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Don’t Freak Out About A Trade War With China Yet

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Early last week, the Trump administration announced a plan to slap 25 percent punitive tariffs on about $50 billion worth of Chinese imports across 1,300 categories of products. China wasted no time to unveil its own retaliation plan which will also impose 25 percent tariffs on a list of over 100 goods it imports from the U.S., and China warned that “Washington must pay a dear price for the trade war.” The Dow Industrial Average Index dropped more than 500 points on Wednesday when the tit for tat import tariff plans of both countries hit the news wire.

On Thursday, President Trump upped the ante by saying that he is considering slapping tariffs on another $100 billion in Chinese imports. The spokesman for the Chinese Commerce Ministry vowed the next day that “China is fully prepared to hit back forcefully and without hesitation.” Are the U.S. and China, the world’s largest and the second largest economies destined for a trade war? Some investors seemed to think so and their panic selling pushed the Dow Industrial Average Index down more than 500 points on Friday.

Yet such panic selling is premature. The mainstream media treats everything Trump does as one step away from the next apocalypse. But there are reasons we shouldn’t freak out about the so-called China-U.S. trade war.

No Timeline for When These Tariffs Become Effective

The Trump administration gives businesses until May 21st to make public comments on the first $50 billion tariff package. After the public comments period, the administration still has 180 days to decide whether to actually implement the tariffs at all. Thus, the administration has given itself plenty of time for behind the scene trade negotiations. This approach fits Trump’s negotiation style: anchoring in an extreme position before a negotiation starts.

Similarly, while Beijing announced it will counter every American trade retaliation with its own, Beijing hasn’t announced any timeline to implement its current tariff proposal. In the meantime, Chinese Preimier Li Keqiang pledged recently to “open up some service sectors, remove equity caps on foreign firms in some areas and end forced technology transfer in manufacture sector.” Such a pledge seems to indicate that China is willing to make certain concessions amid the threat of a trade war with the U.S.

No deadline is a good indication that while both sides are keeping up the war of words, neither side wants to actually rock the boat, probably because both sides recognize that going into an actual trade war is a lose-lose situation for both countries.

Limited Economic Impact

For the U.S. side, the items the Chinese chose to impose an additional 25 percent tariff on include soybeans, airplanes and cars. Commerce secretary Wilbur Ross Wilbur Ross says China’s new tariffs do not represent a threat to the United States because the estimated economic impact amounts to 0.3 percent of the 2017 U.S. GDP.

Some U.S. products on the list actually won’t experience much pain at all. For example, U.S. auto exports to China are already subject to a 25 percent tariff. To avoid paying this tariff and also to meet China’s requirement of having local partners, most U.S. auto makers, except Tesla, have set up joint ventures in China and have held only minority stakes for decades. The U.S. brand cars sold in China are made in China. Therefore, any move to impose more tariffs on U.S. auto imports by China won’t hurt Detroit very much.

It seems the Chinese chose this list aiming for the political impact rather than an economic impact. According to The Washington Post, soybean-producing counties went for Trump by a margin of more than 12 percent. Many of these soy farmers count on exports to China to make ends meet, since China buys 60 percent of all U.S. soybean exports to feed its livestock. By targeting soybean imports, the Chinese are hoping soy farmers will apply enough political pressure to the Trump administration to back off from attempting any trade war with China.

For the Chinese, the Trump administration’s list of the 1,300 items aims to target China’s aspirations — products that benefit most from favorable Chinese industrial policies and the sectors in which China aspires to become global leaders according to its “Made in China 2025” industrial plan. For example, one of the items the U.S. plans to impose tariffs on is made-in-China electric cars. But the U.S. currently doesn’t import electric cars from China. It was chosen because the Chinese government hopes to be a global leader in electric cars and has invested heavily in this sector. So the Trump administration included it to send a message that if China doesn’t change its harmful trade practices, China’s future will suffer. Chinese experts estimate that if the Trump administration moves ahead with its latest plan, the current economic impact will amount to 0.4 percent of its 2017 GDP and China will have no problem absorbing it.

The small negative economic impacts of both countries’ tariff plans is another good indication that neither side is serious about going into an actual trade war. Both sides are setting up negotiating positions and letting the other side know where it can hurt.

Understand Trump’s Pragmatism

Many economists who criticize Trump’s obsession over the trade deficit and his attempt to fix it by using tariffs are right. The late Milton Friedman, one of the most influential economists of the 20th century, explained why. But almost all Trump’s critics seem to forget that Trump is incredibly flexible in his positions. As Holman Jenkins points out in one of his columns with The Wall Street Journal, “Trump is always ready to be best friends tomorrow with whomever he’s at war with today. ”

The most recent example is with Kim Jong Un of North Korea. Last year, Trump engaged in a very public war of words with Kim, promising “fire and fury” and bragging his nuclear button is bigger than Kim’s. The rest of the world was in a panic mode, as if a nuclear war between the U.S. and North Korea is imminent. However, as soon as Kim Jong Un offered to talk through the South Korea convoy, Trump shocked the world by agreeing to it without much hesitation. Now the planning of the first ever leader summit between the U.S. and North Korea is under way.

So, I don’t think we should freak out about a potential trade war between China and the U.S. At least not yet. Putting aside the rhetoric from both sides, the most likely outcome is the two sides will negotiate and both sides will come to some kind of compromise.

Trump Shouldn’t Overplay His Hand

Many people consider Trump the wild card here. But Trump has been very clear about what he wants to achieve — reducing the U.S. trade deficit with China by $100 billion and having China rein in its bad trade behaviors, such as forced intellectual property sharing and business espionage.

To me the real wild card here is China’s President Xi. President Xi is a strong man. He recently became China’s first president for life after a coerced constitutional change which removed the term limit for his presidency. He believes that it has been his destiny to make China great again and the last thing he is willing to do is to appear weak to fellow Chinese people back home.

Therefore, it’s unclear how many trade concessions he is willing to make. Xi is scheduled to give a speech at this week’s Boao Forum, which is supposed to be the Chinese version of the Davos Economic forum. What he says may give indications of if and how many concessions he is willing to make. For example, if he announces any policy measures to further open up China and increase foreign companies access, that’s a good indication that he may give Trump something he wants in order to avoid a full-on trade war.

There is no doubt that Trump is playing a high stakes bluffing game. He also needs to be careful not to over play his hand. Almost all foreigners who want to do business in China have learned an important Chinese culture concept — face (mianzi), which refers to dignity and prestige of a person. For the Chinese, causing someone to lose face on purpose and in public can make an enemy for life and is at the root of many conflicts.

If Trump keeps pounding on China with talks of tariffs and unfair trade practices so openly and constantly, President Xi may feel that he has to save face by not making any concessions. An all-out trade war between China and the U.S. is bad for economies of both countries and for the rest of the world. Trump also needs to think about the political impact of a down stock market on the midterm election for his fellow Republicans. So he may want to take a break from his rhetoric and let U.S. and Chinese trade representatives negotiate.