MIZUHO SECURITIES ASIA LTD. | ECONOMICS RESEARCH
On 10 February, US President Donald Trump had a telephone conversation with Chinese leader Xi Jinping. It was characterised by both sides as ‘cordial’, with President Trump reaffirming the ‘One China’ policy. This is the first positive sign regarding Sino-US relations since Mr. Trump took office on 20 January. However, given the protectionist comments he has made to date and the hawkish views of his cabinet choices regarding China, the probability of a potential trade war may not be small even though China and the US are mutually dependent in many respects. For a comprehensive review, we count the cost of a trade war to the Chinese economy, the cost to the US as China inevitably retaliates, the lessons learned from trade friction between the US and Japan in the 1970s-1990s, and finally we examine China’s best defence—its huge domestic market.
- First, as China runs a significant trade surplus with the US, which accounted for 18% of total Chinese exports and 3.7% of China’s GDP in 2015, a potential trade war with the US would represent a demand shock for China’s economy. China relies on some key hi-tech products produced only in the US, and many Chinese companies look to tap the US capital markets to raise funds. Subsequent to a trade war, growth in China would slow and the unemployment rate could rise with deflationary pressure. China’s government may need to stimulate the economy more aggressively, which could worsen structural problems.
- Second, the cost to the US would also be hefty when China inevitably retaliates. China accounts for 21.8% of total US imports, especially for labour-intensive products. It would be difficult to replace Chinese products in the short run, and a trade war could mean higher inflation in the US. With extensive connections in the production chain, the US’s service export surplus with China, and strong investment from China into the US, we think a trade war would lead to job losses rather than job creation in the US.
- Third, we think China should refer to Japan’s experience with US trade protectionism in the 1970s-1990s by opening its domestic market, shifting some production to the US, and even implementing self-imposed voluntary export quotas. However, the lessons learned from the Plaza Accord suggest that China should avoid relying heavily on exchange rate adjustments to lower its trade surplus, nor should it over-stimulate its economy in reaction, particularly when a housing bubble is already a concern.
- Finally, instead of rushing to react to punitive measures from the US side, we believe China should take stock of its options and identify the possible opportunities that arise from trade sanctions by the US. In our view, China’s powerful domestic market is the best defence against a trade war, as it would be difficult for the US to ignore the cost of losing a big market for its products. China could seek to advance its reforms and its opening-up agenda, which could make the economy more efficient and demonstrate a model of ‘inclusive globalization.’