On Monday, International Monetary Fund (IMF) released a report that lowered the world GDP forecast for 2018 and 2019. The body said that the economy would grow by 3.7% in 2018 which was lower than the previous 3.9%. The lowering of estimates was attributed to the ongoing trade conflict between the United States and China.
In December last year, the US passed the important tax reform package. This was a major victory to the Trump administration and corporate America. Many employees received bonuses and a wage increase as a result of the package. This led to optimism that the US economy would continue to do well. The country was also doing increased deregulation.
After this, the US president started implementing his agenda on trade. For more than 30 years, the president had complained about the globalization of the world. Most importantly, he complained about how American allies like Germany and Japan and ‘enemies’ like China had taken advantage of the country. He argued that Europe continued to maintain a large surplus with the US while still contributing less to its defense. He also complained that the US debt had grown very much under Obama.
This year, he started to act. First, he announced that the US would put in place tariffs on all imported steel and aluminum. Initially, there were no exemptions. After this, he announced that he would start imposing tariffs on Chinese goods. At the same time, he was talking tough on NAFTA. The negotiations were underway.
Last month, he added tariffs worth more than $200 billion to the initially $67 billion to Chinese imports. China responded by imposing tariffs on US goods such as natural gas, crude oil, and soybeans. On a positive side, a deal was reached between the United States, Canada, and Mexico.
The impasse between China and the United States will continue. Already, China has announced that it won’t engage in negotiations with the US. On the other hand, the US has asked that China provides a list of concessions before Trump and Xi meets at the G20 meeting. China has said that such a list exists but it is questioning the statements by the US.
Yesterday, Andrew Ross Sorkin of the New York Times and CNBC wrote a detailed article on the nuclear option that China has over the US. China is the biggest holder of US debt. It holds debt worth more than $1.7 trillion. It is followed closely by Japan. Ross argued that China could use the nuclear option to force the US to the negotiating table. As you recall, in January, China leaked a statement to Bloomberg that said that it was thinking of halting more purchases. This led to a 1000+ point decline of the Dow Jones Industrial Average.
China is likely to make that decision if the trade war continues. This is because China does not have more options to retaliate against US tariffs because the US imports less goods. However, this move will be disastrous for the two countries. The US borrowing costs will increase while China will have a challenge on who and where to sell the debt. A good way to explain this is that of a borrower and a bank. When a borrower owes $100 to a bank, that is the borrower’s problem. When the borrower owes $1 million to a bank, that is the bank’s problem. This is simply because if the latter defaults, the bank will be more affected. In the case of US and China, the figure is in trillions of dollars.
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