In the space of a few hours last night, the US-China trade wars escalated from a modest $50 billion grenade to a $200 billion plus-plus bunker-buster with promises and threats of “strong retaliation” to the last retaliation (driven by the first retaliation) as China stepped up the rhetoric in response to Trump’s direction to USTR.
However, in this ‘tit’ for ‘tat’ exchange, China may have a problem. As Bloomberg notes, with his latest move, Trump has threatened additional tariffs on a total amount of Chinese imports – $200 billion on top of a previously announced $50 billion – that China cannot match.
That’s because it doesn’t have sufficient American imports to apply higher tariffs to, so Chinese officials will need to look at other ways of retaliating.
However, as with all things, it’s not quite as easy as that. This ‘pure’ definition of a trade war misses some crucial nuance.
As JPMorgan’s Michael Cembalest notes, some US officials believe it’s easy to gain the upper hand in a trade war when you’re the country doing all the importing. In a theoretical world, maybe, but not in the world we live in.
Over the last decade, US companies made large investments in their Chinese subsidiaries. In fact, the bilateral US trade deficit with China almost disappears once you include sales of in-country subsidiaries.
In other words, US companies are doing almost the same amount of business in China as Chinese companies are doing in the US, but through their subsidiaries rather than via exports.
The chart below shows examples of US corporate sales in China (not all companies disclose sales by country)
The point is that the US has a lot to lose if China retaliates against US companies doing business in China.
These companies are some of the largest employers and capital spenders in the US, and their shares are widely held in US defined benefit and defined contribution plans.
So like bamboo Chinese handcuffs, bad trade deals seem easy to get out of until you start pulling on them.
In other words, the trade deficit is one small part of it, and China does have a few other devastating options in its retaliatory arsenal as we detailed here, most especially its two nuclear options – Dumping of FX reserves (i.e. US Treasuries), and/or Yuan Devaluation.
So in answering the question above – has China run out of ‘tit’ to respond to Trump’s ‘tat’? Yes, but what come next may be far worse.
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