The latest round of US and China tariffs, about $50 billion imposed on July 6, will have only a muted overall economic impact on both countries. However, the tariffs signal that the risks of a full-blown trade war have increased markedly. The global impacts of such a move could have serious implications for global GDP growth, as the International Monetary Fund has estimated it could shave half of a percentage point off the global GDP growth rate.
However, it is still unclear whether China will punch back aggressively given its potentially larger economic impact from a trade war loss or will seek to placate the United States by meeting its demands. Over the long term, though, we expect China to engage in a more extensive and drawn-out series of retaliatory measures against the United States.
At a high level, we think addressing China's long-standing theft of intellectual property, among other items, is needed, and the US is correct to pursue this. We'd prefer to see the confrontation done as part of a coalition of countries, which we think has a greater chance of success. The current path of angering long-time allies while engaging with China on trade strikes us as not ideal and provides an opportunity for China to pressure the United States from multiple sides.
While an all-out trade war would certainly diminish the long-term spending power and welfare of US consumers, the economy's stability would likely be left intact. On the other hand, we think a trade war could be disastrous for China, given its dependence on its trade surplus as a source of economic aggregated demand. In the past, most notably, post-2008, China has been able to boost debt-fuelled investment expenditure to replace flagging trade as a source of demand, but we think China's swelling debt burden now rules out this option.
As such, a trade war could send China's economic growth into the low-single digits – likely a politically unpalatable option in a country accustomed to much higher levels. For example, the recent reserve ratio requirement cut doesn't expand the amount of productive investments available in China, which would be required to offset any negative trade war impacts. Yet, it isn't clear whether Chinese leadership agrees with our assessment that China has more to lose economically.
Perhaps more important, leadership may see its advantage in political authority as enabling it to weather any disadvantage in short-term economic impact. China's strongest tool in its favour at this point is Xi's tight control over the country, meaning, the odds of any political backlash from any decisions are extremely low, whereas Trump's actions will be scrutinised thoroughly.
Unfortunately, looking ahead to the midterm elections coming up, Trump's popularity with his core base has yet to fracture, suggesting he can continue to escalate and provoke China.
The question now arises if China will pursue the next logical step: punitive measures against US firms operating in China, which can include boycotts and denial of regulatory approvals. Other options on the table are restricting travel to the US for educational/tourism purposes, letting the renminbi depreciate to aid Chinese exporters, and potentially shifting Boeing airplane orders to Airbus.
However, Chinese operations are a major profit driver for leading US multinational corporations—from cars to coffee shops. Any hit to these companies would undoubtedly show up in share prices, gaining US shareholders' attention in short order.
With the US now discussing imposing tariffs on all Chinese imports of $505 billion, far surpassing China's ability to reciprocate in terms of goods tariffs, China's imports of US goods were just $155 billion in 2017, this measure, which includes delaying or denying regulatory licenses and contract awards, would be the most logical next step for China.
The key remaining question is how China can meet US demands adequately, and we don't think it can, suggesting that China might continue to pursue not only measured responses to the United States in the short run, but also more extensive and drawn-out measures over the long run.
The Trump administration's one stated goal of a $200 billion reduction in the US-China bilateral trade surplus is very unlikely to be met, in our view. Oil and gas, or LNG, imports are unlikely to account for more than $90 billion−$120 billion in incremental Chinese imports, even after several years of US export growth, in our view.
Other categories of imports likely have much less flexibility. A successful resolution of US qualms about intellectual property issues is a more ambiguous issue, although there is probably enough flexibility to provide a face-saving compromise for both parties.
