deepening trade ties with China. Future US import demand is constrained, because US consumers are already heavily indebted and their capacity to spend will decline as the Fed gradually drives borrowing costs higher. By contrast, China's consumption boom is only beginning. Chinese people save nearly 50 percent of their income, but as policies to encourage greater spending in China,consumption will emerge as the single largest economic force in the global economy. In short, if the UK wants to export China offers much greater upside than the US.

The case for the UK to look Eastward is not just about realizing long-term gains, however. There are also powerful near-term reasons for looking toward China. The most important is the clear policy divide, which has recently emerged between reform-friendly China and the growing populism of the Trump administration.

In China, President Xi Jinping's political standing has been boosted greatly since last year's 19th National Congress of the Communist Party of China and he will use his new-found powers to open China's economy further. While China will not merely stand by as Trump applies tariffs, China's response can be expected to be measured and targeted. There is no question of U-turning on Xi's broader commitment to free trade made at Davos in January 2017, because China – and the world – have far too much to gain from deeper integration of the global economy, even if the Trump administration fails to see this. China can therefore be expected to fill the vacuum as America shrinks from the world, just as it did when the US withdrew from the Trans-Pacific Partnership (TPP). China's currency, already an officially recognized global reserve currency, will continue to gain greater gravitas as the dollar declines under America's growing twin deficits. Only last week Bloomberg Barclays announced that China will be admitted to its Global Aggregate bond index, a key global benchmark for institutional investors. The UK should bet on China's success, because China IS unremittingly committed to reform.

By contrast, Trump's America is turning inwards, largely due to a misinterpretation of how open economies work. Contrary to the claims of the Trump administration, America's trade deficit with China and other countries is not the result of the sudden adoption of unfair trade against the US. In fact, there have been no major changes in global trade policies, that is, until Trump began to impose unilateral tariffs. The reason why some – but by no means all – American companies struggle to compete is that US productivity is in decline and the Dollar is seriously overvalued. To try to fix these problems by imposing tariffs and debt-financed fiscal expansions is not only economically illiterate, but also likely to worsen America's economic malaise.  

The UK should recognize that Trump's America is now a nation in decline embarking on a desperate but ill-advised path of populism, while China is a nation in the ascendancy addicted to reforming its economy. The UK should look beyond its historical ties to the US and instead turn East, towards the future. Trump's tariffs will not make the difficult challenges facing the US economy go away, so there may well be even worse policies to come. This prospect simply holds no upside for the UK. By contrast, China's growth rests on sustainable drivers and China's commitment to free trade promises the UK access to the largest consumption boom the world has ever seen over the coming decades.