Trump tariffs and doubling down on “Made in China 2025”

The trade war between the US and China is now in full bloom. And it’s likely to escalate. My view here has been that China is more vulnerable in this bust-up than the US. Even so, I don’t expect the Chinese to back down. On the contrary, what is happening now only reinforces the hardliners’ view that China needs to lessen its dependence on the West and continue to power forward. So I anticipate China doubling down on its commitment to the the “Made in China 2025” initiative. Some comments below

First, here’s where we are in the trade war

US President Trump has promised to escalate if China doesn’t compromise. And so far, Trump has delivered on these promises, ratcheting up the number of goods subject to tariff each time. In this past round, Trump added a number of consumer goods to the tariff list. So we should expect those measures to bite for American consumers in due course.

But notice that Trump is trying to leg into this gradually, giving companies time to adjust. Here’s how he put in the statement announcing the latest tariffs:

Today, following seven weeks of public notice, hearings, and extensive opportunities for comment, I directed the United States Trade Representative (USTR) to proceed with placing additional tariffs on roughly $200 billion of imports from China.  The tariffs will take effect on September 24, 2018, and be set at a level of 10 percent until the end of the year.  On January 1, the tariffs will rise to 25 percent.  Further, if China takes retaliatory action against our farmers or other industries, we will immediately pursue phase three, which is tariffs on approximately $267 billion of additional imports…

As President, it is my duty to protect the interests of working men and women, farmers, ranchers, businesses, and our country itself. My Administration will not remain idle when those interests are under attack.

China has had many opportunities to fully address our concerns. Once again, I urge China’s leaders to take swift action to end their country’s unfair trade practices. Hopefully, this trade situation will be resolved, in the end, by myself and President Xi of China, for whom I have great respect and affection.

The key is the ratchet from 10% to 25%. That’s when the real pain will come, both for Chinese exporters and US consumers.

As I indicated in yesterday’s daily note, China is retaliating with tariffs of their own on $60 billion of US goods. But they will soon run out of items to tariff and must turn to alternative retaliatory measures if they choose the confrontational route.

The Chinese will retaliate

I don’t think there’s any question here where this is going. In China, increasingly, these tariffs are seen as the West’s attempt to thwart the rise of China, to keep China down. And since the US embodies the West in that context, seen as the global hegemon, Trump’s latest round of tariffs play right into the hands of hardliners pushing that narrative. We should expect the anti-US propaganda inside China to step up as a result.

There are two lines in the western press on China. In the first, the Chinese are totally prepared for war. Here’s Bloomberg:

Fang Xinghai, vice chairman of the China Securities Regulatory Commission, said Trump’s tactic of trying to pressure China into trade concessions wouldn’t work because the economy was too strong. Tariffs on all exports to the U.S. wouldn’t be enough, he said.

“Even in that scenario, the negative impact on China’s economy is about 0.7 percent of GDP decline,” Fang said on a panel at a meeting of the World Economic Forum in Tianjin on Tuesday. “China has ample fiscal and monetary policies to cushion that impact. So we prepare for the worst, and we think the economy will still be fine.”

In the other, the Chinese are still searching for a response. Here’s the New York Times:

Chinese officials know what they don’t want to do. They have rejected one idea that would replace the matching tariffs with a more sophisticated system, said the people briefed on the discussions, who spoke on the condition of anonymity because of the fragility of the deliberations. That response — discussed in detail within the Commerce Ministry and other agencies — would have led to lower tariffs on American goods in dollar terms, which could be seen as a fig leaf to the White House.

That approach would have recognized a potentially expensive new reality for Beijing: The tariffs may be here to stay. Mr. Trump is suffering from weak approval ratings and could lose influence in congressional elections in November. But while Democrats have opposed most of his agenda, many have supported his attacks on trade with China. Even if Mr. Trump leaves office in two years, there is little guarantee that his China trade policies will be changed.

We will soon find out which view is more accurate. But these are tactical considerations. The long-term strategic view is one in which China is a richer, technologically-advanced country with low unemployment that can be seen as a success domestically and abroad.

I don’t believe Chinese leaders feel they can get there by acquiescing to Trump’s demands, particularly the demand that China dismantle critical parts of the “Made in China 2025” strategy.

Tactically, then, that leads to retaliation.

The Chinese long-term

Since the Chinese know that Trump is not bluffing and that they will feel more pain than the United States, they have to do three things to maintain strategic focus:

1. They will need to retaliate in a way that is meaningful enough to serve as propaganda in the budding ‘us vs them’ narrative where the US is seeing as a bully trying to keep China down. Only by doing so will moderate Chinese leaders keep more radical retaliation measures at bay. Now, US Commerce secretary Wilbur Ross says the Chinese “are out of bullets”. I don’t believe that. Goldman’s Peter Oppenheimer talks of targeting US tech companies. Others are talking about boycotts of US products and red tape for US companies operating in China.  It’s unclear how the currency will figure into this outcome. But the currency is also a potential weapon.
2. The Chinese will need to shore up their economic and financial infrastructure, ravaged by high debt, particularly among state-owned enterprises. The fallout from a trade war will be economic. And that means assessing and shutting down vulnerabilities to slowing growth and financial crisis. All indications are that the Chinese are doing just that already. The real question is the policy mix, particularly whether we are going to see more stimulus.
3. Most importantly, the Chinese will want to aggressively accelerate “Made in China 2025” efforts in order to more quickly severe the technological and trade dependence on the West for growth.

The Chinese are famously focused on the long-term. And so, they will attempt to get through this trade spat in a way that maximizes their long-term socioeconomic objectives. If ceding ground were in their best interest, they would. But the game Trump is playing is too aggressive for them to cede ground and capitulate without undesirable domestic political consequences.

Therefore, I expect the trade war to escalate, and for the Chinese, focused on long-term growth objectives, to accelerate their drive to wean themselves of dependence on the West.