China trade risks: beyond steel and aluminium

An economy on a knife-edge

Markets have yet to fully price in the broader economic implications for China of a long, drawn-out trade spat with Washington. 

The risk is not of an outright trade war as such, featuring dramatic announcements of across-the-board import tariffs on each other’s goods. Rather, the real threat and arguably bigger risk for investors is downward pressure on growth from trade quarrels at a time when the Chinese economy is already on a knife-edge: runaway domestic debt, persistent capital outflow pressures, and the danger of a hard landing for the still-frothy property sector.  

Investor sentiment of late, however, has been narrowly focused. Escalating trade tensions between Washington and Beijing are seen as contained within specific industries and companies. This granular approach is cheered on by media headlines looking for the next new sector to feed investor angst.

The visit this week of a top Chinese trade delegation to Washington puts the media spotlight firmly on steel and aluminium – replacing the earlier furore over washing machines and solar panels.
US president Donald Trump is said to be thinking of slapping import taxes of 24% on steel and 10% on aluminium. 

China is the world’s largest steel exporter and accounted for about 23% of all steel exported globally in 2016. But within China, steel is a smaller story. Steel is not even among China’s top 10 exports and contributes minimally to the nation’s total overseas sales. Yet Beijing lost no time sending its top people to Washington for tariff talks.

Beyond steel and aluminium

The thing keeping China’s leaders awake at night is not just the threat of new US tariffs – however steep – on individual industries. The bigger worry is rapidly deteriorating trade relations amid signs that putting up tariffs is becoming the new normal for Washington in its response to trade differences. Then there is the nagging worry that no one would admit to... that that the Trump administration’s hardline approach might start to resonate with other trade partners, some of whom are also chafing under substantial deficits with China.

The US-China trade gap is huge. US data shows a deficit in merchandise trade with China of $375 billion in 2017, the highest level on record and accounting for more than half of the US trade gap with the rest of the world.

Of further concern to China is the recent decision by the US Commerce Department that steel and aluminium imports imperil US national security. Such a stance raises the bar on what’s negotiable and what’s off the table in trade talks.

Beijing’s recognition of the importance of its trade relationship with the United States is reflected in its decision to send a top member of the Chinese Communist Party politburo to the US for trade talks in the midst of a key Party plenum at home.

China’s Liu He, who is expected to arrive in Washington today (February 27) with a large delegation in tow, is tipped to be promoted vice-premier for industry and finance at the plenum meeting.

Trade trumps Party protocols

The timing of the Chinese delegation’s US visit is important. Party plenums are sacrosanct in China. The current three-day session in Beijing is of particular significance as it will be dealing with major policy changes that include personnel reshuffles, amending the Constitution, and fleshing out plans for the economy for the coming year so that next month’s National People’s Congress (China’s “parliament”) will have something to rubber stamp.

The absence of Liu at this crucial juncture shows how seriously China takes its trade relations with the US and how it is willing to accommodate Washington’s timetable despite potential disruption to a major Party meeting. The message to American corporations investing and operating in China is that Beijing is lobbying hard to keep their access to US markets open. The views of these firms is, of course, of considerable importance to the US Republican Party.

Arguments that China can safely retaliate against the US in a tit-for-tat exchange ignore the reality that the Chinese are not looking for mutual destruction. They are looking for business – for ways to persuade Americans to continue buying Chinese goods. We expect the Chinese team to try to shift Washington’s focus on ways other than cutting Chinese shipments to the US to narrow the trade gap, such as increased Chinese imports of American goods and further opening up of China’s financial markets, boosting demand for US financial services. And more support for Washington on North Korea’s nuclear issue would help sweeten the dialogue.

Beijing is prepared to play nice. Its no-nonsense response to threats to the nation’s economic well-being shows that for all the talk about belts and roads and the renminbi being the next global trade currency, it knows better than the number-crunchers and its own propaganda department what is really crucial to the nation’s survival: trade. 

Pauline Loong is a veteran China policy risk analyst specializing in the broader political economy. She runs Asia-analytica, a research consultancy that looks beyond the spreadsheet to identify the broader issues leading to policy change. She is a Senior Fellow of the CIMB ASEAN Research Institute.