Of late there has been tension brewing between the USA & China as they have been imposing tariffs & counter tariffs on imports from one another. But the real question is whether this trade war between the two countries will continue or will die a natural death.
The US trade deficit with China was $375 bn in 2017. The trade deficit exists because US exports to China were only $130 bn while imports from China were $506 bn. This is because China can produce many consumer goods for lower costs than other countries can. Americans of course want these goods for the lowest prices. China manages to keep prices low due to its large population & lower standard of living, which allows companies in China to pay lower wages to workers. In addition Yuan being partially fixed to the dollar also helps. That means many American companies can’t compete with China’s low costs.
If the US implements trade protectionism, US consumers would have to pay high prices for their “Made in America” goods. That’s why it’s unlikely that the trade deficit will change. China is the world’s largest economy. It also has the world’s biggest population. That means it must divide its production between almost 1.4 bn residents. Thus a trade war will be a lose –lose situation for both the countries.
China sets the value of its currency, the Yuan, to equal the value of a basket of currencies that includes the dollar. In other words, China pegs its currency to the dollar using a modified fixed exchange rate. When the dollar loses value, China buys dollars through US treasury to support it & is the largest lender to the US government. By buying US bonds China helped keep US interest rates low. That in turn helps fuel the US demand. If China were to stop buying, interest rates would rise.
What is happening currently?
President Donald Trump had promised to lower the trade deficit with China in his election speech to increase employment & win over voters. To keep his promise US announced a 25% tariff on steel imports and a 10% tariff on aluminum. The tariff will raise the costs of imported steel, which are primarily from China. But this is unlikely to last long as in the USA all steel-using industries, including the automobile industry, will be squeezed by higher input prices, and their ability to export or compete with imported goods will be eroded. A modern steel or aluminium plant is very capital-intensive, and employs few people. Trump will help these low employment industries at the cost of higher-employment ones.
China in retaliation announced additional tariffs on 106 US products on 4th April 2018, in a move likely to heighten global concerns of a tit-for-tat trade war between the world’s biggest economies. China is an equally strong economy & I think Beijing is very keen to show that it is not going to be bullied by the US. Matching the scale of proposed US tariffs announced, the Ministry of Commerce in Beijing said the charges will apply to around $50 bn of US imports. The 25% levy on US imports includes products such as soybeans, cars chemicals etc.
The possible outcome…
The US cannot afford to impose large duties on Chinese products because it will raise prices and inflation. Large scale sourcing from China by US companies has kept inflation low. Large trade deficits helps keep prices low. High inflation is the last thing that US which is trying to get out of economic slowdown will want. China on its part can risk job losses for its large population & de-valuation of its investments in US treasuries. Thus the current trade war started by US is rhetoric only to satisfy the vote bank there. It is unlikely to last long & we can expect this trade friction between China & US to be resolved through negotiations soon as this will adversely impact both countries.
Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 9 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata. He also manages a portfolio on the online platform Kristal. Find link to the strategy named ‘The Tortoise’