The odds of a full-blown trade war are low, but they just got a little bit higher.
On Friday, China threatened tariffs of up to 25% on $60 billion of U.S. goods, in retaliation for the Trump administration’s latest threat of 25% tariffs on $200 billion of Chinese goods. That was more than double earlier proposals of 10%. That escalation is likely to continue into September, when those tariffs are supposed to go into effect.
All this has money managers, strategists, and economists mapping out the worst-case scenarios. The tit-for-tat over tariffs can only go so far, since China imports just $130 billion while the U.S. imports $505 billion. The primary worry is that China turns to other measures, like letting its currency devalue or taking the battle into the technology sector.
China has used its currency in the past to soften the blow from unfavorable developments—until the rest of the world protests. China-watchers say that this time, the decline in the yuan, down 7% against the dollar in two months, was probably a reaction to market forces, such as a stronger dollar and a weaker Chinese economy. But there’s no question a weaker yuan blunts the impact of tariffs—exporters usually benefit from a weaker currency, since it makes their products cheaper to buy. On Friday, China’s central bank took steps to rein in the yuan’s devaluation and pledged to keep it largely stable, though the yuan right now is at its lowest point in more than a year.
China has been trying to reduce its debt across the board, including cleaning up its state-owned enterprises and shadow banking system. Now, though, strategists are speculating that China will try to stimulate its economy by increasing credit to small businesses and service-oriented companies. That’s worrisome for investors who have long been wary about China’s debt. “The worse-case scenario is that this goes on long enough to push China’s leverage over the brink,” says Michael Kelly, global head of multi-asset at PineBridge Investments.
Next worry? Technology. Some say the trade spat isn’t about deficits, but rather technology dominance. “I worry that this will end up as a cold war of technology,” says Neil Dwane, global strategist for Allianz Global Investors. Dwane’s darkest scenario plays out like this: China and the U.S. create their own technology ecosystems so that a company that makes products for Apple or Google can’t supply Chinese companies, and vice versa, forcing suppliers to choose sides. That would ripple through the markets, especially Asia and U.S. where technology is more well-represented. It would also put a pall over corporate confidence globally, affecting investments and jobs, as companies grapple with a new set of rules.
Write to Reshma Kapadia at firstname.lastname@example.org