China: New Avenues for Retaliation against US

Published on September 25, 2018

China’s President Xi Jinping is reported to have been livid at the imposition of US sanctions on China’s Equipment Development Department and its director, Li Shangfu, for purchasing Russian Su-35 fighter jets and the advanced surface-to-air S-400 missile defense system.

On the heels of the imposition of tariffs on $200 billion of exports from China, the action confirmed Beijing’s deepest misgivings about the Trump administration’s ultimate strategic objectives, above and beyond a now essentially unfettered trade war.

*** In immediate response to the sanctions, Beijing summoned US Ambassador to China Terry Branstad to lodge a stern protest, recalled its naval chief Vice-Admiral Shen Jinlong from a one-week visit to Washington, “postponed” a three-day bi-lateral military dialogue scheduled to have begun today, and warned of further measures including the cancellation of Defense Minister Wei Fenghe’s trip to Washington later this year. ***

*** In addition, Premier Li Keqiang and Vice Premier Liu He privately canvassed current and former State Council level officials for suggestions on how to more forcefully respond to the US trade wars. And for the first time, our understanding is that the recommendations under serious consideration by China’s leadership include a suggestion that China dump $100 billion of US Treasuries onto the market, within two months, as a “last resort” shot to put a full stop to the escalating trade wars. ***

** Whether or when China’s leadership adopts the plan to sell $100 billion of Treasuries over two months is not clear, but this is the most explicit, and highest-level discussion we have learned of to date for using the bond market as a retaliatory weapon against the Trump administration’s continued escalation of pressure on China. And we believe it may be that much more imminent given Beijing’s increasingly limited scope for a tit-for-tat tariff response to Trump due to the imbalance of China’s imports and exports with the United States. ***

Furthermore, this suggestion is not, as rumored from time to time, to slow the pace of purchases of US Treasuries. It is rather for a round of outright sales, and that, even if initially limited in scope and size, would constitute a significant, material difference in signaling to both Washington and to markets.

Further Retaliation – Soybeans, Minerals, and Pharma

If, or more likely when, the US raises tariffs on the latest target of $200 billion of Chinese imports from 10% to 25% on January 1, Beijing is planning to hit the politically charged soybean markets especially hard.

Contingency plans include adding another 15% to existing tariffs on imports of soybeans from the US, raising the total level to 40%, and signing agreements with over two dozen alternative suppliers around the globe. Under that scenario, officials estimate China’s soybean imports from the US will plunge to around 5 million tons in 2019 – from 32.9 million tons last year.

If the US were to follow up with the tariffs on the final $267 billion of imports from China, measures under consideration include the outright restriction of exports of selected sensitive raw materials and “core components” to the United States.

The Ministry of Commerce has identified at least 57 raw materials and core components that the US not only imports, but largely depends on from China, including rare earths, antimony, tungsten, cobalt, graphite, tantalum, bismuth, antibiotics, and other key ingredients for 38 essential pharmaceutical drugs.

Further Escalation Inevitable?

Underlying both those contingency plans is the widely held belief at this point within the State Council that the Trump Administration is not interested in a deal anytime this year, and fully intends to raise the tariff levels on China from 10% to 25% as threatened come January 1, with the explicit goal of shifting supply chains out of China, and “destroying Made in China 2025.”

Indeed, easing into this latest round of tariffs on $200 billion of imports at the 5 % and 10% levels, as opposed to 25%, is being seen not as a conciliatory gesture from Trump, but rather as an effort to minimize blowback on the US economy, and to give US companies a three-month window to adapt and transition their supply chains away from China.

Furthermore, China’s leadership expects and is now making contingency plans for when Trump follows through with threatened tariffs on the final $267 billion roughly remaining of imports to essentially cover all goods coming in to the United States from China.

With all that said, however dim the prospects currently may be, Beijing will still maintain the position that negotiations are ultimately the best path towards a solution for both countries.

Low Expectations for 2018

But while maintaining the door for negotiations open, even if by a crack, senior officials in China fully expect and are planning on no deal this year – even after the November US midterm elections, as still apparently assumed by an ever-hopeful market and analyst community.

President Xi, we are told, does not expect to reach a bilateral trade understanding with Trump at the G20 Buenos Aires summit in November, and has no intention of holding a formal meeting on the sidelines of the G20 with Trump – unless, of course, the US were to propose the meeting.

With all the water now under the bridge, Xi, at a State Council meeting on Saturday, September 22, laid out two fundamental principles for China to engage at this point with another round of talks.

First, Xi stated negotiations with the US will be considered only in response to an invitation from the United States. Second, and more importantly, he warned the US would need at this point to pledge not to impose new tariffs on China before any new talks – a pledge that may be hard to extract.

For the record, senior officials in Beijing scoff at reports in the US media that China canceled plans to send Vice Premier Liu He to Washington after the announcement of the imposition of tariffs on the latest $200 billion of exports by President Trump. In fact, they point out, the two sides had not even settled on a venue for talks – Beijing or Washington – and they note that US negotiators had been warned well in advance there would be no meeting if the US were to impose new tariffs on China ahead of the talks (see SGH 9/10/18, “China: More Escalation, not Talks”). In other words, there was no trip to be cancelled.

In the meantime, with very low expectations for a next round of trade talks, certainly before the G20 summit in November, Beijing has turned its focus on two priorities: ensuring steady growth for 2019 and expanding into new export and import markets away from the United States.

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