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Escalate… retaliate… repeat

Here, Aninda Mitra, senior sovereign analyst, BNY Mellon Investment Management, asks the question: who wins in a US/China trade war?

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We are squarely in the midst of the “it'll get worse” before “it gets better” phase of the Sino-US trade conflict. President Trump directed the USTR to levy 10% tariffs on nearly US$200bn of imports from China, effective September 24. The statement from the President1 also sets in motion further escalation should the Chinese retaliate against US farmers or other industries.

My take on this is that we are firmly on a strategy of compellence, initiated by the US, to extract far reaching trade and IP concessions from China. But there are two tricky bits to this. First, the US itself is unsure about what is ‘maximalist’ and what is ‘realistic.’ That much was signaled by the dissonance of the views of various policymakers: with Mnuchin at the dovish end of the spectrum, and Navarro/Lighthizer on the polar opposite end. So far at least the trade-warrior and defense-hawk alliance seems to be winning out. The second tricky part is that the Chinese reaction of remaining firm, but also remaining open to negotiation is being interpreted as weakness in Washington. I’m afraid it is resulting in a perception that the Chinese are wavering and will capitulate, in a similar way as Japan did in the late 1980s, and that appears to be fueling an increasingly tough posture expressed through a “shock-soothe-repeat” cycle.

The Chinese response was guarded. The ministry of commerce announced that China would retaliate on the same day when US tariffs become effective. But the details of targeted US goods and the tariff rate have not been announced yet.  I would estimate the scale of Chinese retaliation will amount to around US$60bn of US imports but with more than a 10% tariff rate, as China begins running out tariff-able US imports. This is after it initially went toe-to-toe with the US in counter-imposing an equivalent amount of US$50bn in tariffs on US. imports. To my surprise, China’s Ministry of Commerce also did not explicitly rule out another round of negotiations. They merely said today’s actions from the US “add more uncertainty to future rounds of talks.” I would not be surprised if, in coming days and weeks, the CNY fix weakens back to around or above 7/US$ and the trade weighted index of the Renminbi falls below 92.

The first-round growth impacts on China – from 25% tariffs on US$50bn and now an additional 10% tariffs on US$200bn of Chinese imports ‑ is only around -0.2% (annualized) and the effects will start to be felt in the fourth quarter of this year. But that only refers to the first round. The second round impacts will start to get larger as partner countries, with supply-chains in China, starting to see their exports get hit and as demand slows more broadly. The countries most exposed to intermediate operations in China are Japan, Taiwan, Korea, US and Germany.

China will also bear the brunt of supply-chain diversification over the medium-term as assembly operations begin to go either back to the US, or to other countries in South-East Asia and other EMs (see chart 1.) We are already hearing of washing machine production shifting to Vietnam. Furniture could follow –increasingly to Vietnam and also to Indonesia. Samsung manufactures more hand-phones, for export, in Vietnam now than it does in China, and it is opening even larger plants in India. The Taiwanese are heightening the surveillance of unusual export patterns of intermediate goods into and processed goods out of China; they are also providing tax incentives to Taiwanese companies for re-shoring manufacturing operations back onshore.

For now I remain comfortable with my 6.2% year on year growth forecast for China for next year as it incorporates a gradual escalation of trade tensions, and the onset of some second-round impacts. But as the US tariffs have come a bit faster than expected in this year, and as China’s efforts to shore up infrastructure have been delayed the downside risks to growth in Q4 is deteriorating.

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  1. 1 Source: https://www.whitehouse.gov/briefings-statements/statement-from-the-president-4/

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