The US edges closer to a trade war with China

Publication date: 13 October 2011
Author: Dean Peters-Wright

Tagged with: China, Dean Peters-Wright

Policymakers in the US and China are adopting increasingly aggressive positions in respect of bilateral trade relations which are clearly based on economic self-interest rather than the wish to get global trade moving more quickly. It does now seem that a major trade showdown is fast approaching.

The apparent slowdown in the Chinese economy means that a proposed US bill which will penalise nations who artificially manipulate their currencies in order to give themselves what can look like an unfair trade advantage has come at a very awkward time for both countries. The bill, which will put new tariff barriers in place, has already been approved by Congress and now goes to the House of Representatives, currently controlled by the Republicans.

Recent data has shown that Chinese economic growth has slowed. The Chinese economy had been the catalyst for propelling the global economy out of the financial meltdown in 2008 and with the global economic outlook not looking particularly good confirmation of a prolonged Chinese economic slowdown will not improve the mood of investors. China’s trade surplus has fallen in recent months as demand has moderated for its manufactured goods. Although China’s domestic demand remains relatively robust imports have also slowed.

China’s Central Bank has allowed the yuan to appreciate in what it calls a “managed flotation” since 2005. However the rising yuan is having an adverse effect on the competitiveness of Chinese exporters and businesses in China are already feeling the strain. Europe is China’s largest export market and export growth to this key market has slumped to 9.8% from 22% the previous quarter. This adds to the already mounting pressure being felt by Chinese businesses and has resulted in manufacturers and construction companies making smaller profits, and in some cases going into bankruptcy, as they struggle to find new financing for investment.

These factors have made the likelihood of an economic soft landing for China less certain. Although policy is unlikely to change until the Chinese economic conference convenes in December there are a limited number of options that policymakers have available to support the economy. Financial support and tax relief for small businesses are two of the possible options. However, if the trade bill passes the US House of Representatives and is signed into law, China, more than any other country, will feel the effects of the new US tariffs.

The likelihood of a trade war between the US and China is a real possibility if the bill passes as each nation would seek to protect its own economic interests. This is clearly very likely to damage overall relations between the two countries. The Chinese argue that not only would the legislation be breaking World Trade Organisation rules, but the global economic recovery would be put in jeopardy as well. If the bill passes it is highly likely that China will retaliate in some way. It could halt the controlled appreciation of the yuan against the dollar or even reduce its value. More likely China will impose tariffs of its own on US goods. One thing seems certain – a trade war between these two economic giants would be a disaster and not necessarily just for each other.

Some senior Republican leaders are very concerned over trade relations with China and the harm that a trade war could do to US businesses given the increasingly poor economic situation in the US itself. Other US officials are more hawkish, arguing that China has expanded very aggressively on the back of US economic consumption for far too long and the proposed legislation is overdue.

It is unclear at this stage exactly what penalties or tariffs would be put in place by the US should the bill pass into law, but it is clear that investors everywhere are very concerned over the escalating rhetoric.