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News Analysis: In ramping up trade war with China, Trump could be playing with fire

Donald Trump
President Trump.
(Evan Vucci / Associated Press)

Shortly before igniting a new round in his trade war with China, President Trump last week accused Beijing of trying to stall talks until after the 2020 election in hopes of negotiating a better deal with a Democrat in the White House.

But Trump has strong incentives to drag out the fight: Behind a relatively strong U.S. economy and at least the chance of more credit stimulus from the Federal Reserve, he may benefit politically from continuing the confrontation with Beijing because it’s red meat for his political base.

The potential loser in this international game of chicken is the U.S. economy. Both long term and short term, the White House is playing with fire — and it could end up burning Trump’s reelection bid.

“Being tough on China in pursuit of an imaginary deal that fixes everyone’s problems is a very safe political space to be in,” said David Loevinger, an analyst for TCW Emerging Markets Group in Los Angeles and a former senior Treasury Department official for China affairs. “Once you move from an imaginary space to a real deal, it makes a lot of constituencies unhappy and you’re taking a bigger political risk.”

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In the short term, continuing conflict is likely to mean more pain for American farmers, who count China as their best customer. Similarly, expansion of tariffs on Chinese goods will eventually mean higher prices for U.S. consumers, especially Trump’s new 10% tariffs on $300 billion of products. Assuming they take effect on Sept. 1, those tariffs will hit shoes, clothes, cellphones and electronics, among other household things.

And it’s almost impossible to calculate what renewed conflict may mean for global financial markets, though Wall Street’s panicky reaction when Beijing allowed a devaluation of its currency suggests future instability. This at a time when the world economy is slowing.

Longer term, the trade war could cut off many U.S. companies, including producers of materials for high-tech industries, from a lucrative market.

The conflict may also increase pressure on Beijing to move away from dependence on exports and increase its efforts to supply its domestic markets itself. For American companies, that would probably curb their opportunities for future growth in perhaps the richest future market for consumer goods in the world.

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On Monday, Trump added a gut punch to his tariffs by making good on his campaign promise to label Beijing a “currency manipulator.”

If that’s just a hardball negotiating tactic, it has the downside for Trump of making it harder to accept less than total victory.

He would risk a big backlash if he were to accept anything less than a comprehensive deal that includes not just hefty purchases of American goods but major structural reforms to China’s state-run economy.

And this week’s swift response from Beijing to Trump’s new tariffs made it clear that President Xi Jinping isn’t going to cave to U.S. demands, which include the Chinese legislature writing changes into its laws.

Beijing promptly announced it would stop new U.S. farm purchases and let its currency drop against the dollar.

“Up until the latest salvo from Trump, the strategy was working out pretty well,” said Sung Won Sohn, a business economist at Loyola Marymount University in Los Angeles. Trump got an economic boost from tax cuts and then the Fed shifted its interest rate policy that eventually led to rate cuts last week, all of which buoyed stocks. “But the latest salvo, 10% tariffs on $300 billion, was a significant policy mistake.”

Beijing moved to stabilize its currency Tuesday and didn’t react to Trump’s order to designate China a currency manipulator, helping to calm investors and recover some of the losses from recent days.

But the threat that the trade war might expand into a currency battle has raised the odds of a U.S. recession at the end of next year.

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The strong economy is the biggest thing Trump has going for him, but Sohn now sees a 30% to 35% chance of downturn next year, double from just a week ago.

Mark Zandi, chief economist at Moody’s Analytics, raised the probability of a recession by the end of 2020 to 55%, from 40% before the latest trade war escalation. Zandi said those odds could go back down if Trump backed away from his plan to slap new tariffs or moved to de-escalate, which he has done before.

But with both sides having hardened recently, that’s less likely now. The Chinese have given indications they’re prepared to tough it out.

“The Fed could aggressively cut rates to offset the negative economic fallout from the trade war,” Zandi said, noting that he now expects two or three more quarter-point cuts by the end of the year. “If the economy avoids recession, it will be because of the Fed’s efforts, but it will be difficult for policymakers to successfully calibrate the rate cuts to offset the impact of the trade war.”

Sohn was less sanguine about the central bank’s firepower. “I don’t think the Fed can bail [Trump] out even if it wants to,” he said.

The Fed’s policymaking committee is somewhat divided on future rate actions. Two out of 10 officials dissented in last week’s rate cut decision, and among those who voted for it, at least one official on Tuesday pushed back against the thinking that the Fed was going to keep cutting because of trade tensions.

“I don’t think it is realistic for the Fed to respond to each threat and counter-threat in a tit-for-tat trade war,” James Bullard, president of the St. Louis Fed, told reporters in Washington on Tuesday. Bullard said that, for his part, the rate cut last week appeared to have dealt with the uncertainties caused by the trade war.

Throughout Trump’s first term, there has been division within his administration about how to approach China. Hard-liners, who have been gaining influence, want to squeeze China to make concessions and would not mind if ongoing tensions pushed investors and businesses away from China in a decoupling of the two economies. But others such as Treasury Secretary Steven T. Mnuchin have sought a softer tack, worried about the damage to U.S. markets and the broader economy.

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Larry Kudlow, Trump’s director of the National Economic Council, insisted that despite slowing global growth, the American economy is humming and could withstand the hit from tariffs.

“If there’s any consumer impact, it’s very small,” he told reporters on the White House driveway Tuesday morning. He said it’s the Chinese who are struggling with the trade war.

“The economic burden is falling vastly more on them,” he said. “Frankly the biggest loser is China right now.”

Even so, Kudlow said, it’s possible the new tariffs won’t take effect if there’s good progress in negotiations. He said he expects Chinese officials to come to Washington next month as previously scheduled.

Analysts say Trump officials may be overestimating the pressures to China’s leadership from its slowing economy. Beijing hasn’t yet gone all out on stimulus or opened the credit floodgates, suggesting the central government believes the current situation is sustainable.

“I think both sides can tolerate the status quo,“ said Derek Scissors, a China expert at the American Enterprise Institute.

“On the Chinese side, they have some reason to make a deal, but why would you give up a lot in a deal to someone who changes his mind a lot and might not be president in a year and half?” he said.

For Trump, there’s also an incentive to stay the course, he said. “There’s a lot of risk trying to come back and say, ‘I got this great deal.’”


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