The US – China trade war

“The Thucydidean dynamic tells you the slope of the relationship – it gets worse before it is worsening. “

-Graham Allison

The escalating trade war between the US and China has dominated headlines, dragged markets down and aroused fears of a full-scale global trade war as both countries responded to new tariffs with tit-for-tat measures. While US President Donald Trump claimed recently on Twitter that trade wars are “good” and “easy to win” — history paints a very different picture. 

This ongoing dispute in 2018 is America’s third trade war on China. In the aftermath of WWII, in emerging of Cold War and due to the rise of communism in China, the US orchestrated embargos and sanctions 1949-1971 and again due to Tiananmen events 1989-1992. In spite of all kind punitive measures, China managed to keep its economy growing nearly debt-free and later since 1990 became as one of world great powers.

The timeline of US-China recent trade war briefly:

  • Before the running for president, Trump has criticized many times China’s trade practices.
  • While campaigning for the Republican Party’s presidential nomination in 2017 and then running for President, Trump made numerous critical statements on China’s suspicious trade practices.
  • Soon after beginning his presidency, in early 2017, Trump authorized US Treasury to investigate imports of steel/aluminium, agriculture products, energy and other products, as well as policies and practices of technology and intellectual property.
  • In February 2018 the first punitive tariffs were imposed and the tit-for- tat- type retaliatory spiral spun off.
  • Tariff situation in the beginning of December 2018:
    • Total US tariffs applied exclusively to China: US$250 billion
    • Total Chinese tariffs applied exclusively to US: US$110 billion
  • The US and China agreed to a temporary truce to de-escalate trade tensions, in the separate meeting in the sidelines of the G20 Summit in Buenos Aires on December 1, 2018. According to the agreement, both the US and China will refrain from increasing tariffs or imposing new tariffs for 90 days (until March 1, 2019), as the two sides work towards a larger trade deal.
  • However, just a few days afterwards became a new case of extra tension when Canada announced of arrest of Huawei’s CFO, on the request of the US. The case seems to be escalating as more foreign persons have been put in detention in China, obviously as a counter-measure and other similar events have taken place
  • the US trade deficit with China surged to $ 323 billion in 2018, despite higher tariffs

China vowed powerful retaliation against US tariffs from the very beginning of this trade dispute and realized tit-for-tat measures so far.

The statement came within minutes after the US announced first time that it would impose a 25 percent duty on Chinese goods worth $50 billion. ‍“China will launch an immediate, powerful response to US tariffs on billions of dollars’ worth of Chinese goods, threatening to target US goods on the same scale and intensity”, a spokesperson for the Chinese Ministry of Commerce (MOFCOM) said.

The swift and harsh statement from the Chinese government showed that “US President Donald Trump has picked a wrong country for a trade war”, said Mei Xinyu, a research fellow at the Chinese Academy of International Trade and Economic Cooperation.  “Trump’s childish tactics might work with some smaller countries, but it would definitely not work with China,” Mei explained, adding that “China has both the will and power to fight back.”

Economically, both the United States and China would lose from a trade war. Punitive tariffs would push up import prices, decrease exports, cost jobs and curb economic growth so both sides should do best to avoid an outbreak of hostilities.

Headline statistics greatly overstate China’s economic vulnerability and understate America’s. Focusing on trade in goods, as most observers do, US imports from China last year totaled $506 billion, nearly four times its exports in the other direction ($131 billion). But the United States also sold $38 billion more in services to China than it bought in return, its biggest bilateral surplus. US goods exports to China are mostly agricultural produce and finished products consisting of mostly American content and sold by US firms, China’s exports to the United States are typically Chinese-assembled goods that contain many foreign parts and components and are often American-branded.

Tit-for-tat measures

One third of US imports consist of parts and components on which US-based manufacturers rely. So, the Chinese value added of its exports to the US is perhaps $330 billion — some 2.7 percent of China’s $12 trillion economy. Because so many US firms outsource production to China, they are acutely vulnerable to various Chinese tricks, such as halting production for a while on spurious regulatory grounds. The threat is not just to American-branded products but also to US-based manufacturers that rely on Chinese parts and components, by disrupting the supply chains of US manufacturers.

In contrast, China’s potential retaliation is much better targeted. First in line is $16 billion of US civilian aircraft exports, threatening especially Boeing. Second in line is $12.8 billion of US soybean exports. China accounts for more than half of American soybean exports, giving it market power. Indeed, as talk of a trade war heated up, the hit to US farmers was immediate: Soybean prices plunged. Here too China has an alternative supplier, Brazil.

In addition, China’s direct investments in America totaled just $ 1,8 billion in January-May 2018 representing a 92% drop against the same period a year ago. That is the lowest level of investment by China for years.

China also has much more scope to mitigate any economic damage than the Trump administration does. Unlike the US Federal Reserve, China’s Central Bank is not independent, so the People’s Bank of China can be ordered to cut interest rates to boost domestic demand if necessary. State-owned banks can likewise be told to extend more credit.

The Chinese government can absorb the political costs of a trade war much more easily than the Trump administration can. Every time Trump lashes out at China, US stock market plunge. That is particularly problematic for a president who treats the Dow Jones industrial average as his personal approval rating, especially because the single biggest constituent of the Dow is Boeing.

The real “nuclear options” available for the use of Chinese government are the following:

  • A currency depreciation, a sharp one-time yuan devaluation
  • Sales of US Treasuries, China being the second-biggest foreign holder of treasury bonds could sell some of its $ 1,2 trillion portfolio leading to sharp increase of interest rates in the US
  • Block US services, China could limit access for US companies to Chinese domestic markets
  • Curb US oil shipments, China could set counter-tariffs to US crude oil making heavy losses to US oil companies
  • Curb exports of rare earth elements to the US, China has the overwhelming position of producer and importer of rare earth elements in the world.

China published a white paper on September 24, 2018, to clarify the facts about China-US economic and trade relations, demonstrate its stance on trade friction with the United States and pursue reasonable solutions.

According to the white paper:

“China is the world’s biggest developing country and the United States is the biggest developed country. Trade and economic relations between China and the United States are of great significance for the two countries as well as for the stability and development of the world economy.”

The white paper said the two countries are at different stages of development and have different economic systems and therefore some level of trade friction is only natural. The key lies in how to enhance mutual trust, promote cooperation, and manage differences. The administration of the US government has trumpeted “America First” since taking office in 2017 and has abandoned the fundamental norms of mutual respect and equal consultation that guide international relations.

The hidden background of trade war: 

The real reason behind the US-China “trade war” has little to do with actual trade or trade deficit but very much with the strategic industrial politics.

What is really at the basis of the ongoing “civilizational conflict” between the US and China, are China’s ambitions to be a leader in next-generation technology, such as digitalization and artificial intelligence, which rest on whether or not it can design and manufacture cutting-edge chips and is why President Xi has pledged at least $150 billion to build up the sector in China. China’s “Made in China 2025” program and “AI-plan 2030” have awoken fears among American decision makers.