Will the trade war force China to fold?

There is speculation in Washington that the Trump administration will raise tariffs on US$200 billion of Chinese imports to 25 per cent from 10 per cent, upping the ante again in an ongoing trade war poker game. Washington’s raising of the stakes suggests the White House feels it’s holding a winning hand. Or is it just bluffing?

As South China Morning Post writes in an article "Will the trade war force China to fold? The US’ confidence may be misguided", Washington seems convinced that tariffs are the trade dispute equivalent of a royal flush. “Tariffs are working far better than anyone ever anticipated. China market has dropped [27 per cent] in last [four months] and they are talking to us,” Trump tweeted on Saturday, adding that “Our market is stronger than ever”. Washington’s strategy is clear. As US Commerce Secretary Wilbur Ross told the Fox Business Network on Thursday, the deployment of tariffs is intended “to try and convince the Chinese to modify their behaviour” and that the United States has “to create a situation where it’s more painful for them to continue their bad practices than it is to reform them”. That Beijing would reject the idea that China is applying “bad practices” wasn’t something Ross addressed.

Equally forthright, speaking on Friday on the same network, US National Economic Council director Larry Kudlow didn’t seem too concerned about the suggestion that Beijing could itself impose new tariffs on another US$60 billion of US goods, and argued that “China is increasingly isolated with a weak economy”.

But is US confidence misplaced? Investment research firm TS Lombard feels China is holding a strong set of cards, publishing “Trade War: Why China Won’t Surrender” on August 2. TS Lombard’s China Watch team feels that “the impact of Trump’s trade war on [China’s economic] growth will be manageable”, with Beijing having “rolled out a series of limited measures to sustain domestic growth” and with its currency policy aimed partly at “offsetting the impact of US tariffs on [Chinese] exporters”. Indeed, If Trump imposes additional tariffs on US$200 billion of imports from China, then “further yuan depreciation is likely”, TS Lombard feels.

Analysts at Citibank in Hong Kong, writing on August 2, while acknowledging that an increase in US tariffs on Chinese goods to 25 per cent from 10 per cent could negatively affect China’s gross domestic product growth, also argued that those tariffs will have negative consequences for the US. “Given China exports mostly consumer goods to the US, the US [consumer price index] inflation would likely rise, and US [multinational corporations’] profitability using China as an export platform would start to be affected as well,” the US firm wrote, estimating, “Such an impact would likely start to show more prominently leading to the US midterm election in November”. Yet Ross seemed unconcerned in last Thursday’s interview. “Twenty-five per cent on US$200 billion, if it comes to pass, is US$50 billion a year. US$50 billion on an US$18 trillion or so economy is three-tenths of 1 per cent. It’s not something that’s going to be cataclysmic,” Ross said. Admittedly, Ross’ comment makes no mention of the impact of retaliatory Chinese tariffs on US exports but his apparent calmness might be due to the fact that the US economy seems healthy.

Second-quarter US GDP grew at an annualised 4.1 per cent with Federal Reserve policy-setters last week characterising US economic activity as “rising at a strong rate”. The US unemployment rate has fallen to just 3.9 per cent and the Fed seems likely to raise interest rates again next month. Additionally, as a tweet last week showed, Trump is acutely aware that, according to the Rasmussen Daily Presidential Tracking Poll, his approval rating is currently higher than Obama’s at the same point in Obama’s first term. Meanwhile, US bank Morgan Stanley argued on August 3, “China runs an aggregate debt-to-GDP ratio of [256 per cent], suggesting balance sheet de-risking should be its priority”, which would ordinarily suggest tighter monetary policy. But, arguably due to the trade dispute, Beijing has been seeking to free up credit. Morgan Stanley’s view is that, “With debt already high, limiting its fiscal scope, China’s macro policy options seem to be running into limits should it follow [the US'] demands”.

So there would be no point in Beijing folding. In fact the potential loss of geopolitical face means neither Beijing nor Washington could just fold in this trade dispute poker game, leaving a risk that the stakes just keep getting raised. In reality, neither side holds a winning hand. Both sides should just take their cards off the table and start talking.