FROM THE EDITOR

Trade Wars

It is hard to say whether a trade war between America and China will actually play out with the viciousness that some predict. President Donald Trump has often switched positions on how far his administration is prepared to go. Mr Trump imposed punitive sanctions on ZTE, a Chinese telecom equipment manufacturer, but subsequently softened his stance. The United States Trade Representative Robert Lighthizer, together with Peter Navarro, the President’s trade advisor, have held hawkish attitudes. Their intent would be to eventually cut what would seem to be a respectable deal with China from an American point of view. They would not necessarily want to push circumstances towards a full trade war. However, Mr Trump would ultimately take the final call. He has altered his position on how far he will go and is therefore hard to predict.

"US corporations constantly grumble about their inability to access the Chinese market and the arm-twisting that compels them to share intellectual property with local partners."

Following a meeting in Washington with Chinese Vice Premier Liu He in May, the US Treasury Secretary Steve Mnuchin indicated that America would withhold the imposition of punitive duties on Chinese imports. China runs a trade surplus in the region of USD 380 billion with the United States and all that Mr Liu then agreed to do was to buy more American goods with a view to reducing this. America on the other hand expected, perhaps justifiably, more definitive commitments on how this might happen and when these were not forthcoming, imposed tariffs on USD 34 billion worth of Chinese imports effective July. This was in addition to the tariffs on metals and solar panels imposed earlier this year. China retaliated with a similar tariff blanket on US imports, sparking threats of further tariffs from the American administration.

"China accounts for three-fifths of America's trade deficit and opinion, both in the Washington establishment and amongst the people, has turned against that country."

From an American perspective the China issue is becoming bothersome. US corporations constantly grumble about their inability to access the Chinese market and the common arm-twisting that compels them to share intellectual property with Chinese partners. More importantly, the China issue has acquired political overtones with large sections of the American people believing that China was the reason for the closure of several industries, and the job losses that followed, over the course of the last two decades. American opinion, both in the Washington establishment and amongst the people, has emphatically turned against China, which accounts for three-fifths of America’s trade deficit.

"Chinese enterprises will seek to control global market shares in the sectors identified under Make in China 2025. This has created worries in Washington but also across European capitals and other nations like Australia and Japan."

The Make in China 2025 plan identifies ten industries that have been designated ‘strategic’ in nature, where China wants to occupy a position of global dominance. These include artificial intelligence, robotics, electric vehicles, biotechnology, aerospace, advanced railways, renewable energy, etc. Eventually, when this happens, it seems likely that Chinese enterprises will control global market shares in these sectors. This has created worries not only in Washington but also across European capitals and other nations like Australia and Japan. All of this, coupled with the Belt and Road Initiative, which seeks to expand China’s sphere of influence, is now being treated with greater levels of suspicion. Added to this is its military expansion and near-occupation of the South China Sea. More recently, the Chinese landed a military bomber on a tiny atoll, which is claimed by Vietnam and the Philippines. The fear of a rising China is creating insecurities amongst advanced economies, particularly America, which may consequently lose its position as the world’s dominant power. It is no surprise, therefore, that America’s latest round of tariffs specifically targets products in the industries identified under Make in China 2025.

America's response to the China affair may entail a multi-pronged approach. The administration could impose import tariffs on a wider range of Chinese products. Whilst this may not necessarily rock the Chinese economy, it will create flutters leading to retaliatory measures on American imports, specifically in the politically sensitive farm sector. The White House may choose to block Chinese acquisitions of US companies on grounds of national security, specifically in sectors that give access to sensitive technology. These may include semiconductors, electronics, payment systems etc. There is evidence to suggest that approvals for such acquisitions are already much harder. America may also block US exports of sophisticated electronics and semiconductors to Chinese companies who are currently dependent on them, as was the case with ZTE. Should this happen, several Chinese hi-tech enterprises will simply crumble. The ultimate weapon in America’s arsenal is the US dollar. If used aggressively, it could cut off China from all international transactions including trade and capital flows. Most international trade is denominated in US dollars and an American embargo can prevent banks and financial intermediaries from dealing with sanctioned companies in US dollars. In the fullness of time, China may want the Yuan to become a global currency used for international trade and other transactions. But this cannot happen in a hurry. In the first instance, China will need to open its internal financial markets, free interest and exchange rates and allow the flow of capital without any encumbrances. These are steps it may find difficult to live with because both the Chinese Government and the People’s Bank of China will then lose control over important financial parameters.

If a war becomes dirty, China will respond both economically and geopolitically. It may hurt US businesses that currently operate there. Apple for instance, produces all of its iPhones in China and American companies have collectively invested over USD 300 billion in that market. It will most certainly harden its stance with respect to the North Korean negotiations and encourage North Korea to be more threatening. It may also begin to unwind its massive holding of US debt. At USD 1.17 trillion, China is the largest foreign creditor to the US.

Finally, from America’s point of view there are only so many fronts it can open simultaneously. Its tariff decisions have annoyed its allies who expected such action to be exclusively targeted at China. Subsequently, its withdrawal from the Iran nuclear deal and the imposition of sanctions against that country invited further disapproval with other nations publicly announcing their intent to defeat sanctions through legal and financial workarounds. In the long run, it will become harder for President Trump to achieve his policy objectives in the face of continued global alienation.

Mr Trump will also be aware that a trade war will create collateral damage. It will undermine investment and trade amongst all markets, as China and the US are the world’s largest trading nations. Economic growth across the world will seriously moderate and financial markets will crumble. Sections of American industry that depend on imports for raw and intermediate goods or export to markets that have imposed retaliatory tariffs on US products, will be affected. For instance, motorcycle maker Harley-Davidson has decided to shift some of its production out of the US as a consequence of Europe’s 31% tariff on its products. For all these reasons, it does not seem likely that the Trump administration will go the whole hog. But in the longer term America will shift its position on the China dispute. Its recent actions to flex muscles have made a point and going forward it will adopt a more strategic line rather than the transactional one that currently seems in evidence.

Adit Jain, Editor

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