China Could Turn This Feud Into More Than a Trade War

Last Friday, the US imposed tariffs on US$34 billion of Chinese imports.

China hit back with an equal tariff amount in items like soy, whiskey and cars.

The US is looking at imposing another US$16 billion taxes. They also released a list of US$200 billion  worth of Chinese products that they’re planning to target as well.

The US has warned that if China retaliates they will get hit with an extra US$300 billion in tariffs.

This adds up to US$550 billion, a number a bit over the amount the US imported from China last year.

China has promised to retaliate by matching tariff for tariff. Yet they import a much smaller amount from the US.

In 2017, they imported about US$127 billion from the US. Which means that they will run out of imports to tariff well before the US does.

China will go tit-for-tat with the US

Yet, China has another option.

In a recent interview, a senior Chinese government economist, Mei Xinyu, told Spiegel Online:

Asked about what weapons China will deploy in the conflict, Mei told SpiegelOnline, “China has responded to the first instalment of US punitive tariffs by imposing countervailing duties in comparable product categories. Should the US now impose tariffs on imports of another 200 billion, China will extend the conflict to other fields.

He warned that China could sell its US government bonds (it owns more than $1 trillion worth) and dollar reserves, even if doing so is economically painful.

He said, “The US and China are the largest economies and largest financial markets in the world. But in the US, the financial sector plays a much bigger role than in China. In that sense, the US is vulnerable here, so of course, that’s an option”.

He added, “In good times, our competition is that we try to grow faster than the US. But when times get worse, it’s about who loses faster. That would be a financial war – and what such a financial war between the two largest economies looks like is probably beyond our imagination.

China has the largest foreign exchange reserves in the world. China is also the top foreign holder of US treasuries, it has almost 1.2 trillion in US treasury bonds, as you can see in the chart below.

The top foreign holder of US treasuries 12-07-2018


Source: Reuters
[Click to enlarge]

But China is the second overall holder of US treasuries.

Who is the first? Well, the US Federal Reserve.

After the 2008 crisis, the Fed lowered interest rates to record lows and engaged in a massive asset purchasing program to spur the economy. As you can see in the graph below, the Fed went from holding about 500 billion in US treasuries in 2009, to 2.4 trillion in 2017.

The top foreign holder of US treasuries 12-07-2018


Source: FRED
[Click to enlarge]

After years of unconventional policies, the Fed is now trying to normalise the economy. To do this, the Fed has been increasing interest rates. They are also decreasing their balance sheet to have some ammunition before the next recession.

If you want to protect your family wealth, you need to know why this financial expert is predicting economic collapse. Find out more here.

At the same time, the government is spending more. They recently approved a big tax cut, so they are issuing more debt.

The greater impact of these tariffs on the global economy

If China deploys the alternative option, it would be selling treasuries at the same time that the Fed is trying to get rid of them, and the US government issuing more.

In other words, there are a lot of treasuries coming to the market already. If China starts selling, there would be even more, which could mean that interest rates increase.

The US is already holding a massive amount of debt. Exercising this option would massively hurt the US, but it would also hurt China. That’s why we don’t think that China will be rushing into this option.

A bigger risk to us from this trade war is that it could spark inflation.

So far tariffs have not yet affected consumers. But as the US keeps imposing more tariffs, goods coming into the US will become more expensive, and it will begin affecting consumers.

If inflation starts picking up, the Fed will be tightening even quicker. As the US Fed recently acknowledged in their last meeting minutes, higher inflation could lead into a ‘significant economic downturn’.

Some participants raised the concern that a prolonged period in which the economy operated beyond potential could give rise to heightened inflationary pressures or to financial imbalances that could lead eventually to a significant economic downturn.

If things continue to escalate, this could turn into much more than a trade war.

Best,

Selva Freigedo,
Editor, Markets & Money

 


Selva Freigedo is an analyst with a background in financial economics. Born and raised in Argentina, she has also lived in Brazil, the US and Spain. She has seen economic troubles firsthand, from economic booms to collapses and the ravaging effects of hyperinflation, high unemployment, deposit freezes and debt default. Selva now writes from her vantage point here in Australia. She is lead Editor at the daily e-letter Markets & Money. And every week, she goes through each report and research note produced by our global network of trusted advisors to find the best investment opportunities for you in Australia and overseas. She packages these opportunities for you in Global Investor.


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