SANCTION AEROBATICS

This year marks the fortieth anniversary of normalised relations between the U.S. and Beijing; for the first time since the founding of the People's Republic of China in 1949. Chinese leader Deng Xiaoping believed the U.S. is the only country, which could help China carry out economic reforms after many years of isolation and destruction caused by the Chinese Cultural Revolution.

During this time, mutual trade and investment grew rapidly, and the two economies became deeply integrated with each other. China is now an important export market for many U.S. companies - from high-tech manufacturers to soybean farmers.

However, the relationship between the two giant economies, which has become aggravated again since 2018, has consequently turned into a trade war.

Made in China

In 2017, trade turnout between the U.S. and China reached $710.4 billion. China, which imports American goods for $187.5 billion and exports for $522.9 billion, is the third foreign trade partner of the U.S. after Mexico and Canada. With U.S. treasury bonds worth $1.1 trillion, China has long been the largest foreign creditor to the United States.

Many U.S. companies dominate their segments in the Chinese economy. For example, KFC has 40% of the Chinese market, General Motors - 12.8%, Boeing, Coca-Cola/Sprite, Procter&Gamble and Apple - more than 50%, Microsoft - 99.3% of the operating system market.

In turn, Chinese companies are active in the U.S. market. According to forecasts, by 2020 the volume of Chinese investment could reach $200 billion, which means about 400 thousand new jobs.

This is not to say that 40 years of cooperation between the two countries were rosy. But it was close mutually beneficial economic relations that helped resolve political and military conflicts. Moreover, until 2009, the U.S. viewed China not as an equal, but a worthy partner in order to divide the world with it into spheres of influence. In that year, Washington proposed Beijing to create a “club of two leaders” G2, but the proposal was refused.

Some time passed, Washington’s attitude to Beijing began to change. In 2012, in the updated National Defense Strategy of the United States, China is no longer called a partner, but a potential adversary who significantly affects the U.S. economy and security.

The U.S. has become increasingly vocal with China’s trade and economic policies, including the practice of forced technology transfer and theft of U.S. trade secrets. Washington also began to insist on restricting subsidies for Chinese state-owned enterprises and simplifying access for U.S. companies to Chinese markets.

The objective of the new national strategy Made in China until 2025 announced in 2015 is to make China a world leader in modern technologies. This and the One Belt, One Way initiative (New Silk Road) alarmed the West seriously, since all these events took place amidst sharp increase in China’s military potential, including by building up its naval and air forces in the Taiwan Strait and the South China Sea.

Therefore, the election promises of Donald Trump to reconsider economic and other relations with China radically were somewhat expected. It seemed quite logical that Trump accused his predecessors of not having enough courage to do the same before him.

Vain expectations

After the new U.S. President met with PRC Chairman Xi Jinping in 2017, it seemed that the leaders of the two countries found a common language in resolving issues related to trade and economic cooperation, because they agreed to “overcome differences on the basis of mutual respect,” White House statement said.

However, in March 2018, Trump signed Memorandum Targeting China's Economic Aggression and imposed 25% tariffs on Chinese goods: at $3 billion, $16 billion, $50 billion... China responded immediately and on parity terms. In September, the U.S. imposed 10 percent tariffs immediately on $200 billion, promising to raise tariffs to 25% from January 2018. China’s response was $60 billion.

The temporary truce came in December after a meeting on the margins of the G20 summit, when an agreement was reached to “immediately begin negotiations on structural changes relating to the forced transfer of technology, protection of intellectual property, non-tariff barriers, cyber interference, services and agriculture”. For the period of the negotiations, Trump promised not to raise tariffs.

After several months of difficult negotiations (in March) during which Donald Trump has repeatedly tried to fulfil his threating promises, it was reported that China had agreed to “unprecedented” concessions. It pledges to ensure the protection of intellectual property, including by amending Chinese patent laws, to prohibit the forced transfer of technology, to open domestic markets even more, to reduce state subsidies and to embark on other structural reforms.

China has announced its readiness to reconsider the highest tariffs on imports from the United States, for example, cars that make up 40% of Chinese sanctions package, and also to prevent sudden depreciation of the national currency, yuan. Both sides agreed to cooperate on cyber-security issues. But China demanded the immediate abolition of all duties as soon as the agreement becomes effective. Trump also said that tariffs will remain in force “for a long time” as a guarantor of compliance with the agreement.

Negotiations again come to a standstill, and a month later, China cancels all agreements.

Immediately, the U.S. president raised tariffs on Chinese imports by 25% ($200 billion) and threatened to extend the sanctions package to $325 billion on the remaining Chinese goods.

Risk for president

According to Wall Street economists, the current increase in tariffs will become a lever of influence on Beijing, perhaps in the short term, but could provoke a protracted trade war, which will adversely affect the U.S. economy. However, Trump and his advisers are confident that tariffs will damage China’s economy more than the United States, and ultimately force China to return to the negotiating table.

Nevertheless, the aggravation of economic relations with China is a huge risk for the president, who constantly advertises the growing economy and the stock market as evidence of the success of his presidency.

According to the International Monetary Fund, escalation of the trade war will undermine the economy of China, the U.S. and the world as a whole, with the decrease of U.S. GDP by 0.6%. Moody's warns of a possible recession in the U.S. economy by the end of 2020 in the absence of an agreement with China. More pessimistic forecasts promise a recession later this year.

The executives of 67% of American industrial companies surveyed in April responded that duties had increased costs, 50% admitted that they had to raise prices, but sales fell by 42%. Only 1% of respondents reported that they benefited from a trade war.

According to studies, the new 25% tariff, combined with earlier duties, will reduce employment in the U.S. by 934 thousand people and cost the average family of 4 people $767 a year. If a 25% tariff for the remaining imports of $325 billion is introduced, 2.1 million jobs will be cut in total, while an average American family will lose more than $2,000 a year.

Chinas possible response

China's GDP growth forecast for 2019 has also been reduced from 6.4% to 6.2%, and if the trade war gains momentum, it can be less than 6%.

Industry growth in January was the lowest in the last 17 years and amounted to only 5.3%. Automobile manufacturers, whose profits fell by 42%, and electronics, minus 21.6%, suffered the most. The fall in profits will complicate debt service, the total amount of which exceeds $30 trillion. Unemployment increased as well (up to 5.3%).

Such a serious situation forced President Xi to admit that China should prepare for difficult times as the international situation becomes more complex.

By and large, China has not a wide choice for response. Its foreign exchange reserves reach more than $3 trillion, $ 1.1 billion of which are invested in U.S. treasury bills. But it certainly will not make a one-time reset on the foreign exchange market, since it is not interested in a sharp fall in the American economy not only because China still has almost $2 trillion in bonds.

Many are afraid that Beijing may use its dominant position as a supplier of rare earth elements in the trade war against the United States. China owns 37% of the explored world reserves of rare-earth elements, which accounts for 81% of the world production of rare-earth metals. 80% of U.S. imports of these metals come from China.

Rare earth elements are used in a wide range of consumer products from iPhones to electric vehicles, as well as military jet engines, satellites and lasers.

While heavily dependent on these supplies, the U.S. still does not impose duties on them. But China has already decided to experiment. Mountain Pass Mine in California is the only place in the U.S. where rare earth elements are extracted. There is no processing capacity in the country, so 50 thousand tons of concentrates are sent annually for processing to China. Beijing has already introduced a 25 percent tariff on these imported products.

According to many economists, China is likely to use the most effective option by letting yuan to depreciate against the U.S. dollar. This not only compensates for the negative impact of high tariffs, but also negates all attempts by the Trump administration to achieve competitive conditions for the American products in the Chinese market.

Everyone will suffer

G20 summit will be held in Japan on June 28-29. It is expected that the leaders of the U.S. and China will discuss the situation during the event. According to the U.S. Treasury Secretary Stephen Mnuchin, Washington will not raise tariffs for the remaining Chinese imports ($325 billion) until that time.

Both administrations say they are open for negotiations. However, they are only possible and successful if both sides compromise. Both parties must be prepared for it. Otherwise, "the consequences for the entire international trade system will be extremely negative," Pamela Cook-Hamilton, head of the international trade department at UNCTAD, said. Especially for the developing countries.