The Real Trade War Is with China

Art by James Yang

When President Donald Trump imposed trade sanctions on imported steel and aluminum March 1, the tariffs applied worldwide and didn’t seem to be particularly aimed at China. Just wait.

China is the largest importer to the US ($505 billion in 2017) and runs the largest trade deficit with America ($375 billion). And it has regularly been Trump’s chief villain when he inveighs against unfair trade practices. The trade deficit with China has expanded almost five-fold in the 21st century.

Some economic observers even believe the 25% US tariff on steel and the 10% levy on aluminum will eventually be rolled back for most countries, and Trump’s focus will shift solely to Beijing. As Wall Street Journal columnist Holman Jenkins put it, “that will leave the tariffs only applied to China.”

So does this mean the US on the brink of a ruinous trade conflict with China, the world’s second largest economy and America’s biggest trading partner? Wall Street sure hopes not, and all last year took heart that Trump’s actions didn’t match his campaign rhetoric. Now, though, protectionism is back on the White House agenda and China, the world’s largest exporter, bar none, tops the hit list. 

“You have to ask how far this is going to go,” said Frank Rybinski, chief macro strategist at Aegon Asset Management. During Trump’s first year in office, Rybinski pointed out, a lovefest prevailed between Beijing and Washington: “Everyone was playing nice, but now you wonder whether the tit-for-tat of small items will snowball.”

China ships to the US almost three times what the US sends China, the US Census Bureau reported, and that shows no sign of abating. When the trade gap last year grew to a record $375 billion, from $347 billion in 2016, it did so on the strength of numerous high-end products.  The biggest Chinese exports to American shores are cell phones ($70 billion in 2017), computers ($45 billion), and telecom equipment ($33 billion), census data show. The leading US exports to China: transportation, mainly planes ($30 billion), computers and electronics goods ($17 billion), and agricultural products ($16 billion), the International Trade Administration finds.

There are three possible scenarios on how the Chinese-American trade tiff can play out, ranging from dire to merely troublesome. No one thinks that the dispute will fade away, because this is a big deal among Trump supporters and a key issue that helped him get elected.

While other trade flash points exist – the testy re-negotiation over the North American Free Trade Agreement, with Mexico and Canada, is a prime example – all else pales before the China question. Looming ahead is a likely US crackdown on China for stealing American trade secrets, which could make squabbles over tariffs look tame. In February, Trump said that the Chinese have “been killing us on trade for the last long period of time.”

Meanwhile, the US has been venting its grievances to the Chinese about a host of topics. The Trump administration has demanded that China allow more access to its domestic financial services industry, which the Chinese regime seems loath to grant. When China’s leading economics official, Liu He, visited Washington in early March, Trump conspicuously didn’t meet with him. Most significantly, Trump has just promoted aide Peter Navarro, who wrote a book called “Death by China,” a move that signals the White House’s more confrontational approach lately, especially toward the Chinese.

The evolution of Trump’s stances regarding China trade is instructive: On the 2016 campaign trail, this enormous nation was Donald Trump’s bete noir – a malicious force bent on shrinking American manufacturing and evaporating US factory jobs with unfair low prices supported by Beijing’s subsidies and other subterfuges. But throughout much of 2017, President Trump was restrained on his anti-China talk and actions, as he sought to enlist Beijing in containing North Korea’s nuclear ambitions.

Then things changed. Some speculate that Trump realized China’s President Xi Jinping couldn’t or wouldn’t help him with North Korea, and pivoted back to protectionism.

In late January, his administration slapped 30% tariffs on imported solar panels and washing machines, sanctions that were mainly directed at China. Still, the punishment was not that major and the stock market didn’t react with alarm, and even nudged up a bit. (Stocks later began their 10% winter correction, although that had more to do with leeriness over higher interest rates, unrelated to trade.)

A few days after the tariff move, Trump issued a warning at the World Economic Forum in Davos, Switzerland, that the US “would no longer turn a blind eye to unfair economic practices.” While he didn’t mention China by name, it was clear who he meant when he decried “massive intellectual property theft, industrial subsidies and pervasive and state-led economic planning.”

The president’s early-March restrictions on steel and aluminum, which covered all nations importing the metals into the US, raised the most squawking from close allies. China, although the world’s largest steel maker,  is a minor steel provider for the American market these days, making up just under 2% of imports. And it is only the fourth largest aluminum supplier to the US.

Now the White House is eyeing potential Chinese violation of US intellectual property rights. Recently, Trump told Reuters he was looking at a “very big intellectual property fine,” which “is going to come out soon.”

Beijing’s reaction to all this has been restrained, yet it’s widely thought that the Chinese regime will fight back, and hard. “China hopes the U.S. will exercise restraint in using trade restrictions,” the Chinese Commerce Ministry said in a statement, adding that it will “resolutely defend its legitimate interests.”

So what could happen? Three scenarios:

Full-scale trade war. This is many people’s nightmare, a battle royal between the two largest economies, which could spread to others. The template is the aftermath of the Smoot-Hawley Tariff Act of 1930, which radically hiked duties on more than 20,000 imported goods from abroad. The cataclysmic result was a rash of retaliatory tariffs from other nations against American wares, and a halving of US imports and exports.

In a 1995 survey appearing in the Journal of Economic History, the consensus of economists was that Smoot-Hawley, named after the two lawmakers who pushed it through Congress, made the Great Depression worse. Unemployment when the law passed was 8% and two years later was 25%.

How likely is a reprise of Smoot-Hawley today? Not very, because the international business environment is much more entwined than it was in the 1930s. As a Barclays research note put it: “a full-blown trade war is unlikely given the high economic stakes involved.”

While a barrage of higher tariffs could disrupt the global supply chain, Trump’s sanctions thus far have fallen far short of making the Chinese leader, Xi, feel much pain. Trump has targeted only minor players  in China’s US  export portfolio.

Tackling intellectual property thievery would up the ante considerably – this theft costs the American economy up to $600 billion annually, a government study commission finds. The severity of the challenge, however, depends upon how broad-ranging any US penalties turns out to be. Would Washington seek revenge for filched trade secrets for aviation, pharma, and chemicals, or just copied clothing designs?

If the animosities grew very serious, China could go after a menu of America’s bigger trading goods: by axing imports of Boeing aircraft, restricting sales of Apple phones and computers, plus zapping imports of American soybeans and other food products.

Tit-for-tat. Short of a massive global trade war, unwelcome havoc could ensue from an eye-for-an-eye fray, where one US action is met with an equivalent Chinese response. There is, alas, no clean way to conduct a trade retaliation skirmish. Collateral damage occurs, even when the products in question aren’t sizable parts of the US or Chinese economies. China in the past has shown that it will strike back whenever the US knocks it with a tariff.

In 2009, President Barack Obama imposed a 35% duty on imported Chinese tires, which saved domestic tire maker jobs, but ended up costing the US. According to a study by the Peterson Institute for International Economics, tire prices surged 25% for American consumers due to product shortages. And in reprisal, China placed high tariffs on imported US chicken parts, costing American poultry producers $1 billion in sales.

More words than action. The entire controversy may end up as little more than theater. One factor that could mute the fall-out from a small-scale Sino-American contretemps: Much of the globe is enjoying robust economic growth. “If global economies were weakening, it’d be a different story,” said Ryan Detrick, senior market strategist at LPL Financial. Such was the case during the dark days of Smoot-Hawley – the world’s financial structures amid the Depression were too rickety to withstand the trade crossfire.

That’s not to say a handful of US actions and Chinese counter-actions would have zero effect on global commerce, or on specific industries and their stock. But the impact probably would be limited.

Right now, Chinese officials are considering a reprisal action against American sorghum, which is used for animal feed. The value of sorghum imported to China last year was around $1 billion, Reuters reported. Still, sorghum is a minor part of the $16 billion in US agricultural products that China receives.

The loss of their Chinese sorghum market would harm some American farmers, albeit not as much as sanctions on soybeans, whose shipments to China are three times the sorghum volume.

How everything shakes out, of course, rests on what Trump wants to do. Trade, while often discussed lately, is not a hot-button topic in the US, on the order of guns or immigration. The US steel-aluminum tariffs sent the market down a bit, though it was hardly a rout. Still, the over-riding reality is that trade is of enormous importance to the man in the Oval Office and his adherents.