Managing Director, Asia-analytica
The possibility of a China-US trade war is sucking up the oxygen in financial markets. But before we all hyperventilate at the thought of a global trade conflagration wiping $470 billion off the world economy within two years, let us look at the bigger picture.
Relations between the US and China have never been warm and fuzzy when it comes to trade. Arguably, the two have been squabbling over the widening bilateral trade gap since China’s exports took off on joining the World Trade Organization 16 years ago.
The Trump Administration’s $50 billion tariff plan announced earlier this week should be seen in the context of an increasingly confrontational relationship with China that has been building up for many years. The current administration is stepping up the pressure and threatening to push the relationship to the brink.
But an all-out trade war, which we define as across-the-board tariffs and quota restrictions aimed at damaging the other country’s trade position, is still some way off.
For a start, it take two to fight. Note that China countered Trump’s $50 billion tariffs threat on Chinese goods with its own $3 billion tariffs on American goods. That is correct: $3 billion, not $30 billion.
That is a clear message from China that it has no wish to escalate tensions. A message that it is looking to do business not to fight. And that it has no wish to race towards mutual destruction.
The $3 billion could well be just the start. China may raise the stakes in the coming days with further tariff announcements depending on the response of Washington and American industries to its current move.
But any decisions to impose new tariffs will be based on hard-headed considerations. Proposals will be judged for their effectiveness in persuading the Trump administration to return to the negotiating table against the not-unlikely risk of provoking a my-stick-is-bigger-than-your-stick response. China wants to get markets, not to get even.
Arguments pointing to the many ways in which China can punch back at the US miss the point. China is grown up. Just because it can doesn’t mean it will. It has no interest in chest-thumping (unless it works).
The so-called nuclear option – China dumping its holdings of US Treasuries – assume that revenge is an overriding motivation in Chinese policymaking.
Massive dumping of US Treasuries would certainly hurt the US but it is just as likely to decimate the value of China’s foreign exchange reserves with bond prices and the greenback doubtless going into freefall from such a massive sale. And this is without even considering the logistics of offloading more than US$1 trillion in US government paper onto the market in one fell swoop.
More to a fight than just tariffs
Acting as a brake against a rapid descent into a bare-knuckles confrontation between the world’s two biggest economies are three important forces: the globalisation of supply chains, pushback from other players, and China’s pragmatic response.
Companies everywhere are going global on both the supply and demand sides of their businesses. Supply chains are now closely interconnected, with different countries involved in different stages of production. China’s manufacturing and assembly base is fed components, sub-components and materials by a global network with several tiers of production taking place outside China.
And for many American companies, Chinese producers are themselves embedded in their supply chains – ask Apple. From inbound logistics and manufacturing through outbound logistics and marketing, the tech giant’s entire value chain goes through China in one way or another.
Retaliatory trade tariffs have a ripple effect that would leave few players unaffected. And aggrieved countries are not going to sit back and wait as tit-for-tat tariffs put companies out of business and people out of jobs.
Not just China
Grabbing headlines is the Trump Administration’s announcement of $50 billion tariffs on Chinese imports and China’s $3 billion response.
But the US is not just going after China. The Trump Administration has so far been acting as if it is quite comfortable going after friends as well foes to redress trade imbalances – given the recent volleys of protectionist tariffs on solar panels, aluminium, steel, and other products and the US President’s stance that trade wars are good and easy to win.
Retaliation from China is one thing. But a backlash from the rest of the world – American allies in particular – would likely trigger widespread domestic opposition from industries hurt by the move and from national security advisors worried about seriously alienating strategic allies.
This is already happening. The Trump administration has now backed away from its “no exceptions” stance to the steel and aluminium tariffs of 25% and 10% announced earlier this month. As at time of writing, it has given Canada and Mexico a provisional exemption from the steel and aluminium penalties set to clobber the rest of the world.
And then there is China. As I said earlier, it is looking for export markets not for a showdown.
Beijing is under no illusion that the bilateral trade gap is a major political irritant in its relations with the US. Chinese data (which exclude Hong Kong) showed the 2017 US-China trade gap ballooning to a record high of Rmb 1.87 trillion ($286 billion at end-2017 exchange rates) in China’s favour. By US reckoning, the trade deficit with China hit a record high of $375 billion last year.
Beijing is aware of the political dimension to the aggressive $50 billion move by the Trump Administration on tariffs. One line of thinking in China is that the trade war posture is a way for Trump to distract the nation from his domestic political problems. Another line of thinking is that targeting industries in Trump country might exert political pressure on the US president to tread more carefully on trade, as I argued in a previous post.
I also argued that Beijing’s likely response is to try to shift the negotiating focus to increasing Chinese imports of American goods rather than cutting Chinese shipments to the US, and that it is likely to further open up its financial markets. This last move would have the added bonus of sweetening an important lobby in the US: the financial institutions that have waiting for years to break into the potentially lucrative Chinese domestic market.
Chinese Premier Li dropped hints much along those lines in a media address earlier this week.
He said China still has much room for further opening up of its market and will lower overall tariffs on imports. Tariffs on popular consumer goods such as drugs will be slashed and zero tariffs might be phased in for anti-cancer drugs.
More importantly, he dangled hopes of improved market access to the services sector, such as in financial services, medical services and education. He spoke of gradually relaxing and even scrapping foreign-owned equity limits in some sectors and shortening the no-go list for foreign investment. Furthermore, compulsory technology transfers will not be imposed on foreign investment in the general manufacturing sector and intellectual property rights will be protected.
These are the words of a premier who sees no profit in playing tit-for-tat.