China must turn to Plan B as trade war escalates, and spur the domestic economy

David Brown says the potential damage that America’s trade war can wreak on China is no doubt giving Chinese planners sleepless nights, but now is the time to batten down the hatches and shift their focus to shoring up consumer confidence

PUBLISHED : Monday, 16 July, 2018, 4:02pm
UPDATED : Monday, 16 July, 2018, 10:28pm

With trade disputes, currency spats, monetary uncertainty and a wavering world recovery, a perfect storm is brewing. That’s bad news for a global economy in desperate need of a solid spell of uninterrupted growth.

With dark clouds looming, China stands in harm’s way with its economic growth plans at risk of being blown off course. Beijing must batten down the hatches and prepare for all possible contingencies. China’s economy could be in for a bumpy ride in the second half of the year. 

Up until the moment US President Donald Trump started getting serious about slapping sanctions on nations he felt were wielding an unfair trade advantage over America, the global outlook had been encouraging. A decade on from the 2008 crash, even the habitually cautious International Monetary Fund had been pinning hopes on 2018 global growth hitting 3.9 per cent, with world trade flows growing by 5.1 per cent.

Set against these kinds of numbers, Beijing’s 2018 target for economic growth at around 6.5 per cent seemed a reasonable bet as long as favourable headwinds prevailed. Free-flowing world trade, good geopolitical stability, a sound policy environment and improving economic confidence might have seemed fair assumptions when the forecasts were first made, but recent events have thrown it all in the air. Fears about a global trade war may be giving China’s planners some sleepless nights.

US-China trade war: winner will be whoever can lose the most

It is too early to gauge the impact on the economy just yet, but the trade row will take its toll on future confidence. China’s second-quarter gross domestic product numbers showed annual growth eased very slightly to 6.7 per cent from 6.8 per cent in the first quarter, which is fairly encouraging considering last year’s 6.9 per cent overall growth rate. The worry is what happens next.

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News that China’s trade surplus with the US hit a new monthly record in June, with the gap swelling to a record US$29 billion, will have gone down like a lead balloon in Washington. There will be howls of protest that the deficit with China is not only getting wider, but that the US dollar is getting stronger against the Chinese renminbi, too. US claims about unfair trade advantages and charges levelled against Beijing of currency manipulation could leave China’s economy dangerously exposed.

If Washington raises the stakes in the dispute with tougher trade sanctions and a whispering campaign for a weaker dollar, Chinese output, investment and jobs are at risk. Consumer, business and investor confidence could all end up on the defensive, potentially putting a deep dent in China’s future growth potential. This year’s 6.5 per cent growth target is less at risk, but expectations for next year could end up seriously downgraded. That’s not what the government wants.

Watch: China to hit back after new US tariffs

Chinese equities have already been badly rattled in recent weeks, with up to a fifth of the stock market’s value wiped out. It could be a down payment on what is yet to come. A full-blown trade war could sink China’s markets even deeper into bear territory, hitting financial wealth expectations and consumer confidence very hard in the process. This is bad news as consumer spending contributed up to 4.1 per cent of last year’s 6.9 per cent overall growth.

A slowdown on the consumer side could be compounded by China’s corporate sector if companies respond to weaker export demand by cutting back on output, investment and new hiring intentions. The multiplier effects spreading across the economy would be severe, leaving overall demand at a much weaker level than anticipated and the country’s planners at a loss.

As trade war hits, China’s focus should be on steadying growth

Beijing needs a Plan B to deal with any potential fallout. If relations with Washington deteriorate any further and the trade war escalates, China’s policymakers will need to step up their game, making up for any shortfall in demand. One thing is very clear, monetary conditions must be kept loose for as long as possible to boost domestic reflation hopes.

This means keeping domestic interest rates low, money and credit in full flow and helping maintain a very competitive edge for the renminbi. Washington might not like tacit yuan devaluation, but in a trade war, anything goes.

China must maintain strong growth momentum and the trade war is a golden opportunity to place greater conviction on domestic economic strengths. It’s not a total disaster.

David Brown is chief executive of New View Economics