On a sunny spring day in Florida, a crisis was averted. Being wined, dined and most importantly serenaded by the President of the United States’ granddaughter in Mandarin, Chinese President Xi Jinping appeared to have made a strong connection with US President Donald Trump.

Both men following the meeting at President Trump’s Mar-a-Lago resort had agreed to a 100-day assessment of the trade imbalance between the two countries, including a pledge from President Xi to give  US companies better access to key industries including consumer staples. A sense of cooperation was in the air.

Fast-forward a year later and both China and the US are in the midst of a growing trade war kicked off by President Trump’s March 2018 decision to place a 25% and 10% tariff on steel and aluminum products, respectively, from China. As of September the US has imposed a 25% tariff on US$50 billion worth of Chinese exports including electronics, machinery and chemicals. In response the Chinese government has imposed their own tariffs on fruits, pork, soybean and more coming from the US.

 

“Most macroeconomic models predict that the impact of a trade war would be significant, but manageable. It would act as a supply shock resulting in lower global output and temporarily higher inflation. According to recent estimates, a full-fledged trade war would result in a 2-3% reduction of the world GDP over a few years, depending on the assumptions on tariffs,” expresses Silvia Dall’ Angelo, senior economist at Hermes Investment Management.

While the moves by both nations have obvious repercussions on average consumers in their particular economies, the emergence of tit-for-tat tariffs could redefine current supply chains and disrupt trade finance. According to a recent Fitch Ratings report, the growing global trade tensions could weaken the operating environment for banks in the Asia-Pacific region by reducing the demand for export finance.

“The trade war could create strains for borrowers operating in sectors targeted by tariffs. Chinese export-oriented firms that manufacture electronic or automotive components, furniture or consumer electronics are likely to be among the most affected,” states the Fitch Ratings report.

Trade finance revenue has long been a woe for several financial institutions. According to data analytics firm Coalition Development, global trade finance revenues in 2017 fell for the fifth straight year to US$26.6 billion from a high of close to US$40 billion recorded in 2012.

Moreover, the manufacturing supply chain, which for close two decades has been primarily embedded in China, is in store for a shift. According to manager of a foreign-owned company based in Guangdong province, the last several months following President Trump’s first round of tariffs on Chinese imports prompted manufacturers to front-end their production. “In the last five to six months it has become almost impossible to place your items on a ship. People want to get their goods into the US before new tariffs come into place,” explains the manager.

Markets such as India, Vietnam, Bangladesh and Cambodia have been cited as new areas for traditionally China-based manufacturers to consider. In May Samsung dissolved its factory in Shenzhen, China and concurrently inaugurated its new mobile factory in India.

“We need to remember that these [manufacturing location] decisions are not purely because of President Trump. The TPP (Trans-Pacific Partnership) and growing cost of labour and regulation in China offered opportunities where Southeast Asia and South Asia became particularly attractive compared to China in production,” explains Winnie King, a specialist in Chinese international political economy and international relations at the University of Bristol.

China is also using the current trade dispute to reexamine its export markets. After the conclusion of the China-Africa Cooperation in early September, African leaders along with President Xi, committed to opening up further trade between the two geographies. China’s value of trade with the continent between January-July 2018 grew 20% compared to last year. Exports to Africa were valued at US$59.3 billion, a 10% year-on-year increase. 

Other markets likewise in the Asia region have opted to find alternative trading partners in the event that the US targets them with tariffs. Indonesia for instance has in recent months forged closer economic ties with China and South Korea. Meeting in early September, Indonesian President Joko “Jokowi” Widodo and South Korean President Moon Jae-in agreed to target a bilateral trade value of US$30 billion by 2022. In 2017 bilateral trade between the two nations was US$17 billion. “One thing that has come out from the trade war is that there are alternatives for both China and the United States,” notes King.

 

Though the world is going through a phase of increased trade protectionism, there is a clear indication that the recent US tariffs are not necessarily having their intended effect.

Harley Davidson, the iconic American motorcycle manufacturer,  has decided to move its production facilities outside the US. It was a bold move for the company,  which wanted to avoid the cost of imported steel and aluminum imposed by President Trump and the European Union tariffs slapped on US-made motorcycles.

The tariffs have also done little to reduce the current Chinese trade surplus with the US. In August 2018, China had a US$31.05 billion surplus compared to US$28.09 billion recorded in July 2018.

“We think the trade war will hurt China’s exports, but not be damaging enough for China to agree with all the terms that the US demands. China may wait to observe how the new round of tariffs will affect the US. The trade war so far has had little impact on US consumers, but our analysis shows this may change soon,” says Deutsche Bank chief economist Zhiwei Zhang. 

The Chinese response as of now, despite the fiery US rhetoric,  is to match the US and focus on its own domestic levers to counter any negative US trade war effects. This includes letting the renminbi depreciate to as low as 7.4 to the US dollar, according to analysts.

“Valued at current exchange rates, China has a US$12 trillion economy. A 10% US tariff on US$200 billion worth of Chinese goods will probably erase about 0.1-0.2% from GDP. A 25% tariff could widen that to 0.3-0.4% of GDP, all else being equal. The good news for China is that all else aren’t equal. China can counter some of the negative impact by allowing its currency to fall and the renminbi is already down by about 9% since mid-April,” shares Erik Norland, senior economist at CME Group.

“Moreover, China has other tools at its disposal, including monetary and fiscal stimulus. A tax cut will go into effect in September and the People’s Bank of China (PBoC) has already reduced its reserve requirement ratio twice in the past four months. As such, some of the negative GDP impact can be partially offset, at least in the short run,” he adds.

Since he took office in 2017, President Trump has repeatedly assured the US public especially his Republican base that they are “winning” under the current tariffs. However, a true validation of President Trump’s actions will be reflected in this November’s mid-terms where Americans have the ability to restructure the makeup of Congress effecting the US President’s economic policy.  

A more pointed Chinese economic response to President Trump may come after the mid-terms if the Republicans do well. “China doesn’t want to escalate, but it will not compromise on its growth. China won’t fold to pressure from President Trump. China is keeping its cards close to its chest,” shares King. “What we would really normally see by this time when it comes to diplomatic tensions or political economic tensions is that China will bring in the issue of nationalism in national rhetoric.”

That sense of Chinese economic nationalism was on display last year when South Korea installed a US-made anti-missile also known as THAAD (Terminal High Altitude Area Defense) to guard against North Korean threats. That action also seen as a threat to China prompted the country’s national tourism administration to ban organized tour groups to South Korea. Chinese tourists represent around half of foreign visitors to South Korea. However, during the diplomatic dispute, Chinese tourists visiting the country dropped by 60%.

In the past China has directed a boycott of mangos and bananas from the Philippines over the South China Sea and salmon from Norway over human rights issues. Until now China hasn’t publicly voiced a similar approach relating to US goods.

Having already tariffed US$50 billion worth of Chinese exports, President Trump has his sights on more drastic measures to increase the urgency of trade talks. This month the US President aims to apply a 10% tariff on US$200 billion worth of Chinese goods with the condition that the amount will increase to 25% if there is no agreement by year-end.  A good portion of the Chinese imports to be targeted will be consumer goods.

There is no question that negotiations between China and the US will be testy at times. Unlike President Trump’s recent trade disagreements with Canada and Mexico, the US has never signed a free-trade agreement with China.

Without that historic precedent finding some sort of agreement between the world’s two largest economies may be hard to come by. Nevertheless, the supply chain of many companies is being redefined whether it be the traditional manufacturing plants moving to Vietnam or Chinese companies opting to source soy beans from Brazil.