Trade War II will be easy to lose for China

Fragile. “Trade wars are good, and easy to win,” Donald Trump tweeted in March of 2018 when he was U.S. president, just months before kicking off in earnest one of the largest trade conflicts in modern history.

The ensuing campaign of tit-for-tat tariffs between Washington and Beijing hardly proved him right: in June, China notched up a record monthly trade surplus with the United States of $99 billion. But the Republican nominee for November’s presidential election has threatened to raise tariffs on Chinese exports from an effective 10% to 60% across the board if he wins. With Trump polling neck and neck with his Democratic rival Kamala Harris in key battleground states, Beijing faces the very real possibility of Trade War II.

If the first trade war is any guide, Chinese leaders probably can’t stop Trump from imposing tariffs. He remains unhappy with his country’s $280 billion trade deficit with China in 2023. Officials can, though, deploy some tactics they’ve learnt in the past six years to blunt the impact of any fresh assault on annual exports worth some $500 billion, and slow the economic decoupling that took root during Trump’s first term.

COSTLY LESSONS

In the first trade war, outreach and negotiations helped to delay the implementation of some of the steepest tariffs threatened by the White House. Beijing allowed the renminbi to weaken against the dollar cushioning the blow for Chinese exporters early on; rerouting shipments of electronics and textiles to the United States via other countries such as Vietnam and Mexico helped some to skirt new tariffs of up to 25%.

Yet it took a dozen odd rounds of talks over the course of about a year and a half – during which Washington branded China a currency manipulator, then walked back that label – before the two sides agreed on the so-called “Phase One” deal in January 2020 that ended reciprocal tariff hikes.

Perhaps the biggest lesson from the first Sino-American trade war is that once tariffs are applied, they are not removed. The truce paused further hikes, but it provided no clear path towards removal of the tariffs imposed by the United States despite President Xi Jinping’s commitment to buy an extra $200 billion in American goods and services including agricultural products and energy over the next two years.

Since 2021, President Joe Biden has piled on additional tariffs and export curbs. It is unclear if Vice President Kamala Harris will follow the same path if she wins the race to the White House. Equally, Trump may be making empty threats — though much the same was said of his original tariff threats last time he won the White House.

MESSY AFTERMATH

Ultimately, the direct impact of the trade war thus far has not been too severe. Although China’s share of total imports by the United States has fallen 8 percentage points since 2018 to roughly 13%, according to the U.S. Census Bureau, China’s share of global exports has risen by 1.5 percentage points over the same period, data from the International Monetary Fund shows. What’s more, an analysis by the Peterson Institute for International Economics found China bought essentially none of the additional American goods and services it promised.

One of the only real victories for Trump came courtesy of the U.S. share of China’s agricultural imports, which per customs data rose from 10% in 2019 to 19% in 2021 as hog herds recovering from African swine fever in China bolstered demand for grain. But that share slid to 15% last year as Beijing –concerned over food security in the wake of Russia’s invasion of Ukraine – diversified away from American farms in favour of soybeans and corn from Brazil.

Meanwhile, China’s manufacturing edge remains central to some of America’s most valuable companies, including $655 billion Tesla and $3 trillion Apple. Last year the iPhone maker flagged plans to move almost a fifth of global smartphone production to India, but in March boss Tim Cook acknowledged during a visit to Beijing that “there’s no supply chain in the world that’s more critical to us than China.”

NOWHERE TO TURN

Things may be a lot worse for China in Trade War II. Washington will be less likely to give Xi the benefit of the doubt in negotiations, making any de-escalation far more difficult. The stakes will be higher too. UBS economists estimate a hike to 60% could knock 2.5 percentage points off Chinese GDP, essentially halving its slowing headline rate of growth. The Swiss bank reckons about half the hit will come directly from the drop in exports – though Beijing's policy support could help limit the headline fall to about 1.5 percentage points.

The pressure on China’s currency will be immediate, just as the renminbi bore the brunt of market fears with each new tariff threat levelled throughout 2018 and 2019. BNP Paribas has forecast the currency to fall 6% against the dollar with or without domestic stimulus to cushion the blow.

Either scenario would challenge authorities’ controls over the exchange rate – which have already come under pressure this year from lacklustre growth – and run counter to Xi’s desire for a strong yuan to undergird China’s ambitions to become a global financial superpower. Ultimately fresh tariffs could limit China’s ability to ease monetary policy to prop up the economy; it already looks a stretch for Beijing to hit its GDP growth target of “around 5%” this year.

To make matters worse, the latest policy communique from party leaders’ latest summit in July makes clear that they are doubling down on industrial policy that relies on exports of everything from electric vehicles to medical devices to make up for weak domestic demand. That push will leave its economy even more exposed to the threat of U.S. tariffs.

In short, Beijing might be relatively unscathed so far. But the growth model policymakers are investing in will make a second commercial conflagration with Washington both more dangerous and difficult to extinguish. For China, another trade war would be bad, and easy to lose.