What’s Next In The US-China Trade Standoff?

Such an easy way to avoid Tariffs?

That’s a question from Donald Trump. I guess. Although it’s not even close to being grammatically correct. “Such a quick way to go to the store?” “Such a good way to cook salmon?”

But let’s give him the benefit of the doubt and call that a question. Here’s the answer, according to the president:

Make or produce your goods and products in the good old USA. It’s very simple!

Actually, that’s the opposite of simple. The world has spent decades working towards trade openness. This has led to globalized supply chains and highly interconnected markets. It cannot be undone overnight. It will not be undone overnight. This is one square peg Trump cannot pound into a round hole. It simply isn’t possible.

Trump, it would seem, is reverting back to the mentality he exhibited in 2017 and 2018. He’s slapping on more tariffs, ignoring the likely ramifications, summarily dismissing desperate pleas from those who’ll be adversely affected and demanding the impossible.

Consider what the Association of Equipment Manufacturers said in a statement out Thursday:

Right now, farmers, workers, business owners, and families alike–all across the nation–are being hurt by tariffs. These tariffs are taxes on Americans, and they have already caused enormous pain. But now, the Trump Administration wants to raise them even further.

Yesterday, President Trump announced that he will increase certain tariffs from 10 percent to 25 percent on $200 billion of goods, and plans to introduce another 25 percent tariff on another $350 billion of goods in the coming months.

Make no mistake. We agree with the President that we need trade deals that are both free and fair. But doubling down on taxing Americans as a negotiating tactic only makes a bad situation worse.

These tariffs will hurt American families that are just trying to get by, like the soybean farmer who can’t plant crops this year because there is no way to make a profit on account of retaliatory tariffs, the manufacturing worker laid off among 2.16 million other jobs lost as a result of the combined tariffs, or the family struggling to make ends meet because tariffs have cost them an additional $2,300 per year.

This is, simply put, a disaster. There is no ambiguity here. Trump is lying about the effects of the trade war on the US economy, he is mischaracterizing tariffs as free money “pouring into our Treasury” and he is on the verge of pushing things over the edge and into the abyss by slapping duties on the remainder of Chinese imports.

On Monday, the USTR will publish details of prospective levies on some $300 billion in additional Chinese goods. The administration will reportedly move ahead with those tariffs if there’s no deal within a month. At that juncture, Trump will have made good on his long-standing threat to go “all-in” on China.

“The fact that the White House has increased the tariff rate suggests that the probability has risen that tariffs will increase on the remaining roughly $300 billion in imports from China that the US has not yet targeted”, Goldman warns, adding that while the bank still “believes the White House is not that likely to implement the next round of tariffs (30% probability), the risk has risen somewhat now that this latest round of tariffs has at least technically taken effect.”

Make no mistake, everyone knows this is a bad idea. Republicans, Democrats, Independents, manufacturers, farmers, Wall Street, rich people, poor people – everyone. Nothing good will come of this. Have a look at what’s in the cross-hairs thanks to the latest escalation:

(Barclays)

Next up would be cellphones, laptops, toys, video game consoles, small flatscreen TVs, USB drives, printers, and on and on.

Although it was Beijing’s move to strike language regarding changes to Chinese law that sparked the latest row, China is said to be making a series of additional requests that all sound entirely reasonable. For instance, Beijing notes that expectations for Chinese purchases of US goods should be “in line with reality”. Additionally, China says the US should remove tariffs imposed since this whole spat began. That’s according to Xinhua, out Saturday.

“China might feel that time is now on its side, with the US approaching the 2020 presidential election cycle”, Barclays wrote Friday, adding that “there may be a calculation that the cost for President Trump not being able to close the deal, or instead escalating the tariff war, is higher now given its negative impact on growth and markets [and] this could also be one reason China may have tried to renegotiate what may have been agreed earlier.”

It’s also likely that China believes the myriad targeted stimulus measures deployed over the past six or so months are starting to work and will continue to produce better economic outcomes going forward.

That could be a miscalculation, though. Here’s SocGen’s quick take on the implications for China:

China assets, naturally, are the most vulnerable as: (i) last year the decline in equity markets accelerated after the US Administration announced its decision to implement tariffs on an initial tranche of $50bn worth of Chinese products (June 15); (ii) the drag on growth could amount to 1pp of GDP (if the US raises tariffs to 25% on all Chinese products imported to the US); (iii) a likely CNY depreciation would exacerbate negative sentiment on equities. But this time we would expect a gentler decline than in 2018. The only comfort for equity investors is likely to be increased policy easing. After all, China shares have only just started to recover.

One thing that still isn’t clear is what China plans to do next. Obviously, Beijing can’t simply stand down and let Trump run roughshod over the whole process. That would mean the optics around any eventual deal would be bad for President Xi – domestically, it would appear that he not only folded to US demands, but sat idly by as Trump added insult to injury during the final stretch of negotiations.

China, of course, has myriad weapons in the armory, including two financial nukes (a shock devaluation and/or a mass liquidation of US Treasurys). There are all kinds of reasons to believe Beijing wouldn’t risk going “nuclear”, including the fact that a steep devaluation would risk capital flight while dumping US Treasurys en masse would not only be counterproductive, but also risk kicking off a global meltdown.

But Beijing has a bevy of less drastic measures at their disposal too. As you ponder what’s next, we’ll leave you with a list of potential retaliatory measures as delineated by Barclays on Friday:

Tariff retaliation. China could: 1) increase the current 25% tariffs on USD50bn of US imports, and/or 5-10% tariffs on USD60bn of US imports; and 2) impose new tariffs on more US goods currently untaxed. However, the room for expansion in tariff coverage could be limited, given China already imposes tariffs on USD110bn while it imported a total USD155bn from the US in 2018 (the total for 2019 could be even smaller with the imports from the US contracting by more than -25% y/y in Jan-Apr).

Non-tariff retaliation. China is also likely to respond with some non-tariff retaliations at a company or industry level, including, eg, intensifying shipping inspections and prolonging custom checks, applying greater scrutiny to operations of US companies in China, and tightening regulatory discretion of investment by US companies.

Other supportive actions: Stepping up policies to support innovation and high-tech sectors. The State Council meeting this week (8 May) urged relevant ministries to roll out more supportive policies to promote integrated circuit (IC) and software industries, including extending the preferential corporate tax treatment for such companies.

Another RRR cut in the near term is less likely. Following President Trump’s Sunday tweets, on 6 May the PBoC announced a cut of the reserve requirement ratio to 8% for mid- and small- sized banks. Looking ahead, after the broad-based moderation in the incoming April data (PMI, exports, and credit), upcoming activity data, to be released on 15 may will likely show more softness. In particular, we forecast IP growth to fall markedly to 6.5% y/y from 8.5% y/y. That said, barring a significant fall in the equity market or significantly negative news from the trade talks, we think the PBoC is likely to keep the RRR on hold in the near term.