The trade war is back on.
Based on Trump’s comments, 25% tariffs may possibly be applied to an additional US$300 billion of Chinese goods.
China said it would respond with unspecified but ‘necessary countermeasures’.
Some analysts say China can dump its large holdings of US Treasuries on world markets.
That would drive up US interest rates as well as mortgage rates, damaging the US housing market and possibly driving the US economy into a recession. Analysts call this China’s ‘nuclear option’.
There’s only one problem…
Nuclear option won’t work
The nuclear option is a dud.
If the Chinese did sell some of their US Treasuries, they would hurt themselves because any increase in interest rates would reduce the market value of what they have left.
Also, there are plenty of buyers around if China became a seller.
Those Treasuries would be bought up by US banks or even the Fed itself. If China pursued an extreme version of this Treasury dumping, the US president could stop it with a single phone call to the Treasury.
That’s because the US controls the digital ledger that records ownership of all Treasury securities. The US could simply freeze the Chinese bond accounts in place and that would be the end of that.
So don’t worry when you hear about China dumping US Treasuries.
China is stuck with them. It has no nuclear option in the US Treasury market.
Trump means business
How did we get here?
Trump’s trade representatives have complained that China had backtracked on previous agreements and that China was trying to renegotiate key points at the last minute.
The Chinese are not accustomed to such resistance from US officials.
But Trump and his team are unlike previous administrations.
China assumed it was ‘business as usual’, as it had been during the Clinton, Bush 43 and Obama administrations.
China assumed it could pay lip service to trading relations, and continue down its path of unfair trade practices and theft of intellectual property. Trump has proven them wrong.
Trump was never bluffing. He means business, which China is finally learning.
There’s still time to reach a deal, however, before the tariffs actually have any practical impact.
The tariffs only apply to Chinese goods that leave port after the recent deadline. That means goods already en route to the US will not be affected.
Chinese exports mean more to China than US
Trump announced on Twitter recently that ‘there is absolutely no need to rush’ to get a deal done, which removed any urgency from negotiations for the moment.
You can expect the cat and mouse game to continue for the next couple of weeks, with volatile swings in the stock market depending on the news of the day.
But Trump holds the superior hand as far as trade goes.
China exports far more to the US than the US exports to China, so China has far more to lose in the trade war.
Since the trade war began, the US has suffered only minor impacts, while the impact on China has been overwhelming.
The new tariffs will have even more serious effects on the Chinese economy.
A 25% tariff on US$200 billion of goods could take 0.3-0.4% off Chinese growth.
And if Trump carries through with 25% tariffs on an additional US$300 billion of Chinese goods, it could subtract an additional 0.5% from Chinese growth.
That would cost China 0.8-1% of lost GDP at a time when the Chinese economy is struggling and can least afford it.
To go along with slowing growth, the Chinese financial sector is totally insolvent.
Consumers’ savings have been used to finance ghost cities, white elephants, capital flight, Ponzi schemes, bribes and kickbacks.
There are some real assets to show (their trains are the best in the world) and some growth, but not nearly enough to cover liabilities.
With a debt-to-GDP ratio of about 250%, China is already well into the danger zone. How much more debt-financed stimulus can it take?
Research by economists Kenneth Rogoff and Carmen Reinhart indicates that debt-to-GDP becomes a drag on the economy at 90%.
China’s leadership can only hope the damage can be limited before the people begin to question its legitimacy.
China’s leadership lose ‘The Mandate of Heaven’.
All the best,