The real problem with a possible trade war between China and the United States is that nobody knows what it would look like. For years, the successive US and Chinese leaders have left that hot potato well alone knowing the potential pain it could bring. However, Donald Trump is not a typical US president.
There are two key statistics that bother the current US Administration—the amount of outstanding US Treasury debt held by China, and the imbalance of trade between the two countries. China holds approximately 1.2 trillion USD in treasury bonds, which represents some 20% of all outstanding US debt. On the trade balance, Chinese imports of goods from the United States amounts to 131 billion USD, while US imports of goods from China amount to almost four times that amount at 506 billion USD.
One of Donald Trump’s election promises was to tackle the thorny issue of the imbalance of trade between the two world superpowers. However, he specified no particular measures that he was prepared to take. The most obvious action would be to impose trade tariffs on the import of individual types of goods imported into the US. Recently, the President announced a basket of 50 billion USD in tariffs on a range of goods, which was immediately met by a ping-pong response from the Chinese for the same amount. Trump then declared that he would up the ante to 100 billion USD, to which the Chinese have yet to respond. The trade imbalance might actually work in favor of the US as they would be able to impose a greater volume of tariffs compared to the Chinese.
In spite of the public declarations, the Chinese have no desire to rush into a trade war with the US. Most Chinese imports take the form of farm produce, and higher prices will impact significantly on the Chinese cost of living index. Then again, many of the US imports are luxury goods like pistachio nuts and US bourbon, and higher prices on those items could be easily absorbed by middle-class Chinese.
Since trade war talks began at the beginning of 2018, the US financial markets have been volatile. Having reached a high of 26,000, the Dow Jones Industrial average has fallen over 2,000 points, and further falls cannot be ruled out. With all of the bravado on both sides, neither one has any desire to damage their own economies or the lives of their citizens. For this reason, great leeway rests in between the talk and the action and it will be many months before any concrete steps are taken for either side to start raising tariffs on foreign imports.
But tariffs are not the only sanctions available to the Chinese government. China has a range of measures if could impose on US companies based in their country. China could increase the number of regulations imposed on those US companies and even arrange for factory inspections that could impact production. There are many US automakers with factories in China that could find their partners losing enthusiasm for the future business.
Regarding the outstanding US debt, this is another mechanism that China could use to manipulate trade relations with the US. China could threaten to offload US holdings, which would almost certainly lead to a rise in long-term US interest rates, with a resultant rise in US borrowing costs. This would hurt the US economy as it currently tries to emerge from a 10-year slump. However, by redeeming US bonds, China would give up the income from interest coupons associated with those US treasuries, which could result in the loss of billions of US dollars for the Chinese. Ironically, such a move could see a fall in the value of the greenback, which would reduce the cost of imports into the US. In the long run, the impact of any sale of US Treasuries by the Chinese government would not be significant, as such a sale would only represent a small volume of outstanding US debt. It really is a complex picture.
While there is no shortage of financial measures that China could impose on the US if President Trump goes ahead and increases trade tariffs, it is unlikely that either side will enter into a full-blown trade war. Both sides simply have too much to lose.