How serious are President Donald Trump’s latest trade threats against China? The scale of the new measures — 10 percent tariffs on an additional $200 billion of Chinese products — will certainly get Beijing’s attention. But the headline figure matters less than the industries being targeted and their relative importance to China’s economy. By that metric, this latest attack is a serious escalation.
Most consequentially, the tariff list targets basic manufactured goods such as furniture, electronics, machinery, textiles and fibers. Together, these broad categories make up roughly 67 percent of total Chinese exports, which in turn account for 18 percent of gross domestic product. That means the potential for significant economic harm is high, all the more so given that manufacturing is the largest individual employment sector in China.
The new tariffs will also put pressure on China’s trade surplus with the U.S. In principle, this imbalance doesn’t much bother economists. The problem is that China depends on savings, investment, and capital accumulation to drive its economy. Historically, it would print money to buy surplus U.S. dollars, build up reserves, flood the domestic market with money, and thus encourage investment. Beginning around 2012, however, this strategy started breaking down as gray-market capital outflows rose and surplus dollars dwindled.
After years of increasingly stringent capital controls, China has only recently returned to a small surplus in total capital flow. Tariffs on major export industries will threaten its primary source of hard currency and place substantial strain on the capital-control system. That, in turn, will jeopardize China’s dreams of signature international investment and potentially destabilize its finances as it becomes harder to balance capital flows. Unless it can generate more U.S. dollars, this could place serious pressure on the yuan.
Making matters worse, the new tariffs will likely accelerate the migration of low-wage manufacturing from China to frontier markets such as Vietnam and Bangladesh. Even without tariffs, many export-focused firms in industries such as garments and textiles were eyeing the exits after years of double-digit wage growth in China. Tariffs will only exacerbate this shift, for which China was ill-prepared to begin with.
All this, moreover, comes at a bad time. With economic strain rising, Chinese officials were already resorting to risky measures to boost growth. The China Banking and Insurance Regulatory Commission recently advised banks to reduce interest rates on loans to small and medium-sized enterprises, while state-owned banks have increased lending for real-estate investment to ensure the economy continues to grow, even as stocks and key commodities have been plummeting.
Against this backdrop, the prospect of a prolonged trade war is causing growing alarm within China. Academics and key officials have been quietly wondering if the ruling party has made a significant miscalculation. The Commerce Ministry has vowed to retaliate against Trump’s latest measures, but it has little room to maneuver given China’s relative lack of imports from the U.S. The government has even agreed to reimburse some importers for the cost of its retaliatory soybean tariff, which is hardly the sign of a strong hand.
Exactly how China will respond, then, is anyone’s guess. But make no mistake: Trump is attacking the foundations of the modern Chinese economy. And the trade war he initiated is escalating faster than either side seems to appreciate.
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