How China could compel the US to agree to a trade deal
Trade wars are neither “good” nor are they “easy to win.” The tit-for-tat trade spat between the world’s top two economies (with a combined GDP of nearly $32 trillion) escalated even further this week after Washington alleged that China backtracked on previous commitments.
As a result, the US raised tariffs on some $200 billion of Chinese imports from 10 percent to 25 percent. Beijing retaliated by upping tariffs on $60 billion of US goods from 5 percent to 25 percent. For the rest of the world, “cautious optimism” is the sentiment du jour.
Economists expect the trade war to get worse before it gets better amid a pervasive belief that both nations will not risk short-circuiting the global economy.
It is unclear whether each country will withdraw the latest tariff hikes and return to the negotiating table, but what is clear is that this protracted tariff war is self-destructive, unnecessary and potentially damaging for the rest of the world.
At the heart of the dispute is China’s refusal to accept US demands that everything Beijing agrees to in the trade negotiations must be included in the final text of the agreement.
Washington is seeking to end Beijing’s subsidies to local industries and state-owned enterprises because they violate international trade agreements. Unfortunately, this demand is tantamount to committing economic suicide, since the Chinese economic model is dependent on the central government making various forms of state assistance available to local industry.
Beijing would sooner accept more tariffs than give in to Washington’s demands and severely undermine the centralized control of China’s economy. Besides, China will not abandon an economic program that saw real wages and GDP grow faster than in the US over the past 25 years.
The Trump administration initially imposed tariffs because of Chinese intellectual property rights violations and compulsion of foreign entities into joint ventures – tools for forced technology transfers.
A Chinese state-owned chipmaker, Fujian Jinhua, is battling in a US court allegations of stealing trade secrets from American semiconductor company Micron Technologies. Fujian Jinhua is particularly interesting because it is one of the companies that will likely benefit from the “Made in China 2025” industrial policy aimed at rapidly developing the country’s high-tech and advanced manufacturing sectors to compete – and eventually surpass –Western rivals.
China has made it a national priority to locally manufacture some $200 billion worth of semiconductor memory chips that it imports. The US government has since targeted some of the goods associated with the initiative with tariffs in order to force Beijing to scuttle the program entirely.
Despite experts warning that further escalations could potentially damage both economies, China still insists that Washington agrees to its terms. Beijing wants the US to remove all extra tariffs, set targets for Chinese purchases of goods in line with real demand and ensure that the text in an eventual agreement is “balanced.”
China, like the rest of the world, is aware that if the US economy slowed down substantially, President Donald Trump will likely change his tune and seek to quickly end this trade war, if only to save a re-election bid.
There are several ways in which China could compel Washington to agree to a deal.
First, although China only has an additional $10 billion worth of goods left to potentially levy new tariffs on (compared to America’s $300 billion), Beijing could target the $40.5 billion services trade surplus. Other non-tariff barriers exist, such as thumbing the scales in favor of other global companies like Europe’s Airbus for purchases of commercial aircraft, at the expense of Boeing.
Second, Beijing could devalue the yuan in order to make Chinese goods cheaper. Unfortunately, that could lead to a potential capital flight and so far, Chinese leadership has remained unwilling to use currency manipulation as a weapon in this particular trade war.
And thirdly, there is growing debate over whether China could dump its $1.13 trillion of US treasury bills. If that happened, it could lead to a surge in interest rates that could substantially damage the US economy in the short term.
However, this move would be self-destructive to Chinese interests as well, beyond a sharp decrease in the size of its portfolio. Additionally, China must maintain large reserves of US debt in order to manage the yuan. Dumping US treasury bills would only lead to a sharp appreciation of the yuan, making Chinese exports more expensive.
China is likely betting on this trade war ending at the behest of domestic politics. At home, Washington is framed as a bully, out to undermine Chinese sovereignty, while the central government stands as a bulwark against this encroachment. In fact, sanctions targeting ZTE and Huawei, along with increased US Navy patrols in the South China Sea, are construed to fit that narrative, whipping up nationalist fervor that Beijing can utilize to drive hard bargains at the negotiating table.
Meanwhile in America, the Trump administration must answer for a 30 percent drop in agricultural exports to China that has led to a 43 percent jump in farm bankruptcy claims across the midwest. In Wisconsin, for instance, more than 1,000 dairy farms have stopped milking since 2016 and more than 200 will shut down permanently this year.
Elsewhere, Ford Motor Company reported $1 billion less in profit last year and is planning mass layoffs in the wake of a 25 percent tariff on steel and 10 percent on aluminum. For the average American, this trade war is likely to cost $2,300 every year. For the government, 1 percent will be slashed from GDP while 1 million Americans are likely to end up unemployed.
China plans to worsen this by specifically targeting goods from states with vulnerable senators facing re-election as an indirect way to force Congress to intervene and pressure the White House to end the tariff war.
China, like the rest of the world, is aware that if the US economy slowed down substantially, Trump would likely change his tune and seek to quickly end this trade war, if only to save a re-election bid.
Presently, however, Trump remains his own worst enemy. Several tweets critical of US Federal Reserve Chairman Jerome Powell’s unwillingness to ease interest rates have inadvertently provided ammo to Beijing. To them, these tweets indicate that the US economy’s fundamentals are not as strong as the president and US trade negotiators purport. If the US economy was growing, there would be no need for the independent Federal Reserve to dispense with tradition and acquiesce to White House demands.
It appears China still has a variety of tools in its arsenal to dig in and wait things out. It is unclear, which will come first: Washington backing down, a new administration or for its own initiatives to offer viable alternatives beyond the US.
Hafed Al-Ghwell is a non-resident senior fellow with the Foreign Policy Institute at the John Hopkins University School of Advance International Studies. He is also senior adviser at the international economic consultancy Maxwell Stamp and at the geopolitical risk advisory firm Oxford Analytica, a member of the Strategic Advisory Solutions International Group in Washington DC and a former adviser to the board of the World Bank Group. Twitter: @HafedAlGhwell