Picking up where the WSJ left off yesterday, Reuters reports that China is preparing a range of responses to the just announced $50BN in U.S. tariffs and will "stand up to protectionism", but that it still hopes for dialogue, according to Beijing’s WTO ambassador, Zhang Xiangchen.
As a reminder, yesterday the WSJ reported that China is preparing to hit back with its own countertariff aimed at President Donald Trump’s support base, including levies targeting U.S. agricultural exports from farmbelt states in retaliation to the mounting trade offensive from Washington.
“Any Chinese response to new U.S. tariffs would be measured and proportional,” said a Chinese official involved in policy-making. Specifically, China is said to target U.S. exports of soybeans, sorghum and live hogs.
However, as a first step Reuters notes that Zhang Xiangchen said China was considering a WTO complaint against the package of tariffs that President Donald Trump is expected to announce later on Thursday.
“This is a legitimate right for China to do that. But I would not exclude other options, because if the flood approaches you have to bank up to keep it out,” he told Reuters.
Meanwhile, as Trump just said moments ago, Thursday’s tariff announcement is the first in a string of U.S. trade restrictions aimed squarely at China and intended to curb alleged theft of U.S. technology. U.S. Trade Representative Robert Lighthizer said on Wednesday the tariffs would target China’s high-technology sector and could also include restrictions on Chinese investments in the United States. Other sectors like apparel could also be hit: full details are set to emerge over the next 2 weeks.
And while we wait for the details, the imminent question is what China will do next.
To answer this question, Deutsche Bank has laid out several possible scenarios of how China will retaliate to the Trump tariffs.
As the German lender notes, Europe has already outlined the limited actions it would take in response to the steel and aluminum tariffs, targeting areas of US imports that may be politically important to key congressmen (bourbon from Kentucky, motorcycles from Wisconsin, and so on). It notes that if these actions do not spiral upward, their overall magnitude is likely too small to have significant macroeconomic implications.
Digging into the specifics, here are the details from Deutsche on every possible scenario:
Baseline: Under the baseline, we expect China would actively negotiate with the US to avoid an escalation of trade frictions. The US administration has reportedly asked China to reduce the bilateral trade deficit by $100bn. It is not clear what the time horizon for this goal is, though the number itself is too large to be achieved in a short time period (and definitely not before the US mid-term election).
China nonetheless would be willing to offer to import more from the US in products such as automobiles, airplanes, and natural gas. China already announced that it will cut tariffs for automobiles and “some consumer goods.”
Other products where China could potentially cut tariffs and increase imports from the US include plastics, meat, cotton, glassware, fruit, and beverages – China has a weighted average tariff of 15% on US exports of these products, compared to 9% on all trade partners.
China has also promised to open up its manufacturing sector completely, and improve market access to services sectors. There are already discussions about opening up foreign holdings of financial institutions, and China could further open up market access in telecommunication, healthcare, education, elderly care, and electric cars.
Trade war light, Scenario A: Limited tariff on tech imports: Under the trade war light scenario, we would expect China to retaliate, but not aggressively. The Chinese government is likely aware that trade tensions are related to the US political cycle. If the damage from trade frictions is manageable on the macro level, the Chinese government may want to avoid further escalation. The policy options could include:
Trade war heavy scenario: The imposition of a 45% tariff on all imports from China would cause significant damage to China's economy. In such an extreme scenario China would have to respond with drastic measures. Here are the various actions that could be taken and our judgment on the likelihood they would be taken.
Among these policy options, 1 through 4 are likely to happen. One advantage of these measures is that they are bilateral. Rebalancing reserve holdings away from US treasuries would have global ramifications given the role of US interest rates in global financial markets. A disruptive rise of US interest rates would be damaging for China's economy as well. Hence, we think it is less likely than the first four options.
Besides government actions, private companies in China will likely diversify their production base to other countries such as Vietnam. This process has been ongoing for several years, but a trade war could accelerate its speed. Countries in Latin America, such as Brazil and Argentina, could potentially gain from the trade war by taking the lost market shares both in the US and in China. Countries and regions closely integrated with China’s supply chain, such as Korea, Malaysia and Taiwan, would still lose on a net basis.
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And while there are many nuances, these can be summarized into two general categories: trade war light and trade war heavy, or "nuclear." The latter could escalate into a recession:
And now all eyes on what China will actually do next.