US-China: Cold War is a real worry

The China-US trade feud is fast morphing from a “trade war” to a “face war”. The latest turn in the dispute has every appearance of a competition over who will have the last word in talking tough than which is the best approach to resolving the dispute.

This matters. Markets are all about predictability – and there is very little of that going round. The Trump administration’s doubling down on the tariffs dispute could well be a pre-negotiation tactic. But it could also be a serious threat from a president who believes trade wars are good and easy to win. China’s position, on the other hand, has been quite clear from day one. As its restrained initial US$3 billion response to the US tariffs plan signalled, it does not wish to go down the destructive path of mutual retaliation.

The decision, days later, to raise the amount to US$50 billion was widely – and we would argue wrongly – interpreted as China ratcheting up the fight. Markets tumbled. But that scary headline number tells just half the story. Domestically, Beijing is under substantial public pressure to “stand up” to the US after widespread derision of its earlier US$3 billion response. Now, by mirroring the US tariffs with its own US$50 billion retaliatory list, it is telling its own citizens and the world that it is prepared to punch back.

But there is a problem. China may be a huge market but its economy is much less robust and more vulnerable to external shocks than that of the United States. Even apart from issues such as the threat to systemic stability from debt and pressures on capital outflows, China has a much bigger exposure to trade. American exports of goods and services come to some 12% of GDP. Chinese exports account for about 19%.

A tit-for-tat response would not be the strategy of choice for Beijing. Retaliation has costs – whether it is keeping American soybeans out of China when there are few suppliers to meet its demand or dumping US Treasuries in the absence of other safe havens for its reserves. But the Chinese government cannot afford to be seen by its own people as unwilling or unable to fight back. The catch is finding that fine line between delivering a response that is acceptable domestically as well as puts enough pressure on the Americans to negotiate but, hopefully, without provoking an escalating mine-is-bigger-than-yours reaction from a very sensitive US president.

And it probably thought it had found that balance in the US$50 billion package. The headline numbers are large enough to raise cheers from the Chinese public, the industries on the list promise a big enough punch to the gut in Trump country to encourage negotiation, but with the fine print signalling that China really just wants to talk.

Soybeans, the top US agricultural export to China, are on Beijing’s list. Chinese leaders would not be unaware that Trump was supported by eight of the top 10 soybean exporting states in the 2016 election. Or that Wisconsin, the home state of Republican House Speaker Paul Ryan, is a major exporter of soybeans as well as cranberries and motorcycles, which are also on the list.

In some sectors, the list is more bark than bite. Consider three items: aircraft, beef, and wheat and corn. As explained in a Bloomberg report, "the proposed Chinese duties on US aircraft exclude all planes with an operating empty weight above 45 metric tons, a provision that looks to spare every aircraft that matters to Boeing Co". As for beef, US exports to China are minimal and resumed only last year after a 14-year ban due to fears of mad cow disease. And the new 25% duties proposed on wheat and corn are unlikely to do much additional damage to a trade that's already small given the 65% import tariffs that China already charges on those crops.

China is portraying itself as the sensible and level-headed nation willing to solve problems through negotiation. The next strategy might be to give Trump more rope – finding ways to lure the US administration into moves so unacceptable by global norms that the US will lose the support of even allies should the threatened tariffs war come about.

The truly bad news for investors – and the world – is that tensions between China and the US go beyond trade. The real issue is competition for global dominance. China has made no secret of its global ambitions – from its campaign to establish the renminbi as a reserve currency to the industrial programme “Made in China 2025” to the national drive backed by state aid to dominate global technology to the Belt and Road initiative that eyes even the Arctic.

And it has not been shy in making its military presence felt – from building islands in disputed regions in the South China Sea to challenging US warships and planes in the area to planning or actually setting up military bases that it calls logistical support facilities from Djibouti to Pakistan.
American pushback is already happening in the global race to dominate cutting edge technology, as can be seen from the US government’s intervention to block the takeover of Qualcomm.
 
Qualcomm, a leading innovator in 5G which is the next generation of wireless technology, was the target of a takeover by Broadcom. The deal was essentially blocked on fears that the takeover, albeit by a Singapore-based company, would result in giving an edge to Chinese competitors. Several acquisitions linked to Chinese buyers have been also blocked by the American authorities over the past year over similar concerns.

Trade is not a zero sum game but in the race for global dominance there is only one winner. It is not a trade war investors need worry about – it is the coming Cold War.