China is running out of options when it comes to hitting back at President Donald Trump’s tariffs.
Due to China’s massive trade surplus over the U.S., China can’t keep up with the magnitude of Trump’s levies — Beijing doesn’t buy enough American products on which to impose the equivalent volume of tariffs in the first place. In 2013, China sold $506 billion worth of goods to the U.S., while importing just $130 billion in American goods.
Trump has said he’s ready to erect tariffs on all $506 billion worth of Chinese imports to the U.S. So far, Washington has slapped duties on $50 billion worth of Chinese goods, and a fresh $200 billion more could be facing the same fate this month. In turn, China has imposed tariffs on $50 billion of U.S. goods and threatened another $60 billion following Trump’s latest volley, indicating it’s not willing to give in any time soon. But its remaining options for retaliation could backfire on its own growth.
One option, some economists say, is a move by China’s central bank to further devalue its currency, making its exports cheaper and more attractive and thereby offsetting the costs of the tariffs. The yuan has depreciated around 8 percent against the dollar since April, and economists Bo Zhuang and Rory Green of TS Lombard believe that the 25 percent levies placed on the bulk of Chinese goods “would damage China’s trade enough to provoke over the next six months or so a further 15 percent depreciation.”
But while some see this as a predictable tactic, other economists argue that China’s done all the devaluing it can and could instead clamp down on U.S. firms inside the country. This could mean increasing the regulatory burden on American companies, impeding the visa process and cash transfers to get money out of China, raising taxes on foreign businesses and further propping up domestic companies. While it would send a clear message, this tack would likely deter new investment.
China has yet to call for a national boycott of U.S. businesses and goods like it did with South Korea in 2017, which badly hit South Korea’s market share in the country after it installed a U.S.-made THAAD anti-missile system.
And inherent risks in further devaluing the yuan mean that strategy could seriously backfire.
“It’s what they’re fearful of,” said Josef Jelinek, senior China analyst at Frontier Strategy Group, speaking to CNBC’s “Street Signs Europe” on Wednesday. “On the one hand a depreciated currency helps them offset some of these tariffs. But if it falls too far too fast, then investors may get frightened and they could see huge capital outflows, which is exactly what they don’t want right now.”
In 2015, China devalued its currency by about 4 percent over a few days, representing the yuan’s biggest drop in 20 years and sending markets reeling. The resulting capital outflows meant Beijing ended up burning through $1 trillion of its foreign currency reserves in order to support the yuan.
Indeed, on August 24 this year the People’s Bank of China re-introduced its counter-cyclical factor, which lends itself to supporting the yuan’s value amid the worsening trade war. This could be “seen as a coded signal for a CNY (yuan) strengthening policy,” Mizuho Bank said in a note on Monday. The move could even be “a gesture from the Chinese authorities to the U.S. side,” one Asia researcher was quoted as telling the South China Morning Post.
On top of the currency risk, the world’s second-largest economy is already dealing with headwinds of its own, independent of Washington’s trade war.
“It’s very important to say that Chinese growth woes are homegrown, they’re not the result of the U.S. tariffs,” Jelinek said. Instead, they’re due to two factors. The first is the government’s concerted effort, over the last five quarters, to tighten credit and stabilize China’s heavy debt levels. The second is a dramatic drop in investment spending by local governments.
“So now China is trying to walk this very difficult tightrope of on one hand not backing away from the deleveraging campaign, but on the other hand cushioning the economy against these weak fundamentals and trade tensions,” the analyst described.
Meanwhile, China believes its economic system is under attack, and President Xi Jinping appears determined to preserve at all costs “the state-directed development process that is in marked contrast with the U.S. free-market system,” said Charles Dumas, chief economist at TS Lombard.
And while this system isn’t likely to face any existential threats in the near future, the risks to China’s growth still loom large. Slowed Chinese growth would severely impact emerging markets and the Middle East’s oil exporters, for whom China is a major buyer, and a devalued yuan would create major problems for Japan and Korea, Dumas warned, adding that he did not see an easy end to the current impasse.
“The U.S. challenge over trade has been linked to a broader challenge to China’s economic system,” he said. “Both sides seem now to be in entrenched positions from which compromise is unlikely, at least in the near term.”
