Trump and China: Truce or no truce, are we back at trade war?

Amid President Donald Trump’s intense political pressure and persistent market expectations, the policymaking Federal Open Market Committee (FOMC) on 31 July dropped the target range for its overnight lending rate to 2% to 2.25%, or 25 basis points lower than the previous level. It was the first rate cut by the Fed since December 2008.

In approving the cut, the FOMC cited “implications of global developments for the economic outlook as well as muted inflation pressures”. The Committee called the current state of growth “moderate” and the labour market “strong”, but decided to loosen policy anyway. The Committee insisted that this rate cut is an insurance policy not against what’s wrong with the economy now, but what could go wrong in the future.

The Committee went on to describe the move as a “mid-cycle adjustment” and indicated they not see the type of marked economic weakness that would necessitate a longer rate-cutting cycle. Could this “mid-cycle adjustment” be the Committee essentially succumbing to the intense political pressure from Trump? Perhaps not, given the independence of the central bank, as its monetary policy decisions do not have to be approved by the President or anyone else in the executive or legislative branches of government.

Call it coincidence or perfect timing, a day after FOMC cut rates, President Donald Trump signalled that he would hike tariffs on Chinese imports beginning September, a complete turn from the trade war truce that President Trump and President Xi agreed at the G‑20 summit towards the end of June. President Trump warned he could “always do much more” with respect to tariffs, adding the 10% tax could go “well beyond 25 percent” if necessary, inevitably escalating the trade war with Beijing.

The existing 25% tariff on $250 billion of Chinese imports, as well as duties on imported appliances, steel and aluminium, is already set to reduce economic growth by three-tenths of a percentage point next year according to market analysts. The proposed tariff on $300 billion in Chinese shipments would shave off another 10th, cutting growth by nearly half a percentage point to 1.7 percent.

Before this latest announcement, the average tariff on Chinese goods imported to the US was 18.3%, up from 3.1% in 2017 (according to the Peterson Institute for International Economics). After – and if – the new round takes effect, the average tariff will rise to 21.5%. This looks like Washington and Beijing are back at war.

What happened to the trade war truce?

Beijing responded to President Trump’s threat in two ways, firstly by letting its currency, the Chinese renminbi, sink to the weakest level in over a decade, a position the People’s Bank of China (PBOC), the country’s central bank, denied. It claimed that the drop was market-based.

The timing of this market reaction came just a day after Washington signalled that the trade war truce was broken.

The renminbi weakened to worse than seven per US dollar, hitting its lowest level since 2008, as Beijing looks to cushion the blow from Trump’s tariffs. A weaker yuan makes Chinese goods cheaper for overseas buyers, which may be necessary as China just lost its spot as the US’s biggest trading partner. The latest trade data released by the Department of Commerce showed that US imports from China fell by 12% in the first six months of the year, allowing Mexico to supplant it as the US’s biggest trade partner.

The cheaper the renminbi relative to the US dollar, the more attractive Chinese exports seem to Americans and the more expensive US exports become to the Chinese, thus tilting the balance of trade. Trump has long complained that the renminbi is too weak and the dollar too strong. He has lobbied the Federal Reserve to cut interest rates to help US exporters and boost the US stock market.

China, for its part, has argued that it has kept its currency at a reasonably high level to assuage US concerns (the currency pair used to trade above 8 before 2006 for a period of time). It has also feared that a tumbling currency could spark panic about its slowing economy and trigger an outflow of capital.

Secondly, Beijing told state-controlled buyers to halt all purchases of US agricultural imports; a direct hit mainly to the soybean farmers in Midwestern (Trump) states. President Trump claimed in June that Chinese President Xi Jinping had agreed to large amounts of agricultural purchases. Additionally, Trump’s administration last month announced a $16 billion aid package for US farmers. President Trump says the new 10% tariffs are the result of President Xi not making those purportedly agreed upon purchases. Although China claims it’s not true that it halted buying agricultural products, Bloomberg news reported that China intends to wait and see how trade negotiations play out before it makes any purchases.

Reacting to the retaliation from Beijing, President Trump wrote in a tweet, “China dropped the price of their currency to an almost historic low. It’s called ‘currency manipulation.’ Are you listening Federal Reserve? This is a major violation which will greatly weaken China over time!” Indeed, after the US markets closed on 5 August, the US Treasury Department designated China as a currency manipulator. The last time Treasury designated any country as a currency manipulator was in the early 1990s, when China was named.

Are we back at trade war again?

Investors should prepare for another roller-coaster ride; the truce card has just been dropped.

Richard Maparura is a portfolio manager with Butterfield.

Sources: The New York Times, Bloomberg, The Wall Street Journal and CNBC.
Disclaimer: The views expressed are the opinions of the writer and while believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information.