Valdai Club

The confrontation between China and the US that has been escalating for several years reached a new level this August due to the actions of the US administration, which itself is likely to become the first victim, followed by China, the world trade system and the entire global economy.

Since 2012, when Washington started turning its entire war machine to the East, Beijing has been convinced that US global strategy is directed against China. As for Russia, North Korea, Vietnam and Afghanistan, they were seen merely as neighbors that Washington must pressure in order to isolate Beijing from the rest of the world. Beijing views this course as undeclared war and scrutinizes all moves by the White House.

 The only difference is that Beijing, unlike Moscow, can afford to take action (though not necessarily symmetrical) against Washington in response. Russia’s economy is too weak for tit-for-tat escalation, but the country does have an effective diplomatic tool – its categorical refusal to discuss sanctions and conditions for lifting them. The Kremlin’s stance neuters the anti-Russian sanctions as a political tactic.

On August 1, 2019 Donald Trump threatened to impose tariffs on a total of $300 billion worth of Chinese products. Beijing’s response to this threat was unconventional – the value of the Chinese renminbi declined. To some extent, this was due to jittery market players. But the Chinese Central Bank did not object to the devaluation. Currency has become the latest front of the China-US conflict.

This is bad news for the US for two reasons. First, China has openly declared an end to its “strong renminbi” policy that lasted for almost 15 years. Since the start of the Chinese reforms in the 1980s, the exchange rate was eight yuan to one US dollar, and this parity was preserved despite the record Chinese economic growth of the 1990s and its giant foreign trade surplus. Ending the policy of artificially devaluing the renminbi rate following China’s entry into the WTO in December was a major concession by Beijing, which Washington had demanded for many years. Between 2005 and 2014, the rate dropped from 8 to 6 yuan per dollar and has remained thereabouts ever since.

Second, the devaluation of the yuan, whether artificial or due to strictly market processes, poses a macroeconomic threat to Washington. It may lead to a decline in US stock indexes, higher inflation, economic stagnation and even recession. US economic growth has lasted for an unprecedented 117 months. It cannot last forever and so the debate about whether the inevitable landing will be “soft” or “hard” has become universal. China’s actions increase the risk of a hard landing. Escalating the trade war with China ahead of the presidential election in 2020 would be a fatal mistake for Donald Trump. However the conflict plays out exactly, it would inevitably sink the incumbent’s popularity, resulting in the loss of the election or even his party’s nomination.

Beijing still has many reserves for pushing back against Washington. China’s powerful propaganda machine could lead a boycott of American goods, and there is no doubt that it will be supported by hundreds of millions of Chinese citizens. Beijing could escalate the conflict by reducing sales of rare earths on the world market where it essentially has a monopoly (almost 90 percent of scandium, yttrium, lanthanum, cerium, samarium and terbium is produced in China). In the long term, reducing their export will damage the Chinese economy too, but a sharp increase in prices for these metals could deal a major blow to the US automobile and electronic industries ahead of the presidential election. Finally, Beijing may step up the pressure on US companies operating in China, make it harder for them to work on the Chinese market or even demand they exit the market altogether. This would have disastrous consequences for the US stock market.

As such, while China is not happy about the current crisis, it does not yet view it as an existential threat. Since the 19^th Congress of the Communist Party of China in October 2017, the machinery of state has been mobilized to respond to any threats, both domestic and foreign, and it has responded effectively for almost two years now.

We believe the decision to start a new round in the trade war with China is a huge blunder by the Trump administration and could have disastrous consequences. President Trump is trying to reduce the gigantic trade imbalance with China ($419.2 billion in 2018). However, to reach this goal, it is not necessary to destroy the very fragile foundation of current US economic prosperity. Washington should continue working to gradually open the Chinese market to US goods and convince Beijing to buy more from the US. The only alternative is full-scale conflict between the world’s two most powerful economies.