President Donald Trump argues that the US’ record trade deficit is economically damaging and has pledged to reduce it. In 2018, the US had a $419.3bn trade deficit with China and, since 10 May, is applying a 25 per cent tariff on $200bn of Chinese goods.

China retaliated last year with tariffs worth $110bn, covering almost all of its imports from the US, and has threatened to go further. In November, the US halted higher tariffs as the two sides agreed to negotiate.

Talks appeared to be edging toward a deal until the first week of May, when, shortly before a scheduled US meeting with Chinese vice premier Liu He, the US received an amended draft agreement with changed wording deemed unacceptable to the White House.

While any 150-page trade accord would need amendments once translated into Chinese, the US argued that the changes reneged on planned commitments covering industrial subsidies, intellectual property protection and market access.

“They broke the deal. They can’t do that, so they’ll be paying,” Trump told one rally, gearing his statements towards his 2020 bid for re-election. At the same time, US agitation is validating the combative stance of Chinese premier Xi Jinping for his own domestic audience.

‘No rush’

Yet estimates of the damage that the tariffs will inflict on the Chinese economy are between 0.5 per cent and 1.5 per cent of GDP, according to the Washington-based IMF, which warns that the dispute in turn threatens the global economy.

Markets initially fell in response to Trump’s fresh tariff proposals. Then, when the tariffs were confirmed, investors took the optimistic view that, since the duties only apply to shipments loaded from 10 May, there may be a deal in the weeks before companies and consumers in the US start paying for goods arriving at the border.

“China deeply regrets this, and we will have to take necessary countermeasures,” the Chinese Commerce Ministry responded within minutes of the US tariffs coming into effect, without spelling out how it plans to retaliate.

While China stands to lose more in a straight tariff fight, it could choose to retaliate by making it harder for US companies to do business in China. Indeed, the Chinese government has some experience in non-tariff retaliations with both Japan and South Korea.

Trump then tweeted on the same day that “there is absolutely no need to rush” to reach a deal as “these massive payments go directly to the Treasury of the US”.

The US president’s lack of urgency is worrying, however, because the longer the dispute lasts, the greater the risks of wider contagion as companies look to replace existing trade routes.

Rapid escalation

Much of the positive news around a negotiated settlement was already priced-in before Trump’s about-turn, which is why markets fell off so dramatically. Any more bad news may undermine markets further.

Frighteningly for businesses trying to ship between the US and China, the lead-time between the first signs that there was a hiccup with the negotiations and the tariff hike has been less than a week. In the past, the Trump administration signalled increases well in advance.

Of course, the dispute is as much about the geopolitical balance of power as trade. China is trying to manage its transition to a more services-led economy along with falling growth, rising wages and the increased social costs that go with an ageing population.

The US argues that China should provide more support and leadership for the global trading system, and that China’s policies distort many industries.

In November 2017, US trade representative Robert Lighthizer called China’s decade-long plan to modernise the country’s manufacturing capacity “a very, very serious challenge, not just to us, but to Europe, Japan and the global trading system”.

At the same time, China is uniquely dependent on its US exports, which dwarf its shipments through Hong Kong and to the Eurozone.

President Trump has said that “the process has begun” to impose a further 25 per cent tariff on all remaining Chinese imports. Unless the US and China can find face-saving grounds to reach a compromise, this trade row looks like the greatest immediate threat to global economic stability.

About the author

Stephane Monier is chief investment officer at Banque Lombard Odier & Cie