The trade war between US and China is not showing any signs of slowing down. The two countries are adopting a tit-for-tat strategy further escalating the tensions. Recently, the US raised tariffs to 25 percent on nearly $200 billion worth of goods from China. In response, China announced a tariff hike on $60 billion worth of goods from the US.
Once the game is started, there should be an end to it. In this article, we are analyzing the different scenarios that might turn up, if the present situation prevails. Firstly, the impositions of tariffs will bring a huge cost to both economies. In 2018, US imports from China stood at $ 539.5 billion, and its exports at $120.3 billion. The figures clearly indicate that both economies are dependent on each other. The tariff business will be a setback to China’s economy that has embraced an export-led growth. For instance, in 2017, the export of goods and services had a share of around 20 percent in China’s GDP, whereas the number stands at 12 percent for the United States. In a similar way, US consumers will have to carry the brunt from this game with an increased price level. It should be noted that the US imports from China include daily necessities such as clothing, shoe, household items, mobile phone, etc.
Secondly, the rising price level in the economy through the imposition of tariffs will place the Federal Reserve in a difficult situation. If the inflation rises beyond a comfortable level, the Fed will be forced to hike the interest rate. However, as per the IMF estimates, the trade war is going to shave around 0.3-0.6 percent from US GDP. In such a scenario, there will be pressure on the Fed to cut interest rate to revive the growth. The US central bank would be in a difficult position fixing both the rise in price level and slowing growth.
Thirdly, China has always been tagged as a currency manipulator. With the trade tensions prevailing, China might opt to devalue its currency to revive its slowing economy. The devaluation of the currency can be a boost to the exports sector in the country. But, how far this policy turns out to be successful needs to be looked into. There is a general consensus that China’s export-led growth story has reached its limit and the country needs to now on focus on the consumption-led growth. The global economy is also expected to slow down in FY19, and with the wave of protectionism, it won’t be an easy walk for China to pursue its export-led growth story.
Fourthly, China is the largest holder of US treasury bonds. China owns around $1 trillion in US treasury bonds. If China decides to dump all its treasury bills, it could cause a huge ruckus in the bond market. Flooding the market with treasury bonds would push down the bond prices and increase the bond yield. There is a limited possibility that China will resort to this weapon to counter the US, as it could cause damage to China as well. However, it can be seen that China is reducing its share in US treasury bonds and is accumulating more gold. If this trend continues, there would be an increasing demand for gold which would be reflected in the price of the yellow metal.
Lastly, the impact of the US-China trade war won’t be confined to the two economies. The ramification of the trade war will be also felt by other economies. The slowdown in the two major economic powers in the world will have spill over effects. It is also giving a caution sign to countries like India that is also in the US’s radar for a tariff hike. India might also lose the Generalised System of Preference (GSP) status, which is hinting towards more actions.
In this globalized world, free trade is essential for the economic well-being of every economy. Any obstacle in the movement of free goods and services will bring a huge cost not only to the individual economies but to the global economy as a whole. It should be reiterated that trade war is not a ‘zero-sum game’ but a ‘negative-sum game’.
Posted on 21 May 2019