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Decoding the Tariff War

Was it all about the tariffs?
The US trade deficit with China reached an all-time high of $4 billion in 2018. This created an alarming situation for the US. It had already lost over 35% of its manufacturing units due to stiff competition from Chinese imports in the past decade.[1] To prevent this from further happening, the US responded to this development by replacing its traditional “open economy” approach with a protectionist policy. What followed was a series of tariffs and quotas that gave birth to the infamous ‘US- China Trade War’. However, the fate of this Trade War now hangs in the balance since the appointment of Joe Biden as the US President. While the Biden Administration claims to have “reviewed” and retained the tariffs placed by their predecessors, it is uncertain if that would keep China in check. After all, the trade deficit of the US wasn’t the only trigger behind this Trade War.

The Currency War
In 2019 the US labelled China as a “currency manipulator” and exposed its central bank- The People’s Bank of China (PBOC) for maliciously devaluing the yuan.[2] The PBOC did so to maintain the cheap prices of Chinese exports in global markets despite the increasing tariffs. Interestingly, this wasn’t the first time when the Chinese government used currency manipulation to aid its export-led economy. In 2013, when President Xi Jinping took on the reins of the Chinese economy, it was experiencing its slowest growth rate in decades. The yuan was also steadily appreciating against the US dollar, accounting for a 33% appreciation between 2005-2015.[3] In an attempt to boost its exports, China devalued its yuan by over 4% in 2015.[4] Conventionally, international trades involving two currencies have had a self-correcting mechanism. Under this mechanism, when a country exports more, it receives multiple payments in foreign currencies. That increases the supply of foreign currencies and creates a scarcity of domestic currency in the market. As a result, the value of the domestic currency appreciates against foreign currencies. Consequently, exports become costlier while imports become cheaper. Gradually the exports reduce and the imports increase, reversing the initial scenario.[5] However, in China’s case, the PBOC intervenes and prevents the yuan from appreciating against the dollar despite rising exports to the US. It does so by buying the excess dollar from the exporters and in return, providing them with the required yuan. That keeps the dollar’s foreign exchange rate higher than the yuan and helps the PBOC accumulate large forex reserves of the US dollar. The PBOC uses these reserves to buy US treasury bills and bonds.[6] Over the years, this has enabled China to buy large shares of the US debt. As of January 2021, it owns $1.1 trillion, which is over 15% of the US debt owned by foreign countries.[7] China’s position as one of America’s biggest bankers has rewarded it with significant political leverage. China’s demand for its treasury allows the US government to borrow at low rates. That, in turn, enables the Congress to increase federal spending and spur economic growth in the US. This dependence of the US on China poses a threat to the US. If China calls in its debt, it will slow the economic growth and plummet the demand for USD leading to a fall in its value. Fortunately, the following reasons deter China from doing so:

1. If the dollar depreciates, it will raise the yuan’s relative value to the dollar. That would hurt the competitiveness of China’s exports. It doesn’t make sense for China to bear economic losses only to possibly harm the American economy. So it must expand its export market in other regions and increase its domestic demand before initiating this process.
2. The US dollar is the most convertible and traded currency in the world. Owning large USD forex reserves is desirable for many countries. So, if China decides to dump its US treasuries to sink the dollar, it will have to sell them in one go.[8]
In fact, China has been gradually reducing its share in the US debt, fearing that its excessive reliance on the US dollar might expose Beijing to financial sanctions from Washington. It is also sceptical that a devalued yuan might prove counterproductive for its growth in the long run. Accordingly, China has taken multiple measures in the recent past to internationalize the yuan. For example, it has employed the yuan in cross-border deals and loans under the Belt and Road Initiative (BRI). However, since the yuan is not freely convertible, China has taken the route of digital currency to achieve its goal. While central banks around the world are still exploring the potential of Central Bank Digital Currencies, China has already launched real-world trials of its digital currency program called Digital Currency Electronic Payment (DCEP).[9] Furthermore, China has partnered with SWIFT, Hong Kong Monetary Authority, and various other PBOC related entities to test the DCEP for cross-border payments. Many speculate that companies planning to do business at the 2022 Beijing Winter Olympics will have to use DCEP.[10] Evidently, China is progressing towards dethroning the US dollar and replacing it with DCEP.

The IPR Tussle
Theft of Intellectual Property (IP) by China has also caused tremendous damage to the US. As per the reports of the US Trade Representative, it costs them over $600 billion annually.[11] Subsequently, IPR was one of the most pivotal aspects of the Phase One Agreement signed last year. As per the agreement, China was asked to strengthen its legal framework to protect the IP of foreign companies dealing in China against forced technology transfer, reverse engineering, and other malpractices.[12] So far China has briefly worked on the frameworks for pharmaceutical patents and trade secrets. But it has deliberately left out the portions regarding technology transfer and new rules for IP litigation.[13]

The Imminent Threat
The COVID-19 pandemic has added another dimension to this conflict. China has been aspiring to surpass the American economy for almost a decade, and now it seems plausible. It has emerged as the fastest recovering economy with a growth of 18.3% in Q1 of 2021.[14] The US, on the other hand, managed only 6.4% in the same period.[15] China is slowly cementing its political influence through BRI and credit lines in Asia, South America, Africa and European Union. The signing of the Regional Comprehensive Economic Partnership has further enhanced China’s economic prospects.[16] If China continues to grow at this pace, it will not only boost its exports but also pave the way for its digital currency in international markets.

The Way Ahead
Certainly, the US cannot abandon this Trade War if it wishes to retain its position as a superpower. It must reconcile with its traditional allies by capitalizing on the anti-China sentiments fuming from the controversies surrounding the origins of the coronavirus. Furthermore, it needs to learn from the COVID experience and uproot its supply chain from China. For this, it can take a cue from Japan[17], and incentivize the American companies operating in China to move their manufacturing units to other regions. This would erode China’s manufacturing and exporting capacity, and also encourage other foreign companies to depart. Moreover, it would enable the US to effectively counter China’s influence in regions where these American companies would set up their businesses. In the future, when these regions prosper, they will serve as a market for American exports.
Undoubtedly, this war is now unfolding on a global scale where every action and counter-reaction is bound to create ripples down the international markets.

Kriti Panwar
Writing Mentorship 2021

[1]US Trade Deficit With China and Why It’s So High [2]The U.S. Labeled China a Currency Manipulator. Here’s What It Means (Published 2019) [3]China’s Currency Policy: An Analysis of the Economic Issues [4]Economics The Impact of China Devaluing the Yuan in 2015 [5]Understanding Floating Rate vs. Fixed Rate [6]How China Influences the US Dollar [7]How Much US Debt Does China Own?. [8]US Debt to China: How Much, Reasons, What Could Happen [9]China’s Digital Yuan Status: Tracking its Roll-Out, Impact for Businesses [10]China’s Digital Currency and What This Could Mean For Foreign Companies and Financial Institutions in China [11]2017 Special 301 Report [12]ECONOMIC AND TRADE AGREEMENT BETWEEN THE UNITED STATES OF AMERICA AND THE PEOPLE’S REPUBLIC OF CHINA JANUARY 15, 2020 FACT SHE [13]Anatomy of a flop: Why Trump’s US-China phase one trade deal fell short [14]China’s economy grows 18.3% in post-Covid comeback. [15]Gross Domestic Product | US Bureau of Economic Analysis (BEA) [16]Analysis RCEP trade deal: a geopolitical win for China By Robert Ward25th November 2020 By [17]Japan to Fund Firms to Shift Production Out of China
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