Whether a full blown war or isolated skirmishes, a confrontation between the U.S. and China on trade may be inevitable, even if the only outcome is a Pyrrhic victory.
Economists at Goldman Sachs this week predicted that a U.S.-China standoff is a near certainty given President Donald Trumps anti-trade rhetoric.
Trump has been publicly critical of U.S. trade policy for decades and made it a key aspect of his campaign; we see little reason to believe that he will not follow through on these commitments in general terms, said Andrew Tilton, chief Asia-Pacific economist at Goldman Sachs, in a report he co-authored with Alec Phillips, senior U.S. political economist.
What is less certain, however, is how the battle between the two Goliaths might unfold. As part of their research, Tilton and Phillips explored the various strategies that the Trump administration might deploy as it goes after China and determined that the new president could either resort to small tactics or large actions.
The small measures would be declaring the country a currency manipulator and introducing selective tariffs on Chinese imports.
Throughout his campaign, Trump had pledged to make China accountable for alleged unfair trade practices that hurt U.S. interests.
The most likely options in the near term involve the announcement of a formal process to determine whether China is manipulating its currency, said Tilton.
Deutsche Bank, in fact, believes the move to declare China a currency manipulator could come as early as next week given Trumps determination to keep his campaign promises.
However, bullying China at a time when its financial authorities are struggling to prevent a sharp depreciation of the Chinese currency could be a pointless exercise.
The yuan USDCNY, +0.0830% fell roughly 4.5% against the U.S. dollar in the past 12 months with analysts projecting the currency to further weaken on continued capital outflows. Chinas foreign exchange reserves shrank $12.31 billion from December to $2.998 trillion in January, dropping below the $3 trillion mark for the first time since 2011.
Michael Spencer, chief Asia-Pacific economist at Deutsche Bank, ruled out the possibility of Beijing caving to pressure and floating the yuan, as Chinese officials are too worried about the ensuing financial instability.
Apart from currency, Trump may also order the initiation of trade remedy cases on products with significant domestic production which are being threatened by imports, such as steel, large appliances and machinery.
The president has the authority under several U.S. laws to impose such tariffs if he chooses, and the Trump transition team was reportedly considering a tariff on impo rts as high as 10% in December, Tilton said.
Meanwhile, Helen Qiao, China economist at Bank of America Merrill Lynch, believes the new administration is more motivated by job creation than lowering the trade deficit with China. As a result, she expects Trump to target specific industries metal and metal products, chemicals, machinery and equipment, and auto parts to erect barriers.
Bank of America Merrill Lynch
Qiaos view makes sense if viewed within the context of the following chart from Goldman Sachs, which shows substantial job losses in machinery and automobile industries, particularly in key swing states.
On the large front would be an announcement of across-the-board tariffs on all Chinese imports, but given the repercussions of such a damaging move, the economists think Trump will use this card to pressure China to concede early.
Except China is not expected to fold.
Should the U.S. act unilaterally, Chinese policymakers are likely to react proportionately, said Tilton.
Beijing is not without options. It could retaliate by imposing tariffs on U.S. exports or make it more difficult for U.S companies to do business in the country. China, the second-biggest holder of Treasurys after Japan, could also sell some of its $1.05 trillion in U.S. debt to punish Trump.
Economists were universally agreed that a U.S.-China trade spat is likely to be costly. Goldman Sachs estimated that an 11% increase in the effective tariff rate could weigh on U.S. economic growth rate by 0.7 percentage points. Likewise, a 5% tariff against Chinese goods could lead to a 0.1 percentage-point drag on Chinas GDP growth, according to Morgan Stanley.
With the new U.S. administration only a couple of weeks old, its hard to be confident, said Tilton. But he remains hopeful that the two largest economies in the world will reach a mutual understanding and avoid a showdown.