New round of US tariffs raises the pressure on China

The Trump administration has taken a large step forward in the ongoing trade war with China, imposing 10% tariffs on USD 200bn worth of Chinese imports. Moreover, these tariffs will increase to 25% on 1 January 2019, most likely to limit the risk of any potential economic fallout for the US before the midterm elections in November. This new package comes on top of the previously introduced charges on solar panels, washing machines, steel and aluminium, and the most recent package of 25% on 50 billion USD of Chinese imports.

The tensions between the US and China will increase considerably as a result of the announcement by the Trump government. Beijing has already indicated that they do not want to negotiate de-escalation now that Trump has actually put his previous threats into action. We have already indicated what the background of this conflict is. At first glance the losses for the Chinese economy will be greater than for the US. The European and Dutch economies will also suffer from further escalation, especially through lower growth in world trade and possible turbulence in financial markets. On the other hand, the tensions also offer opportunities for Europe.

In the announced package of USD 200 billion three phases are evident. After this 'first' round of 10% tariffs on 200 billion dollars, the levies will be increased to 25% as of 1 January. If China retaliates, the US is also prepared to impose levies of another USD 267 billion, which in effect makes all imports from China subject to a 25% tariff. The USD 200 billion that has been announced should not be a surprise. However, the original list of products on which the levies were announced is larger than the list now proposed: about 300 product groups were removed from the tariff list. These are mainly consumer (electronic) products. Next to tariffs, the US is considering non-tariffs barriers as well, as the ZTE example shows. Sanctions on the Chinese telecommunication company could be imposed again.

As we have indicated on several occasions, China has limited options for countermeasures compared to the US. This is because they import far less from the US than the other way around. China indicated that they are taking countermeasures on USD 60 billion of US imports, which means that after the previously imported USD 50 billion, 87% of the total US exports to China are subject to higher tariffs (Table 1). Because China’s limited ability to implement countermeasures by tariffs, they will make more use of so-called non-tariff measures, which makes it more difficult for US companies to do business in China. This could include additional security inspections for American companies or higher safety requirements. Chinese state-owned companies that maintain strong relationships with these companies can also significantly reduce their orders in order to damage the American companies operating in China. Finally, China can choose to be less co-operative as a mediating party in the conflict between the US and North Korea.

US

The US economy is currently running at full speed. Unemployment is currently 3.9%, the annualized GDP figure for the second quarter was 4.2% and consumer and producer confidence is very high. We therefore expect that the US economy can tolerate some damage. The bill for the higher tariff rates will ultimately have to be paid by three parties. First, American consumers who have to pay a higher price for products imported from China; secondly, SMEs will have to pay higher prices for semi-finished products originating from China - for example, the costs of American steel have already risen by 33 percent in Washington (see WSJ); finally, American multinationals that take care of the assembly of their products in China are confronted with higher tariffs or lower profits. For example, we know that US tariffs that relate to electrical products are 87% down to foreign companies. With the announced Chinese import duties of USD 60 billion, additional tariffs are levied on USD 127 billion of US exports: this translates into a loss in GDP growth of -0.3ppts. Yet this only concerns the direct effects through lower exports from the US to China. What is not included here are negative effects through lower economic sentiment, turbulence on financial and FX markets, and negative effects through the disruption of international value chains, or of lower labour productivity growth.

China

For China, things can turn far worse than for the US. As a result of the new package, more than 250 billion dollars of Chinese exports to the US are subject to tariffs, and perhaps almost all of them in the ‘third 200 bn phase’ starts. With a cooling domestic economy that is surrounded by risks, for example in the area of ​​excessive debt, the Chinese economy is a lot less well situated in this trade war than the US. China posted a strong 2018H1 and recently additional stimulus measures have been announced to keep growth on track. However, a sharp correction has taken place on Chinese stock exchanges -opposed to US stock exchanges- and the Chinese yuan has declined by 9.3% since April 2018 (figure 1). This depreciation has somewhat mitigated the negative impact of previously introduced measures, but any further weakness could risk panic: senior officials have stressed further devaluation is not planned, but if USD earnings are impacted by the trade war, depreciation could certainly follow anyway. Another factor is that several American producers have already announced that the tariffs and uncertainty caused by the trade war will cause them to move production from China to other low-wage countries, such as the Philippines, India and Vietnam (see here and here). This will be at the expense of employment in China and put further pressure on the economy. It also undermines the country’s aim of achieving its Made in China 2025 goals.

If not 10%, but 25%, is ultimately levied at 200 billion USD, this could according to our calculations result in an additional GDP loss of 0.9ppts for China, on top of the 0.3ppts of lower growth that we already included by the previous US protectionist packages. The described indirect effects of the trade war are not included in these calculations, which also holds for a scenario under which the US would up the ante to tariff all their imports from China.

What about Europe and the Netherlands?

Since the Netherlands and Europe are only a limited part of the current trade conflict, we expect the direct effects to be negligible for now. However, prices will be upwardly pressured from specific product groups shipped from China via the US to Europe. Consider, for example, electronic semi-finished products, consumer electronics and high-tech devices in the healthcare sector.

However, the indirect effects can turn out to be much more macroeconomic if investment sentiment and consumer and producer confidence are dented. It is true that this backdrop may offer opportunities for European companies in some areas, for example related to ​​food and agricultural products, chemicals and high-quality products from the processing industry as Chinese importers could decide to switch to Dutch or European producers. In addition, China will focus more on other trade and investment partners through the increasing tensions with the US. In July, there was a summit between the EU and China, which included on plans for more cooperation on trade and investment. However, the chance of any EU-China coalition is far lower than EU cooperation with the US, as we wrote before.

China has already indicated not to want to negotiate with a gun pointed to their head and Trump may be trying to force something for the midterm elections. What also plays in the conflict between the two countries is that it goes beyond pure and only unbalanced bilateral trade relations. Within the Trump government, the conviction prevails that China poses a risk to geopolitical relations and that, for example, it has been a mistake to admit China to the World Trade Organization. That is why we believe that the tensions between the US and China will not be less in the coming years, but will rise on the other hand. Only when we actually see that the US economy will cause damage will Trump repent, but this seems infeasible in the short run. That is why a deal is unlikely in the short term.