Many of the proposals or suggestions on how China could respond to US tariffs have the air of "surrendering or I will shoot myself in the foot". Not only will they harm China, but they will damage the country's campaign to establish itself as a financial power and will hinder the use of the yuan as a reserve currency.
China may use talks on these steps to make the Trump administration more flexible, but Beijing is unlikely to be able to comply.
The proposals that have been submitted include:
- Depreciating the yuan.
- Sell United States Treasury bonds.
- Sell US stocks.
- Place tariffs on United States oil exports along with soy.
- exports of services from the United States.
- Displacement of United States tariffs with subsidies to Chinese exporters.
Some of these would be difficult to accomplish simultaneously, pushing in opposite directions. The temptation to fight in the financial markets is there. Exports of Chinese goods to the United States represent approximately 4.25 percent of the gross domestic product, while the United States. UU They export around 0.65 percent of the US GDP to China. It seems plausible that China threatens to retaliate in financial markets, but the threat is less convincing when China itself would be seriously affected.
The key problem is that these financial measures cause as much harm to China as to the US. US, and several of them cause tremendous damage to China's neighbors and emerging market countries that Beijing is looking to make the yuan an international currency. 19659002] The last time China significantly depreciated its currency, in August 2015, triggered a sequence of cascading falls in emerging markets and an increase in asset volatility. That was caused by a mere 2 percent depreciation of the yuan. Depreciation would have to be much greater to have an impact on trade. The widening of the range of countries and markets of assets that are affected by a bilateral trade dispute will make China receive strong criticism from countries that might otherwise be its partners.
Similarly, sell US Treasury bonds. UU It is a problem for both China and emerging markets. US Treasury yields UU They tend to lead the Chinese returns, as shown in the first table below. The co-movements are not identical, but they are close enough to be very significant. In addition, an increase in the yields of the EE. UU It would spread globally. The People's Bank of China could change domestic policy to compensate for this, but that would not isolate the rest of the emerging markets and even the developed world. China will get neither sympathy nor gratitude for pushing the world's highest interest rates.
Nor is the Chinese stock market isolated from Wall Street. The two have moved together to a large extent since the trade began to top the agenda, as evidenced by the second table below. If you are going to tank US stocks UU., It is difficult to avoid throwing yours and your neighbor's.
The monetary implications are uncertain. Sell US Treasury bonds UU And buying European bonds or Japanese assets will likely weaken the dollar, pushing down China's own currency. Emerging market currencies would probably follow suit and decline against the euro and the yen. If China were to boycott the US Treasury auctions U.S., Even for symbolism, the dollar would fall sharply even though US yields. They went up The trade deficit of the United States still needs to be financed and the dollar would slide until the funds emerged.
Preventing US exports of oil or services would be a nuisance, but oil is quite fungible. The announcement would affect West Texas Intermediate, the type of oil produced, refined and consumed in North America. But the impact is likely to be determined relatively quickly, since China bought in other markets. It is likely that some hydrocarbons from the United States will end up being re-exported from third countries. The United States has a trade surplus in services, but it is relatively small compared to the trade deficit of goods. Much of the surplus of services goes to travel and intellectual property, areas where interference would be unpopular or harmful.
The Chinese government's reimbursement to its exporters for additional tariffs is the most benign measure that Beijing could take. Part of the reimbursement could be financed by the tariffs that China raised in US companies. UU This would have the least impact on bilateral trade and minimal international spillover and asset markets. It could become a fiscal problem in China (and the US, in case Washington did the same), but it could serve to remind us that there is more at stake than rhetoric.
In short, China is more likely to threaten retaliation through the financial markets that actually carry it out. If China were to act on the threats, the country could do more harm to its aspirations to an international yuan than any plausible gains that could arise.
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Daniel Moss on dmoss @ bloomberg.net