Top negotiators from China and the United States at trade talks in Beijing on March 29, 2019. Nicolas Asfouri | AFP | Getty Images

Washington apparently went too far. Instead of seeking an immediate and rapid rebalancing of U.S.-China trade, the White House asked for legislative changes in China's trade and economic systems under a permanent threat of sanctions. And then it got worse. China seemed to have offered a bait, pretending that it might acquiesce into such unthinkable concessions, only to show its political establishment Washington's true intentions.

What followed was a theatrical coda to a negotiating collapse. When word got back from China that Washington's conditions were unacceptable, the White House cried foul, accusing Beijing and President Xi Jinping of reneging on a "done deal." The Chinese simply retorted that they were in a negotiating process where nothing was agreed until everything was agreed. Predictably, trade negotiations broke off.

China's message is clear

While both sides agreed at the G-20 meeting to resume talks and hold off any new tariffs for the time being, Washington and the media still seem to have problems in decoding China's conditions for trade negotiations. Indeed, Beijing's repeated statements that it wants to negotiate in an environment of respect, equality and due consideration of its national interests have been widely ignored as declaratory posturing. But what do the Chinese mean? Beijing is simply warning that it would not tolerate any foreign attempts to interfere in its: trade and economic regulations, national unity and territorial integrity — referring to Hong Kong, Taiwan and Tibet, maritime borders, religious issues that could destabilize China, and development of flagship industries. If those conditions are met, China would be willing to talk — trade or anything else. The White House received that message with comments that the Chinese were eager to do a trade deal, because their economy was in trouble with a growth rate of 6.2% in the second quarter of this year — 10 or 20 basis points below the markets' wishful thinking. Nobody seemed to notice that the Chinese were laughing all the way to the bank with $137.1 billion of surpluses on their U.S. trades in the first five months of this year, based on numbers from the U.S. Department of Commerce. Taken at an annual rate, that's close to $400 billion of America's wealth and technology transfers to China's economy. The question is: When will the White House understand that the trade deal it wants with China is a mirage? Beijing is playing hardball because it knows that an election-bound President Donald Trump wants a trade deal to calm down Wall Street, boost asset prices and maintain growing economic output, demand and employment. The Chinese see no reason to oblige, unless that's done on their terms. Both sides are miles apart from what the other wants.

US has the upper hand

What can Trump do? The answer is simple: With negotiations going nowhere, Trump should respond with a devastating one-two strategy, instead of sending that meekly defensive tweet last Friday that his people "had a very good talk" with their Chinese counterparts. What's that lethal one-two combination? It's an immediate tariff hike on all Chinese imports, and a signal to the Federal Reserve to cut interest rates in order to support domestic demand and America's long-suffering import-competing industries. Trump should ignore the free-traders' howls for a number of reasons. First, Beijing has a limited scope to retaliate. Taking, as an example, the bilateral trade in the first five months of this year, China could raise tariffs on $43 billion of its U.S. imports. That's nothing compared to Trump's knockdown punch to $180 billion worth of Chinese goods sold to American markets. But that's a huge disruption of supply chains? No, it isn't. The Chinese will absorb most of the tariff hikes to maintain competitive pricing and defend their U.S. market shares. Chinese suppliers will not simply fold and vanish from markets where they invested for decades. If allowed — and that's another policy lever for Trump — they would also rush to invest in U.S.-based production facilities. And if the policy change on China trade is credible, U.S. industries would get a breather and an incentive to stand up and compete. A long shot perhaps, but that's an outcome import tariffs are supposed to produce. Second, such a trade blow would soften China on bilateral commerce and finance, and probably on a range of other issues as well. Trump's quest for balanced trade would be taken seriously — and he may even get the Chinese to expedite mega deals with his financially exhausted Farm Belt supporters. Third, to prevent market exaggerations of "trade war" chatter, the Fed would then have a good reason to come in with interest rate cuts — reminding China that Wall Street responds to the U.S. central bank and nobody else. Fourth, the ensuing new wave of dollar liquidity would be another blow to China and the rest of the large trade surplus countries. They all know it's too tough to compete with a cheap dollar. And more would follow. China would respond with credit easing of its own. The European Central Bank would do the same thing to pacify German automobile and machine tool exporters, and the Japanese businesses may no longer consider that there was no need for the Bank of Japan's new liquidity provisions. That would mean that Trump did what the G-20 and G-7 failed to do to revive the world economy. Trump, of course, would get no credit because mercantilists' opprobrium remains his lot. But he might not care because four more years at the White House could be his consolation prize. Many other people would not mind that either, if Trump got more jobs and incomes for the U.S. and the rest of the world.

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