World Economy

Trump's tariffs may anger China and here's how it may retaliate

Key Points
  • The U.S. agriculture industry is particularly vulnerable to Chinese actions.
  • One concern is that China, the largest foreign holder of U.S. Treasurys, may decide to reduce its purchases.
  • Goldman Sachs fears exchange rate depreciation by China and a change in stance on North Korea or other geopolitical issues.
This is what a potential trade war with China means for the markets

China will likely enact its own duties that would hurt U.S. exporters, now that President Donald Trump has announced tariffs on steel and aluminum imports, analysts said.

"I believe that China would stick to trade responses by raising tariffs on select U.S. products that would hurt U.S. exporters, particularly in [the] agriculture sector," Wendy Cutler, vice president at the Asia Society Policy Institute and former acting deputy U.S. trade representative, said in a statement to CNBC.

Trump announced Thursday that the U.S. will set a new tariff of 25 percent on steel and 10 percent on aluminum imports. The tariffs are set to take effect as early as next week and will be applied broadly, without targeting specific countries.

China ranks 11 among the largest sources of U.S. steel imports, according to the International Trade Administration. But Trump has long had his eye on "unfair" trade with the Asian country. Thursday's announcement also comes as China's chief economic advisor, Liu He, is in Washington this week to try to ease trade tensions.

"China will use today's news as another opportunity to paint the U.S. as protectionist and themselves as victims and defenders of win-win globalization," Scott Kennedy, China expert at the Center for Strategic and International Studies, said in an email. "It'll also give them time to more pick carefully calibrated responses."

The Chinese Embassy in DC did not immediately respond to a request for comment on this story.

Trump's tariffs could lead to unintended consequences

On trade, the U.S. agriculture industry is particularly vulnerable to Chinese actions.

The country is the second-largest market for U.S. agricultural exports, according to the U.S. Department of Agriculture Foreign Agricultural Service, as of January 2017. And in retaliation for any U.S. tariffs on China, Beijing will take action against the soybean and corn industries, China's state-backed Global Times said in an editorial after the U.S. presidential election in 2016.

"China this past month initiated an antidumping investigation on sorghum grains from the US. China imported over a billion USD of sorghum in 2016," Adams Lee, an international trade lawyer at Harris Bricken, said in an email. "If Trump imposes steel/ aluminum duties on China, I think China likely will initiate a new antidumping investigation on U.S. soybeans, which had about $12 - 13 billion exported to China."

However, the initial extent of Beijing's reaction may be muted since Thursday's tariff announcement does not appear directed specifically at China.

"If all countries affected more or less equally by Trump's tariffs, then China probably will measure their response in line with other countries' response," Lee said.

In the short term, stock markets were quick to react Thursday. The Dow Jones industrial average closed more than 400 points lower as all three major indexes fell more than 1 percent.

"The market is concerned this is just the beginning of a tit-for-tat exchange between the U.S. and its trading partners," David Lefkowitz, senior Americas equity strategist at UBS Wealth Management's Chief Investment Office, said in a phone interview. "I think it's really not a big deal. ... the biggest thing is it creates some uncertainty."

One concern is that China, the largest foreign holder of U.S. Treasurys, may decide to reduce its purchases. That would add to recent upward pressure on yields, which move inversely to prices. A four-year high in the 10-year Treasury yield helped trigger U.S. stocks' first correction in two years in early February.

"They're definitely going to fire another shot at Trump on the long bond," said Larry McDonald, managing director at ACG analytics, referring to the longer-dated Treasurys.

In January, Bloomberg reported, citing sources, that senior government officials in Beijing are recommending slowing or stopping purchase of the U.S. government bonds. China's State Administration of Foreign Exchange called the report "fake news."

Ultimately, however, some kind of tariff is the most likely Chinese action, according to Goldman Sachs economists Alec Phillips and Andrew Tilton. In a Jan. 26 report, they laid out five ways China could react to U.S. tariffs:

  1. Tariffs or other import restrictions on U.S. goods or services to China, particularly for agriculture goods or transport equipment. This is the most likely course of action, the economists said.
  2. Regulatory or other unfavorable action against U.S. companies operating in China.
  3. Exchange rate depreciation, mitigating the negative effects of tariffs on China's exports.
  4. Sales of U.S. assets, such as U.S. Treasurys.
  5. A change in stance on North Korea or other geopolitical issues.

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