Ok, so assuming Trump manages to refocus after spending his morning gaming out possible scenarios for a “fast and hard” fist fight with former VP Joe Biden, the President will take action against China this afternoon in what’s widely being billed as a significant escalation in global trade tensions.
This is the result of U.S. Trade Representative Robert Lighthizer’s investigation into China’s IP practices (the section 301 probe). Basically, Lighthizer can do whatever he wants if Trump gives him the green light and this is apparently going to entail slapping tariffs on $50 billion of Chinese imports covering some 100 different types of Chinese goods – everything from shoes to gadgets.
Trump is also planning on suing China at the WTO for trade law violations.
“Trump officials had earlier said that the tariffs would apply to about $30 billion in Chinese imports,” WSJ reminds you, adding that “an accompanying report on Chinese trade practices is expected to estimate that the harm to the U.S. from improper technology transfer to Chinese firms is $30 billion annually.”
As noted earlier this morning, China will invariably retaliate. That’s especially true now that Xi is “king” (as Trump would put it) for life. As Bloomberg notes on Thursday, there are multiple ways China could strike back including retaliatory measures against US crops, a crack down on tech companies that manufacture in China, replacing Boeing orders with Airbus, a move to shrink the services surplus, an effort to cut down on the number of Chinese students who attend U.S schools and, as mentioned last night, using the yuan as a weapon.
All of this has implications for NAFTA and for U.S. trade with the rest of the world, because the more aggressive Trump gets towards “Gyna“, the more worried everyone is going to be about what he might do next. In short, this is a goddamn mess.
In an effort to make some sense of things, Deutsche Bank has come up four scenarios for US protectionist policy action:
We can (probably) go ahead and rule out their baseline to the extent it assumes “the remedies pursued relating to the Section 301 investigation into China’s infringement of intellectual property rights will be relatively limited in scale.”
Ok, so the most applicable scenario to today’s news would appear to be “Trade war light (A)” and here’s what Deutsche says the Chinese response would likely be.
Trade war light, Scenario A: Limited tariff on tech imports: Under the trade war light scenario, we would expect China to retaliate, but not aggressively. The Chinese government is likely aware that trade tensions are related to the US political cycle. If the damage from trade frictions is manageable on the macro level, the Chinese government may want to avoid further escalation. The policy options could include:
- Higher tariffs on selected US exports to China: China would likely target imported products that would have significant impact on the US, and that China could afford to import less from the US. Based on these criteria, we have identified the following products: seeds and fruits (including soybeans), aircraft, pulp, nonferrous metal, wood, ores, and raw hides (Figure 8). Imports of these products amount to about $40bn. China could select from this list and retaliate by imposing “reciprocal” tariffs on imports from the US. It remains to be seen how such retaliation will play out under WTO’s rules.
- Some warning shots on US business interests in China: Many US firms already generate significant shares of their revenues from China, and their sales may not be reflected in the bilateral trade data. General Motors, for example, has a joint venture in China which supplies the Chinese market. The latest data show that while GM’s global auto sales were down by 9% in Q4 2017, its sales volume in China was up 6%. China already accounts for half of GM’s global sales as of Q4. A US- China trade war potentially puts companies like GM in a tough position. Similarly, when the diplomatic relationship between China and South Korea cooled in 2016, some Korean companies with large operations in China suffered losses in their sales revenue, suggesting that non-tariff barriers can be as damaging as tariff measures.
- Delay the process to open up the service sector, or provide preferential access to countries other than the US.
Ok, so what if China gets really pissed? Or what if, for instance, Trump gets even more aggressive?
Well then things spiral out of control as we transition to Deutsche’s “trade war heavy” scenario. Here’s what China might do under duress:
Trade war heavy scenario: The imposition of a 45% tariff on all imports from China would cause significant damage to China’s economy. In such an extreme scenario China would have to respond with drastic measures. Here are the various actions that could be taken.
- Impose higher tariffs on all US exports to China: China imported $153bn of goods from the US in 2017, based on data from China’s Customs Office. Assuming China also imposed a 45% tariff and a price elasticity of 1.2, this would lead to a drop of US$83bn of US exports to China, equivalent to 3.6% of total US exports in 2017. As China runs a large trade surplus against the US, hiking bilateral tariffs by the same percentage will cause more damage to China than to the US. Hence China may go beyond tariff measures to retaliate.
- Restrict market access for US firms in China: Similar to what we discussed under the trade war light scenario, China may set barriers and obstacles for China-based US firms. US business interests in China would suffer as a result.
- Provide preferential treatment to US competitors: China may try to strengthen its relations with the EU and other countries to offset the damage of an emerging bilateral trade war with the US. This may lead to more free trade agreements without US participation. China may also open part of its service sector to other countries rather than the US.
- Restrict US travels by Chinese nationals: Similar to what happened with South Korea, China may make it more difficult for Chinese nationals to personally travel to the US, such as for tourism or education purposes. Chinese spend $30bn per year on their US travels (including accommodations, shopping, education expenses, etc.). The impact could potentially be large, depending on the scope of such restrictions and how strictly they will be implemented.
- Sell US treasuries and buy other government bonds: China does not disclose the composition of its reserves holding. According to the IMF COFER database, the typical holding by central banks is 64% in US dollar assets, most of which US government bonds. The US TIC data shows that China holds $1.18tn of US treasuries as of December 2017.
Some of that (notably the selling of U.S. debt) has been discussed here and elsewhere at length and there are reasons to think an aggressive push to diversify reserves (a euphemism for dumping USTs) isn’t particularly palatable for China (more on that here).
But whatever the case, it’s probably safe to say that Trump doesn’t fully appreciate all of the above and I’d be willing to go out on a limb and say that Navarro is so blinded by his own bullshit that he’s incapable of objectively evaluating the possible repercussions.
So now you know the risks. Adjust your expectations for “winning” a trade war accordingly.
And remember, Larry Kudlow will save us…