June 2018

The trade war between the US and China is heating up, says Deutsche Bank China economists Zhiwei Zhang and Yi Xiong as they share their outlook on the impacts and outcomes of the most recent US escalation of trade hostilities

“President Trump announced that he has asked his team to work on a plan to impose a 10% tariff on US$200bn worth of Chinese exports to the US. If China retaliates again, the US side would impose a tariff on another list of Chinese exports worth US$200bn,” explains Zhang. China’s Ministry of Commerce has issued a short statement which promised to retaliate with "comprehensive quantitative and qualitative measures" if the US imposes more tariffs.

Impact and risk

If the trade war escalates to include US$200bn of Chinese exports at a tariff rate of 10%, it would have a meaningful impact on both sides. Zhang’s team expects the cumulative impact on China’s GDP growth would be 0.2-0.3 percentage points (that is, including the impact of a 25% tariff on the first U$50bn Chinese exports).

"This impact is close to our earlier estimates, which assumed a 25% tariff on US$100bn of Chinese exports. The products affected would likely include consumer goods, which the US government so far has been carefully trying to avoid hitting (see Figure 1)."

US’s next tariff targets
Figure 1: What could become the US’s next tariff targets – major Chinese exports to the US
The big question is whether China will move beyond trade and target US business interests in China. Deutsche Bank analysts estimate that US firms sold US$448bn worth of goods and services to China in 2017, US$168bn through trade and US$280bn through local operations by US subsidiaries in China. China has not officially threatened to target US firms in China, but as trade tensions build up the risks are rising.

Tariff components

On Friday 15 June, the US administration announced a 25% tariff on the final list of 1,102 lines of products imported from China, worth US$50bn in total. This action follows the US Section 301 investigation on China that was concluded in March, and an earlier tariff list announced in April. The US and China subsequently entered into trade talks, and by mid-May the trade war was largely "on hold", as described by US Treasury Secretary Steven Mnuchin. But a White House statement on 29 May put tariffs back onto the table.

The tariff will be implemented in two stages:

  1. The tariff on 818 lines of products worth some US$34bn, all from the April list, will be imposed on July 6; and
  2. An additional 284 lines worth US$16bn will undergo further review and public consultation before being implemented.

Six hours after the US announcement, China posted its retaliation measures (Saturday 1:30am Beijing time):

  1. A 25% tariff on a first list of US$34bn US agricultural products and automobiles, effective 6 July; and
  2. A 25% tariff on a second list of US$16bn US oil and gas, chemical products and medical instruments, to be implemented at a later stage. China also reiterated that any deals the two countries reached in recent negotiations will be voided on the day that the US actually implements the tariff list.

What's new in the latest tariff lists?

Compared to the initial US tariff list of 1,333 lines in April, 515 lines were cut from the new list, their value totalling US$16bn. They are replaced by a new list of 284 products. According to USTR, the new list "does not include goods commonly purchased by American consumers such as cellular telephones or televisions".

  • The 515 dropped items are mainly consumer products and/or their parts, such as TVs, printers and copying machines, air conditioners, dishwashers, and medical supplies. Aluminum plates and steel nuts, which are commonly used by US consumer goods manufacturers, are also among the dropped items.
  • The 284 new items are largely intermediate goods, and particularly semiconductors, electronic integrated circuits, electric motors, and industrial materials.

The US strategy appears to prefer taxing intermediate/capital goods over consumer goods (see Figure 2). The US also aims to target products "related to the 'Made in China 2025' initiative".

Proposed US tariffs on non-consumer goods
Figure 2: Proposed US tariffs are mainly on non-consumer goods

Geopolitical tensions may rise again

China may feel that they helped the US have a successful summit meeting with North Korea, but got punished right afterward. This may have implications for geopolitical relations in the region. There have been big swings in policies on both the US and North Korea sides in the past 12 months, and further escalation of a trade war would likely have a negative impact on the geopolitical risk in the Korean peninsula.

"We expect China to loosen policies", says Zhang. If trade war goes into a second round, China could:

  • Tolerate the property and land market boom in Tier 3 cities, potentially loosening controls in some Tier 2 cities, and raising mortgage loans quotas for banks;
  • Cut the reserve requirement ratio (RRR) twice during the rest of 2018; and
  • Raise central government transfers to cities suffering from the worst economic performance.

Note: this article is based on two reports, ‘Second round of trade war is looming’ (19 June 2018) and ‘First round of trade war manageable, second round could be much worse’ (18 June 2018) by Dr Zhiwei Zhang, Ph.D, Chief Economist, China, and Dr Yi Xiong, Economist, China, from Deutsche Bank Research. Read more at db.com.

Past performance is not indicative of future returns. Forecasts are based on assumptions, estimates, opinions and hypothetical models or analysis, which may prove to be incorrect

Dr Zhiwei Zhang

Chief Economist, China | Deutsche Bank

Dr Zhiwei Zhang

Dr Yi Xiong

Economist, China | Deutsche Bank

Dr Yi Xiong

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